“Treasury sticks to hard line on top-end homes” – source: Financial Times 12th December 2012

The Treasury has finally issued an element of their long awaited draft legislation in respect of the proposed changes to the manner in which “high value residential property” (those properties with a market value in excess of £2m) will now be taxed where the property in question is held within an offshore structure.

Whilst an important concession has been given to certain rented properties from both the Annual Residential Property Charge (“Annual Charge”) and a future capital gains tax (”CGT”) charge, the bulk of the original proposals remain unchanged and those affected by the changes should now be considering the suitability of their structures.

However, the draft legislation detailing the proposed CGT changes have yet to be issued, and are not expected until January 2013.

Annual Charge

The annual charge will apply where UK residential property is held by companies, collective investment schemes and partnerships with company members, valued in excess of £2m on specified valuation dates.

The definition extends to include both foreign & UK companies and partnerships involving either, but ownership by an offshore trust is not to be included.

The Treasury has watered down their original proposals and relief will now be given where the property is “leased out in a property rental business or held for sale in a property development or rental business”. This is defined to include only those properties rented out to “qualifying persons” – broadly, individuals unconnected with the underlying
settlor/owner of a structure.

The Government has therefore made it very clear that they are targeting high value homes that are held for the benefit of the true, underlying owner (or individuals connected with the owner – broadly, other family members).

Genuine, high end residential property, commercially let to unconnected individuals will not now be caught by these provisions, as was the case with the original consultation proposals.

The original proposed charges remain unchanged and will be chargeable as follows:

Property value £2m to £5m £5m to £10m £10m to £20m Above £20m
Annual charge £15,000 £35,000 £70,000 £140,000

The first valuation date will be 1 April 2012 (or later, if the property was acquired after that date) and every 5 years thereafter.

The previous proposal for a property development business to have been carried on for two years appears to have been dropped.

Extension of capital gains tax charge (“CGT”)

The Government is also pressing ahead with the introduction of a CGT charge with effect from 6 April 2013 and the current regime will be extended to include any capital gains on the disposal of such properties where the owner is a non-resident, “non-natural” person (“NNP”).

The original proposal to include offshore trusts has now been dropped, leaving only a company (and a partnership consisting of at least one corporate partner) and a collective investment scheme within the definition of NNP.

It is worth noting that if an exemption to the annual charge applies there will also be a corresponding exemption from the CGT charge as well – ensuring symmetry between the two charges. This will be particularly beneficial to those structures holding residential property that is let to unconnected third parties.

It has also been confirmed that there will be no “special rate” as such and CGT will be applied at the rate of 28%, although it is now proposed that there will be some form of tapering relief for properties falling “just” over the £2m threshold. Further details are likely to be issued in January 2013 along with the draft legislation.

Interestingly, the Government has also taken on board the points raised about properties held long term within offshore structures, where there may be significant accrued capital gains. In that respect the new provisions will only apply to capital gains in relation to the value as at April 2013. This therefore means that all properties will be automatically rebased up to their 2013 values. Again, details are unlikely to be available until January 2013.

Whilst this is good news for properties that have been held for many years, it does of course mean that any future gains will now come into charge.

The Government has also dropped the idea of taxing capital gains arising on the disposals of shares in an offshore company that in turn holds high value residential property.

One final possible “sting in the tail” – whilst the CGT charge will apply to both UK and non-resident companies, it should be noted that the proposed rate of 28% (for a non-resident company) is significantly higher than the current corporation tax rate applicable to a UK limited company (23% from 1 April 2013 and 21% from 1 April 2014). The Government has confirmed that it will therefore consider whether to extend this increased rate of 28% to UK companies.

Summary

Whilst the above changes are on the whole, very welcome, the draft legislation still appears to be a strange lopsided attempt to legislate against their original concern – which before we forget, was to stop the mitigation of stamp duty land tax on purchase of high value property.

Strangely this concern has still not been addressed as it would still appear possible for a new purchaser to acquire the shares in an offshore company with no liability to stamp duty and then liquidate that company in order to extract the property out. Providing this exercise is done carefully, it will generally be possible to extract the property without incurring a liability to stamp duty land tax (subject to the anti-avoidance provisions of s.75A). This may get tricky where bank debt is involved, but nevertheless, with some assistance from the bank this should still not be an issue.

Whilst there could potentially be a CGT liability on post April 2013 gains, this of course would not impact on the purchaser as such as any potential liability would be reduced from the price of the shares.

That said, the scattergun approach of the original proposals will to a major extent, come into play in a little over 100 days and will have significant ramifications where UK family owned and occupied property is held through an offshore structure.

What can be done with existing structures?

All structures must be reviewed ahead of these changes. This will have to be undertaken on a “case by case” basis as structures are likely to be bespoke to the individual in question. A review will need to be undertaken to see if it is possible to restructure ahead of the changes without incurring any unnecessarily high tax costs – such as stamp duty land tax, CGT etc. In some cases it may be possible to do so in others it may not be possible.

3 options are likely to exist:

1. Do nothing (perhaps because the tax costs of restructuring will be too high),
2. Collapse the existing structure completely and hold the property personally (giving rise to a potential future Inheritance Tax (“IHT”) charge, or
3. Modify the existing structure – perhaps avoiding the annual charge but potentially leaving an exposure to a future CGT charge and IHT charge.

One thing is for certain – each exercise will be bespoke and there will be no “one fits all solution”. It may not be possible to solve all future tax issues and the optimum structure may well be a balance between income tax, a future CGT charge (if the property is likely to be sold) or an IHT exposure (if it is intended to retain the property as a long term investment).

Structures involving trust and corporate ownership

A complete collapse of such a structure could be the best solution, with the IHT exposure being dealt with separately – for example, it may be possible to secure a debt on the property or insure through life assurance.
If IHT is particularly important, and cannot be dealt with by alternative planning techniques, then it may best to simply retain the existing structure and pay the Annual Charge.

It is worth noting that where ownership is held directly through an offshore trust then the Annual Charge will not be in point and an automatic rebasing of the property will also be given. This will potentially leave an exposure to IHT at 6% on each decennial anniversary of the trust however it may be possible to mitigate this liability through bank debt.

New future acquisitions

The optimum structure for new residential property acquisitions will very much depend upon whether the property is being acquired for personal use or investment potential.

Consideration should be given to personal ownership as this will avoid the Annual Charge, a future CGT charge on disposal and the 15% stamp duty land tax charge.

Confidentiality could be protected through the use of a bare trust arrangement or a corporate nominee however care will need to be exercised in the way these arrangements are documented to ensure they stand up to HMRC scrutiny.

It may be possible to protect against IHT in a number of ways such as securing a mortgage (if borrowings are intended), the creation of a debt against the property through the use of a carefully structured trust arrangement (if no third party borrowings are intended), life assurance or split family ownership of the property.

Where the property is intended to be acquired for its investment potential (i.e. will be let out) then an offshore partnership may be an attractive alternative structure in order to secure IHT protection.

Clearly all existing structures will need to be reviewed in light of the above and, where appropriate action may well need to be taken. There is unlikely to be a “one fits all” solution and bespoke planning will need to be undertaken on a case by case basis.

Interesting stats have recently been published showing that 2,400 people have come forward under the Liechtenstein Disclosure Facility, with £363m of tax having being paid.

HMRC are now predicting that the LDF will generate upwards of £3bn in tax by 2016, well in excess of their original prediction of £1bn.

As a recap the LDF is an opportunity for those with unclosed tax liabilities, not only in connection with an offshore bank account also other offshore structures anywhere in the world, to come forward prior to 31 March 2016 and settle on favourable terms – this includes an immunity from prosecution, an ability to discuss the situation with HMRC on a “no names” basis plus a settlement on outstanding liabilities from April 1999 rather than the usual 20 year settlement.

Interestingly, the LDF has also received criticism from some commentators in that the likely settlement penalty offered to “tax avoiders” is 10%, which is similar to that where a genuine mistake has been made on a tax return rather than up to 100% where a more traditional tax investigation was initiated the enquiry.

The Government’s aim is to ensure that everyone pays their fair share of tax on residential property. While most people do pay their property taxes (and without them the Government could not begin to afford the public services on which the country depends) there are some who avoid paying their share. The Government is determined to address this.

 Para 1.2 HM Treasury Consultation Document issued 29^th May 2012

Following on from this year’s Budget, the Government has recently issued its draft consultation document[1] setting out in further detail their proposals to tax UK residential property that is held through certain structured arrangements (i.e. not held personally by the individual in question).

At the moment, the document merely sets out the proposed changes which are open to discussion through to 23 August 2012 when the consultation period closes. We would then anticipate that draft legislation will be issued in the autumn statement with a view to forming part of the 2013 Finance Bill, hence going “live” in April 2013.

However, with the Government taking its usual blinkered view that anything other than personal ownership must be tax driven, we would not expect there to be (m)any material changes to these proposals – this is despite their recent U turns on the restriction of income tax relief on charitable giving and the proposed introduction of the now infamous “pasty” tax and caravan taxes.

With that in mind, anyone owning residential property with a market value in excess of £2m through a “structure” must review the suitability of that arrangement in the light of these proposals and if necessary take remedial action to reduce any adverse UK tax exposure that may result from April 2013.

Annual charges

With effect from 1 April 2013 Residential property held by a “non-natural” person will be subject to what is nothing more than an annual wealth tax – this will include property held through a corporate (UK or offshore), a partnership that includes a corporate and certain other vehicles including collective investment schemes. Interestingly, trustee ownership does not appear to be caught.

Property values will be self-assessed and taken as at April 2012 (or later if the property is acquired after that date) and revalued every 5 years. There does not appear to be a reduction in value where a mortgage is secured on the property.

The following bandings are being proposed:

Capital Gains Tax on future property disposals

Capital Gains Tax (“CGT”) is also to be extended with effect from 6 April 2013 so that any non-natural (as defined above) non-resident will become liable to tax on any capital gains realised on the sale of UK residential property.

This is a significant change from the rules that we currently have, where non-residents generally have no liability to UK CGT.

One important point to note is that offshore trustees will be classed as “non-natural” persons for the purpose of this charge (but not the annual charge above), although it should be possible for the trustees to claim the benefit of Principal Private Residence Relief (“PPR”) where a beneficiary occupies the property under the terms of the trust.

Where property is held by a company (irrespective of whether that company is owned by a trust or not) CGT will always be payable and therefore some element of restructure is likely to be needed here.

The above proposal has been further tightened by the inclusion of a CGT charge where a shareholding in a company is disposed of and more than 50% of the assets of that company are represented by UK residential property.

It is important to note here that any capital gain is based on the original base cost of the property within the structure. Where an existing property has been acquired through the purchase of an offshore company, further due diligence may well be required as any capital gain will not be based on what was paid for the company, but instead will be based on the price that the company originally paid. This could well lead to significant potential capital gains.

At the moment there does not appear to be any rebasing of property values to April 2012 and therefore there could be some significant potential CGT charges in store if and when a property is sold after April 2013.

For example, a property acquired through a BVI company (owned by a non-resident individual) in April 2005 for say £2m is now worth £5m. If the property (or the shares in the company) were sold in March 2013 there would not be a CGT liability based on these proposals. However if the sale were delayed to say May 2013 there would be CGT of £840,000 to pay.

Therefore care needs to be taken to effectively re-base the property so that any appreciation before April 2012 will be tax free. This may be quite tricky in practice, with there unlikely to be a “one fits all” solution – care will therefore need to be exercised to ensure that any restructure does indeed trigger a capital gain but at the same time also side-steps a stamp duty land tax charge.

What should I do?

The above proposals will have a significant impact on virtually all individuals that own UK residential property in excess of £2m through an offshore structure.

In that respect anyone with such a structure will need to be mindful of the potential impact and take advice accordingly.

There are still certain advantages that may be worth securing such as UK Inheritance tax being the primary one.

That said, it may well be possible to restructure existing structures to secure a CGT free uplift, without any corresponding SDLT charges and at the same time also secure a beneficial IHT treatment going forward.

We would not recommend any immediate changes to an existing structure.

Draft legislation will follow once the consultation window has closed and in that respect we would anticipate it being issued around the time of the autumn statement (expected to be 22 November 2012) – only then will we know with relative certainty what legislative changes will be introduced.

There will then be approximately 4 months to implement any changes, which in the vast majority of cases should be sufficient time. In the meantime, initial reviews ought to be undertaken and potential restructuring opportunities highlighted accordingly.

Despite having introduced a new 5% rate of SDLT just twelve months ago on properties costing £1,000,000 or more,this has now been increased to a 7% rate, as of 22 March 2012, on properties exceeding £2,000,000. This new rate will apply to property sales where contracts are exchanged after 22nd March 2012.

Consequently, this increase will impose significant additional costs on those purchasing a residential property in the UK, especially those in Central London where property prices can often well exceed the £2,000,000 threshold.

Up until recently, tax planning schemes have been in place to avoid these extensive costs however anti-avoidance legislation has been amended with immediate effect with the intention of controlling this.

Alongside the 7% rate of SDLT, a massive 15% rate will be imposed where a residential property is purchased not by an individual but by a “non-natural person” (typically this will be a company or trust, usually offshore).

This extended rate is likely to act as a deterrent, preventing the historic purchase of properties through the medium of an offshore company, where traditionally there has been no duty on the purchase of the shares.

This still poses the question of how will a company or trust be strictly defined in this case?

Will there still be ways of reducing the SDLT/stamp duty charge?

According to a recent press release, the definition stands at “companies, collective investment schemes (including unit trusts), and partnerships in which a company is a partner”, this leaves potential exclusions for property developers and corporate trustees only in certain circumstances.

Whereas the new 15% rate will prevent future transactions of property from within a company, it does not currently affect such property already tied up in these arrangements. To counteract this, the government proposes to include two further amendments to the 2013 Financial bill.

The first intention is to introduce a CGT charge on residential property owned by non-resident companies or trusts however it is unclear whether any charge would arise on the transfer of shares in a non-resident company.

Secondly, the introduction of an annual “wealth tax” (possibly a kin to the Lib Dems “mansion tax”) on UK residential properties exceeding £2,000,000 which are owned by certain non-resident companies.

As ever the devil will be in the detail. Now the draft finance bill has been published, no doubt tax planners will be burning the midnight oil!!

Those with a keen eye for detail may have noticed that the recent 300 page draft Finance Bill issued earlier this week, did not include anything in respect of the proposed new residency test.

The Government has confirmed that it will now be delayed until 2013 at the earliest.

Despite issuing their consultation document in as far back as June and having a comfortable 12 week consultation period, it apparently seems that there is still not enough time to bring the proposals in for the start of the 2012/13 tax year – uncertainty will therefore simply continue for another 12 months.

The reason?

Nobody really seems to know, with the Government being quoted as confirming “the consultation on tax residence raised a number of detailed issues which will require careful consideration to ensure the legislation achieves its important aim of providing certainty for individuals and businesses,” he said. “The government will therefore legislate the statutory residence test in Finance Bill 2013 to take effect from April 2013 rather than April 2012. It will introduce any reforms to ordinary residence at the same time. This will give time to consult thoroughly on the detail of these changes well in advance of implementation.”

We can only assume that they were deluged with comment at the consultation stage and the initial proposals could well be rehashed quite significantly.

Is this another own-goal by HMRC?

That may be a little unfair, but with clarity needed in the current economic times, only time will tell whether a 12 month delay was worth the possible ”fine tuning”!