The Tax Reasons Why International Private Clients Are Renting

by Andy Wood, Founder and Technical Director, Enterprise Tax Consultants


Introduction

I note with interest the article in the Times Bricks and Mortar section entitled 'The Rental Revolution: Why even the wealthy are renting'. This was largely a non-tax article.

This piece made me recall a conversation I had with a London Property lawyer. He had spent many years advising overseas clients on how to structure property purchases in the UK and mainly London.

At the end of our conversation we came to the conclusion - why on earth would a wealthy person buy a high-end property in London?

Simpler times

Not too long ago, and we are talking less than a decade, advising an international client as to how to hold property was a relatively simple affair. When I say 'international client' I mean either (i) they are non-resident; or (ii) a UK resident but non-domiciled individual.

Quite simply, aside from certain anti-avoidance rules, a non-UK resident person would be outside the scope of UK CGT. As such, he or she might only be concerned about sheltering the value of the property from Inheritance Tax ("IHT") as such a person would have an exposure on UK assets. The 'enveloping' of such a property (sticking it in to a non-UK company) would generally do the trick.

For a UK resident non-dom things were slightly harder (though not by much). Again, it was usually the case that a property would be held within the Company. However, as the UK resident non-dom had a CGT exposure the shares had to be held by a non-UK trust. If the UK property was held in this structure then it was protected from both capital gains and IHT.

In recent years, new stamp duty rules have become the Japanese Knotweed of the tax system. However, in days gone by, one only needed to know the rates of stamp duty for residential properties and those for non-residential properties. Of course, although stamp duty was due on the original purchase or transfer to the company, future purchasers of the property, if they bought the shares, could do away with stamp althogether (albeit there may have been other downsides of doing so).

For the international private client, they were good times.

Residential property taxes - the goose that doesn't stop laying?

But then George Osborne stumbled upon bricks and mortar as a method for raising tax revenue. Since then, the Government has barely paused for breath.

Originally, these changes were directly targeted at the international private client. However, now almost all new purchasers of property will find themselves much worse off than once was the case.

Initially there were two measures introduced which attacked the enveloping of dwellings. Firstly, a super SDLT rate of 15% where a high value property was acquired by a company essentially for the beneficial owner to live in. Originally, high value was £2m, but that was quickly reduced to £500k. This essentially prevented the formation of new vehicles.

Alongside this, the Annual Tax on Enveloped Dwellings ("ATED") was introduced. This provided for an annual levy on the structure by reference to its value. At present rates, this starts at £3,600 per annum for a property worth between £500k and £1m up to a whopping £226,960 if your property is worth £20m. ATED was very much intended to make existing envelopers pay for any IHT advantage they were gaining from the structure.

Note, as with the SDLT super-rate, ATED does not apply where the property is held for a commercial purpose.

We also then had the Government's first foray in to levying CGT on non-residents with the imposition of ATED-related capital gains. This brings in to charge any capital gains which arise whilst the company is within the ATED regime. The rate being 28%. As noted above, before this, the enduring principle of UK CGT was that generally there is no exposure to UK CGT unless resident in the UK (subject to anti avoidance provisions).

Then, with effect from April 2015, the CGT door was fully kicked open with the introduction of non-resident CGT (NRCGT). The new rules meant that a non-resident individual selling a direct interest in a UK residential property was within the scope of UK CGT. Only any part of a gain that arose after this date was chargeable, meaning there was effectively a rebasing of the property to 6 April 2015.

Generally speaking, SDLT rates have increased substantially over this period (SDLT receipts have more than doubled in well under a decade). As an added bonus, we also have the 3% surcharge where an 'additional property' is being acquired. For the purposes of determining whether this surcharge applies then homes overseas are counted.

The cherry on the cake was the revision of the definition of 'excluded property' for IHT purposes which was grafted on to the wider reforms for non doms. What does this mean? Well quite simply, where the underlying asset was UK residential property, the use of a non-UK company (often topped with a non-UK trust) is now ineffective. These assets would fall within the estate of our client. The introduction of this change means that ATED is no longer necessary. However, it has not been repealed and now a person is in a worse position if the property is held through a company than if it is held directly. This is some turnaround.

However, the changes show no sign of coming to an end. Even this last weekend, we have seen the Prime Minister propose yet another stamp duty surcharge for overseas purchasers of UK property. Not only does this seem a step too far but the reasoning does not make a great deal of sense. It seems to be directly advertised as a solution for the homelessness crisis. However, and I do not profess to be an expert on the topic, I cannot see how non-residents buying property in the UK (which has, in my experience, historically been higher end residential and more recently student accommodation) is preventing anyone from obtaining a home. Perhaps the historical selling off of social housing and a continued failure to replace this stock is to blame?

£5m property purchase - feeling the pinch?

Let us say we have a non-resident client, May. She comes to London for a couple of months per year in the Summer.

She is aware of all the changes listed above and, although she has been told that 'other structures are still available', she feels happiest holding the property in her own name.

Initially, as she has other properties available around the world, she will pay £663,750. This is a staggering amount of tax (albeit not enough it seems for Mrs May). Even if she was to live in the property full time this still gives her £5.5k per month to play with in rent for 10 years!

Assuming she is a cash buyer, she has no finance costs going forward. However, if she dies in possession of her £5m property then, after benefit of a nil rate band of £325k (which may be double if she marries or enters in to a civil partnership) then she will suffer IHT of £1.87m (40% x £4.675m).

So, let us say she died after owning the property after 20 years. She will have paid £663,750 in stamp taxes and £1.87m in IHT which is a total of £2.53m in taxes. This is an annualised tax cost of £126,687.

Perhaps the intention is to sell the property in anticipation of her death (knowledge that is somewhat difficult in real life). If she does, her pattern of visits to the UK mean it is probably unlikely she would then have any prospect of obtaining main residence relief on the property. She will pay tax at 28% on any gain as residential property was left out of the reduction in the headline rate CGT when it fell to 20%.

Of course, she may have obtained some capital growth if she had purchased the property - although this seems a bleak prospect at the moment. Indeed, there are other non-tax benefits of owning your own home as opposed to renting.

However, my view is that, from a tax perspective, the numbers just do not stack up.

April 2019 changes?

Could it get worse. Well, yes it could with the Government that, when it comes to property, never stops taking.

It is expected from April next year that the NRCGT rules will be extended to cover direct interests in non-residential property as well.

Further, the rules will also be extended to included indirect interests in any kind of property rich company. Broadly, this is a company where at least 75% of its value comes from interests in UK land.

How wise is this policy?

Well, it has only taken until the final furlong of this article to mention Brexit. However, after steps to squeeze as much tax as possible out of HNW internationally mobile individuals one might think, faced with Brexit, that a moratorium on further significant changes was a suitable response.

Alas, this is not the case. Without missing a step, we still appear to be blundering on with the changes that will take effect from April making commercial property investment less attractive to overseas investors.

Conclusion

It seems that the Treasury's attention remains transfixed on property taxation. It is, however, a fine line that relies on the wider attractions of London (and the wider UK) compensating for the shifting economics for internationally mobile wealth.

It is a tightrope. Let's hope we don't fall off.

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