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Investing in United Kingdom Property

As secure a Property Investment as Possible!

For many years, investment in UK property has been very popular both because of the stability of the UK property market and because of its tax friendly investment regime especially for those non-domiciled in the country. In fact, in other European countries (including France and Spain) tax efficient non-commercial property investment can be very difficult. However, in the UK a foreign investor (or even a UK investor using a private interest foundation) may purchase property through an offshore vehicle and remain outside the UK tax net provided his affairs are properly structured, theoretically allowing the avoidance of taxes including inheritance and capital gains tax. In fact, with the prudent use of EU Directives and UK Tax Treaty provisions it may even be possible to avoid withholding taxes on rental payments made by tenants especially if ‘back-to-back’ financing is arranged. Such a liberal regime coupled with the remittance basis of tax assessment for non-domiciled individuals in the UK makes the UK an attractive home for investment for the foreign domiciliary so much so that it has been estimated recently that as much as 70% of all property in prime areas of London (such as Kensington, Chelsea and Belgravia) are owned via offshore tax efficient structures.

Understanding UK Taxes relating to UK Property Investment

Non-Resident Individuals making a UK Property Investment

Where a non-resident individual owns property a withholding tax of 22% or 40% will be levied on rental income paid to the overseas landlord. The basic rate of 22% will normally satisfy the Inland Revenue and they are unlikely to pursue the landlord for higher rate tax should the income received exceed the lower rate threshold. If however the taxpayer claims deducibility of expenses such as repairs carried out on the property the higher rate of tax of 40% will be levied on the net income.

Tax is levied on the net rental received by the foreign tax payer, if rental income is paid directly to that person then basic rate tax of 22% will be withheld at source regardless of there being any expenses incurred in the management or upkeep of the particular property. This expense would then have to be detailed and reported to the revenue and a claim for a part refund would have to be submitted for tax paid. This may cause cash-flow difficulties and a way around this is for the foreign investor to appoint a management agent in the UK to receive the rent gross and for all allowable expenses and deductions to be made in the UK by the agent and for the net income to be paid to the overseas landlord on which the withholding tax is levied.

Rates and Allowances - Income Tax

Income Tax Allowances

The Chancellor announces the rates of allowances at the Pre-Budget Report which precedes the start of the tax year to which they relate. Generally speaking, Pre-Budget Report takes place in November or December.

Income Tax Allowances table

Income tax allowances

2006-07 (£)

2007-08 (£)

Personal allowance

5,035

5,225

Personal allowance for people aged 65-74 (1)

7,280

7,550

Personal allowance for people aged 75 and over (1)

7,420

7,690

Married couple's allowance (born before 6th April 1935 but aged under 75) (1) (2)

6,065

6,285

Married couple's allowance - aged 75 and over (1) (2)

6,135

6,365

Income limit for age-related allowances

20,100

20,900

Minimum amount of married couple's allowance

2,350

2,440

Blind person's allowance

1,660

1,730

(1) - These allowances reduce where the income is above the income limit by £1 for every £2 of income above the limit. They will never be less than the basic Personal allowance or minimum amount of Married Couple’s allowance.

(2) - Tax relief for the Married Couple's allowance is given at the rate of 10 per cent.


Taxable Bands

The Chancellor announces the taxable bands and the rates of tax at the Budget Report which precedes the start of the tax year to which they relate. Generally speaking, Budget takes place in March.

Taxable bands table

Taxable Bands Allowances

2006-07 (£)

2007-08 (£)

Starting rate 10%

0 - 2,150

0 - 2,230

Basic rate 22%

2,151 - 33,300

2,231 - 34,600

Higher rate 40%

over 33,300

over 34,600

Offshore Companies making a Property Investment

For non-resident corporations the withholding tax on gross rental income is 20% (small companies corporation tax rate) less deductible expenses including management fees, property costs and so on, thus in some cases it may be more beneficial to hold the property through an offshore structure than a direct holding - this is certainly the case in respect of Capital Gains Tax and Inheritance tax. Where a non-resident corporation is used to acquire the property the income generated will be subject to the standard corporation tax rate of 30% if that company is deemed to have created a branch presence or permanent establishment in the UK. As such only the applicability of a double tax treaty with the appropriate non-discrimination clause will ensure that that the lower rate of 20% tax is paid and not the higher rate.

It should be noted that where property is purchased through a company and the investor has use of the property it might be that he is deemed to be a shadow director of the company and has in fact received a benefit and could face a tax charge.

A method of mitigating income tax on rental income, which is used commonly by foreign investors in the UK, is the back-to-back loan. The benefits of the back-to-back loan are derived from the tax treatment of interest and deductibility thereof from rental income. In essence interest payable on a loan taken out for the purchase of a UK property is deductible against the net rental income. However where the loan is from a connected party the interest on the loan must be at a commercially acceptable rate. Furthermore, where interest is paid to a non-resident of the UK it may only be deductible from that tax base if:

  1. It is classified as short interest in respect of a loan where the principal sum is repayable within a 12-month period or if;
  2. The standard withholding tax rate of 20% is deducted.

Provisions introduced back in 1994 mean that one non-resident entity may borrow from another (not necessarily a bank) for the purchase of UK real estate and there is no requirement to withhold tax from the rental income. Previous legislation provided that interest had to be paid to a UK bank or to a UK branch of an overseas bank. In order to ensure that the interest on the loan does not have a UK source and to ensure that the interest is deductible the following steps should be taken:

  1. Loan agreements between the two offshore companies should be signed at
    the same time as the purchase of the property, this loan for management and control
    purposes must be signed outside the UK and preferable retained at the registered office
    address of the offshore company, the banks accounts of both companies should also be
    held outside the UK
  2. The company actually purchasing the property in the UK must have a
    sufficient share capital to satisfy the Inland Revenue's thin capitalisation rule

 

 Corporation Tax on profits - figures

Rates limits and fractions for financial years starting 1 April

2006

2007

Main rate of corporation tax

30%

30%

Small companies’ rate (SCR)*

19%

20%

SCR can be claimed by qualifying companies with profits at an annual rate not exceeding

£300,000

£300,000

Marginal small companies’ relief (MSCR) lower limit

£300,000

£300,000

MSCR upper limit

£1,500,000

£1,500,000

MSCR fraction

11/400

1/40

Special rate for unit trusts and open-ended investment companies

20%

20%

* For companies with ring fence profits the small companies’ rate of tax on those profits remains at 19% and the MSCR fraction 11/400 for financial year 2007 starting 1 April 2007. Ring fence profits mean the income and gains from oil extraction activities or oil rights in the UK and UK Continental Shelf.

The main rate of corporation tax applies when profits (including ring fence profits) are at a rate exceeding £1,500,000, or where there is no claim to another rate, or where another rate does not apply.

Capital Gains Tax Issues

Individuals

A non-resident of the UK is not subject to Capital Gains Tax in respect of gains made from the sale of investment property with a UK situs provided a permanent establishment has not been created in the UK. If however the gains are deemed to be from trading assets the gain will be treated and taxed as income and as such it is vital that the investor does not cross the line from being an investor to being a dealer or trader in the UK. Provided the purchase of the property is deemed to be an investment gains may be realised tax-free and the following points will indicate that the acquisition is an investment:


- the property should be held for as long as possible
- income is derived from rental of the property
- only a small amount of development should be carried out
- if the property is to be sold then it should be sold as a whole rather than sub¬
divided

Another possibility for the investor, if the activities in the UK are not completely passive, is for a UK company to be formed to perform and/or organise the development and selling activities. This company should of course charge commercially acceptable fees for the work it undertakes.

Inheritance Tax Issues

Inheritance tax is levied on individuals’ worldwide assets if the individual is both domiciled and resident in the UK. Where however, the individual is not domiciled in the UK, his UK inheritance tax liability is restricted to only assets with a UK situs. Thus, as far as the non-domiciled individual is concerned it is very much more advantageous for the purchase of UK real estate to be effected through an offshore company or trust. In this case the asset does not belong to the foreign investor personally but to the offshore company which has its own legal personality and on his death it is the shares in the company that are transferred as opposed to the UK property.

Stamp Duty Land Tax (SDLT) Issues

Non-Domiciled Individuals Using an Offshore Company can often Legally Avoid SDLT!

The cost of transferring property in the UK is much less than on the continent. The Stamp Duty on the transfer of real estate is between 0% and 4% of the value of the property transferred. Only once the Stamp Duty has been paid (this must be done within 30 days of the sale) can legal title to the property be registered. The rates and exemptions are as follows:

Residential property - purchase price

Rate of Stamp Duty Land Tax

up to £125,000

0%

£125,001 - £250,000

1%

£250,001 - £500,000

3%

£500,001 or more

4%

It should be noted that where the property is owned by an offshore company and the shares in the offshore company are sold or the beneficial ownership of the company is transferred no stamp duty will be payable. In certain circumstances, it may even be possible for a UK domiciled and resident person to avoid SDLT if he uses a private interest foundation – Please enquire for details with a SCF Tax Planning Consultant.

LOCAL PROPERTY TAXES

Of much debate over the last decade in the UK has been the introduction by the last Conservative Government of Poll Tax which has now evolved in to Council Tax which is levied by the council where the property is located and is calculated by reference to the individuals living in the property. The tax paid is not deductible for other purposes unless the property is used as business premises.

VALUE ADDED TAX

A landlord may now register for VAT and charge VAT to the tenants in order to VAT input tax. It is interesting to note that non-resident companies may register for VAT in the UK without creating a UK taxable presence.

MISCELLANEOUS

Solicitors Fees: Although it is not a requirement to appoint a solicitor to perform the conveyancing of the property it is recommended that a solicitor be engaged in order that good title to the property may be ascertained and subsequently registered. Solicitors will usually charge a flat fee in the region of £1,000.00 to £2,000.00 and this should include all the fees for the searches which will need to be carried out in relation to the property in order to ascertain that the property is not subject to any restrictive charges or onerous covenants which would otherwise act as a deterrent to the purchaser.

Estate Agent Fees: When a property is put on the market for sale an estate agent may be appointed in order to co-ordinate the sale of the property and organise viewing of the property for potential purchasers. It is standard practice for estate agents to charge about 1-2% of the sale price

TAX SAVING STRUCTURES - EXAMPLES

  1. Back-to-Back Loans: The classic back-to-back loan involved the loan of the money from a bank to the offshore company, since the Finance Act of 1994 companies can also loan the funds; In this case two Delaware non-resident companies are used for the purchase of the real estate. DL 1 loans DL 2, say £1,000,000 for the purchase of the real estate with an interest rate of 10% per annum on the capital sum. DL 1 makes the purchase for £1,000,000 and then rents the property to Mr Jones for £1,000 per week equalling £52,000 per annum. The rental income may then be offset against the interest payable to DL 2 and as such no withholding tax is payable. It is quite possible to substitute DL 1 for a bank; the principal remains exactly the same.

  2. Using the Cypriot Tax Treaty to Invest in UK Commercial Property: Under the terms of the UK/Cyprus Double Tax Treaty of 1974 a Cyprus company engaged in UK property trade is taxed at a very low rate and will only be liable to tax in the UK if the company carries on a trade in the UK through a permanent establishment. Under the treaty (Art. 5) states that a permanent establishment shall include a building site or construction installation which exists for more than 6 months. Thus if a Cypriot company is looking to develop a property for sale it may undertake the renovation itself provided the work is completed within 6 months. Any subsequent gains from the sale of the property will be exempt from UK taxation and subject only to Cypriot tax at the rate of 10%.

   

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