The scope of the UK legislation relating to UK residential real estate owned by non-UK entities has changed drastically since April 2013. Despite this being almost eleven years ago, we still frequently encounter such structures.
A common arrangement is where a non-UK domiciled person (frequently, based in the Gulf) owns shares in a non-UK company which, in turn, holds UK real estate. This arrangement used to be very tax efficient from a UK tax perspective but, in most cases, it does not remain so.
The annual tax on enveloped dwellings (ATED) is ever increasing in line with inflation. From 1 April 2024, a residential property with a value of over £5 million will see you pay an annual charge of £71,500, increasing to £143,500 for a property worth over £10 million, and £287,500 for a property worth over £20 million. Understandably, to avoid these charges many clients are now looking to own such property directly.
Rather than talk about the introduction of the ATED, UK inheritance tax (IHT) transparency, or capital gains tax (CGT or UK corporation tax) within this article, all of which been widely covered, I wish to discuss the trap that catches many clients looking to ‘de-envelope’ UK residential property from a non-UK company when there is shareholder debt in place.
Working Example
When the original purchase of a UK property owned by a company took place, it was frequently the case that the shareholder (often, our client) lent funds to the company to enable it to complete the purchase. This ‘shareholder loan’ could be provided in isolation, or sometimes alongside a mortgage. A working example is as follows:
a. A non-UK company owns a single asset, being a UK residential property with a value of £2 million on 5 April 2019, and £2.5 million as of today's date.
b. The property was (and remains) subject to a mortgage in the region of £500,000.
c. In addition, there was an outstanding loan of £1.5 million, on 5 April 2019, owed by the company to the shareholder, granted to assist with the purchase of the property and also with ongoing property-related expenses. On the face of it the shares would therefore have no value, as the mortgage and the shareholder loan would be equal to the value of the property.
d. The sole shareholder (our client) now wishes to de-envelope the property so that he owns it directly, to avoid ongoing ATED charges and corporate administration fees, particularly as the structure no longer offers him any IHT protection.
On such a de-enveloping, there will be two disposals from which UK capital taxes may arise:
- The company will be within the charge to UK corporation tax on any chargeable gains it realises on a direct disposal of the property, considering the value of the property on 5 April 2015 versus the present day.
- The shareholder will be within the charge to CGT on a disposal of his shares in the company because the company is ‘property-rich’ and the shareholder has a substantial indirect interest. This is due to UK legislation introduced with effect from 5 April 2019.
The complications we have seen arise from the second disposal. This is where the trap appears for the unwary.
When such a company is wound up, the assets in the company are distributed to the shareholder(s) of the company. If the only asset in the company is the UK property, and the sole shareholder receives this, for CGT purposes the shareholder is deemed to have 'disposed' of their shares in the company for a value equal to the market value of the property they receive. So, if the shareholder in the working example above owns 100 per cent of the shares and receives 100 per cent of the property following the liquidation of the company, the shareholder will have disposed of their shares in the company for £2 million (ie the property net of the mortgage).
Calculating CGT
To calculate the shareholder's taxable gain, it is necessary to first establish the shareholder's base cost in the shares. Usually this is the amount that the shares were acquired for, but for shares that were owned before 5 April 2019, the shareholder will be deemed to have acquired the shares for their market value on 5 April 2019 (although it is possible to elect to use the historic acquisition costs, which the shareholder should do if that would produce a higher acquisition cost). The value of the shares is not determined only by the value of the property; it would be affected (and reduced) by any other liabilities in the company, such as the amount of shareholder debt or third-party debt at the valuation date.
CGT will therefore be due if the value of the property, which the shareholder is treated as receiving in return for their shares, is greater than the base cost in the shares – ie the market value of those shares in the company as of 6 April 2019 (or their historic base cost, if such an election is made).
Looking at the working example, the value of the shares in 2019 would have been nil (the sole asset of the company being the UK property worth £2 million, less the £500,000 mortgage debt and £1.5 million shareholder loan), and therefore the shareholder would be making a gain equal to the value they receive on their deemed disposal (ie £2 million, at a rate of 20 per cent taxation).
This is clearly unpalatable, even more so given that it will be a dry tax charge, and so the shareholder will likely wish to consider:
- Capitalising the shareholder loan by the shareholder subscribing for new shares, which would increase the base cost of the shares, resulting in a lower gain for CGT purposes.
- Having the transfer of the property made in consideration of the satisfaction of the debt (and the mortgage).
However, both options have UK stamp duty land tax (SDLT) implications that will need to be reviewed by a specialist in this area. It is likely that input will also be required from lawyers in the jurisdiction where the company is tax resident, to ascertain which options are actually viable in practice upon liquidation of the company.
A Brief Word On SDLT
Where a property is transferred in return for the waiver, release or satisfaction of a debt, the starting point is that the amounts so satisfied, released, or waived, will be treated as chargeable consideration for SDLT purposes, capped at the market value of the property. Similarly, if a property is transferred subject to a mortgage or charge, the amount of the mortgage for which the transferor accepts liability will be treated as consideration for the transfer of the property (ie as if they paid that amount in cash). This is not insignificant, given that the standard residential SDLT rates are now increased by five per cent for non-UK tax resident persons owning another property anywhere else in the world. The SDLT risk also exists in the case of capitalisation as discussed below.
Proceed With Care
It may be sensible for a company in this position to take steps to ‘tidy up’ the structure to remove any debt before any decision is made to terminate the structure in the future.
Particular care must be taken given the broad extent of the SDLT anti-avoidance legislation contained in Section 75A of the Finance Act 2003, which applies when there is a scheme or arrangement that reduces a charge to SDLT, regardless of whether there was any intention to save tax.
It is also worth noting that, even if CGT were not an issue, HMRC's SDLT guidance, which applies to capital distributions to a shareholder following liquidation of a company, is fairly vague and parts have not been reviewed for many years. HMRC's SDLT Manual does state that where a company that only has a debt to its shareholder is liquidated and the company's property is transferred to the shareholder, the transfer is not in settlement of the loan (as the loan is terminated by the liquidation). Whilst this is helpful, the analysis itself is questionable. I query how much we can continue to rely on it while assuming that there are no SDLT consequences of liquidating with shareholder debt in place. In relation to the application of Section 75A, HMRC do say that the anti-avoidance rules can apply to impose an SDLT charge if a shareholder introduces funds into a company (such as a share subscription) in order to allow a third-party mortgage to be paid off and enable the property to be distributed to the shareholder.
A final point of interest is that the UK has released a new, interactive map which shows, in street view format, all non-UK entities owning UK real estate. Along with other developments, such as the introduction of the register of overseas entities (ROE), the privacy benefits to owning UK real estate via a non-UK entity are ever decreasing. It is, perhaps, only a matter of time until personal tax returns are published alongside home addresses. We query whether this lack of anonymity is how it was meant to be, however, it is clearly another reason that in many scenarios, people now consider the use of non-UK entities owning UK real estate as an unnecessary administrative burden.
First published in IFC Review – 26 March 2024
