Our regular newsletter readers will know that I try and select each month a topic that I think would be interesting not only to professional colleagues but also to clients and non-tax colleagues who would like to have a general understanding of such topics. Thus the past few newsletters have dealt with transfer pricing issues, corporate and personal migration and this month I have selected “Transactions in UK real estate” as an interesting subject where often structures fail to cope with the myriad of tax considerations that should be considered.
UK Real Estate I wrote a book entitled ‘Structuring International Real Estate Transactions’ in 1991, published by Sweet & Maxwell, the preface of which introduced the fictional Maurice Brightman and his exploits in advising on real estate transactions around the world. Maurice appears again in this month’s article. Such is the interest I found amongst clients and colleagues in the different ways of structuring real estate investments and developments in countries such as the UK, US and southern European countries that I intend to devote next year’s IFS conference to this topic. As a reminder to those who may have overlooked the May newsletter announcement, the Second Annual IFS ITSAPT Conference to be held again at The Landmark Hotel, London on 3 November 2011 is on the subject of personal and corporate migration. And this is going to be very relevant for the new Statutory Residence Test in the UK just announced by HMRC last Friday.
Statutory Residence Test This consultative document introduces the long awaited statutory definition of residence aimed to replace the current set of rules primarily based on court precedents. The importance of this development cannot be overstated – even HMRC have admitted that the current residence rules are “vague, complicated and perceived to be subjective”. They have acknowledged that presently in certain circumstances it is not possible for a person to be sure whether they are tax resident in the UK or to know what activities or circumstances would make them tax resident; factors that remove certainty and predictability, which are much sought after by foreign individuals. The new rules seek to introduce clear and objective tests to determine a person’s affiliation with the UK. They will become law in April 2012. HMRC will also publish an online residence self assessment tool on its website.
Currently it is possible to acquire residence even by spending a seemingly insignificant number of days on UK soil. The proposals stipulates a de minimis rule, i.e. the minimum number of days that a person must stay in the country during a tax year before he/she becomes sufficiently connected with the UK. For those who have not been resident in the UK during the previous 3 tax years, this is 45 days; for others who have been resident in the previous 3 years it is 10 days unless they leave the UK to carry out full-time work abroad.
They also state who will conclusively be considered resident in the UK, namely those present in the UK for 183 days or more in a tax year, or who have only one home and that is in the UK, or those who carry out full-time work in the UK. And then there are the in-between ‘connecting factors’ which fall under Part C, which include (a) where the family is resident, (b) the use of available accommodation in the UK, (c) substantive work in the UK, (d) presence in the UK exceeding 90 days per annum in either of the previous two tax years, or (e) more time in the UK than in other countries. The proposals identify those who are arriving in the UK and those leaving the UK; for arrivers who have not been resident in the UK in all of the previous 3 tax years but exceed the de minimis limit of 45 days and are in the UK for less than 183 days, two of the connecting factors (a) to (d) need to exist if their number of days is between 120 and 182, 3 factors need to exist if their number of days is between 90 and 119, and all four if their number of days is between 45 and 89. For leavers who exceed the de minimis limit of 10 days but who are in the UK for less than 183 days, all 5 connecting factors (a) to (e) are relevant and an individual only needs one of these to be present for the number of days between 120 and 182, two for the number of days between 90 and 119, 3 for between 45 and 89 and all four between 10 and 44 days in a tax year. Simple huh? Well at least this is a mechanical presence test as opposed to a subjective test, although the connecting factors may in themselves have some subjectivity which will presumably be ironed out during the consultative process. And there are anti-avoidance provisions in the consultative document which parallel to some extent the capital gains tax rules whereby those leaving the UK to achieve tax free income (e.g. from accumulated UK corporate dividends) and returning within a certain period may nevertheless be taxed on such income even if considered non-resident when the income was received. At the same time as issuing this consultative document, HMRC have clarified the announcement in this year’s Budget that non-domiciles who have been in the UK for 12 of the previous 14 years will have to pay £50,000 rather than £30,000 each year if they want to retain the remittance basis of taxation in respect of overseas income and gains. However, HMRC states that it is recognised that non-domiciled individuals contribute significantly to the UK economy and will therefore allow remittances for certain types of investment without subjecting these to UK tax. Let us hope that this finally puts an end to the conjecture as to whether the Government is likely to put an end to the nondom rules for income and gains, or to introduce a similar 7 out of 10 years provision (or 12 out of 14) after which non-doms will be treated for income tax and capital gains tax in the same way as domiciled and resident individuals.
All of the above issues will have become clearer nearer our November conference and we will be examining these in detail during the UK sessions in the programme – for the programme and booking form, please click here. What is clear is that having your only home in the UK will make an individual UK taxresident under this test, and that trying to restrict days of residence in the UK to under 90 days per annum over a four year period will not avoid UK residence if factors (a) to (d) above are relevant. Nevertheless, it has to be realised that even if an individual is UK resident under the Statutory Residence Test, he may be resident in another jurisdiction as well under the laws of that country, in which case the relevant double tax treaty provisions will still apply to determine which country has the taxing rights for the relevant income and gains under that treaty. I will also be speaking at the occasion of a private conference organised by the Belgian-Luxembourg Chamber of Commerce in Great Britain on 12 July 2011 at the Luxembourg House in London. My presentation will be on the subject of Luxembourg Services & Solutions for UK residents, focusing on investing in commercial, hotel & residential real estate in/outside the UK.
Readers of this Newsletter are invited to attend – again, for more details please contact Linda at the office.
Finally, as for last summer, I am closing down the Newsletters until September so I wish you all a very enjoyable summer.
With my best regards
FOUR UK REAL ESTATE CASES
Maurice Brightman was walking through Regent’s Park withCharlie, his border collie, reflecting on four different UK property cases that he had been involved in during the past week. The first involved his old client Albert Stonemiller, an Australian national who had come to the UK 20 years ago and had acquired a very substantial private home through a trust and company structure. The second was a very recent client, Sven Johanssen, a Norwegian national who was coming to live in the UK for approximately ten years whilst his children were being educated at a well known private school. The third was the Russian oligarch Alexander Nabokov, who had been resident in the UK for several years and had recently acquired a rare plot of land in central London for which he hoped to get planning permission for a large hotel, and then sell the undeveloped land to a hotel group with relevant permission. The fourth individual was a dear friend, Jonathan Powell who is UK domiciled and resident and has a similar opportunity to Alexander, but this involves a plot of land in Worcester for which he hopes to obtain planning permission for an office development. There were so many possible structures that came into mind, andMaurice thought, not for the first time, how complex structuring real estate transactions was. Not only did one have to consider the income tax and capital gains tax consequences on current and future profits, but also whether loan interest could be deducted against these profits and whether there were any withholding tax issues on payment of interest to third parties; inheritance tax at 40% on estates situated in the UK above £325,000 is a huge potential bombshell waiting to explode at any time; and of course stamp duty land tax and value added tax needed to be considered. He sat down on a park bench with Charlie and started thinking about the various possibilities.
Albert Stonemiller and existing property
Owning a private home through an offshore company owned by a trust was the standard way of avoiding potential inheritance tax consequences for non domiciled individuals, but nowadays this is not a structure that Maurice would advocate. Not only is Albert now deemed domiciled in the UK for inheritance tax purposes, but he is living in a private home now worth £10mn owned by a company whose directors meet all the expenditure required in the house, including the salaries of servants working in the house under the direction of the ever vigilant and rather irascible Albert. HMRC have won far easier cases where a UK resident individual has been deemed to be a shadow director of an offshore company, in effect making the individual in employment with the offshore company and therefore liable to the benefits in kind provisions relevant to all employees. In Albert’s case, this would mean a benefit in kind equivalent to 4% of the value of the property over £75,000, involving a 50% tax charge on a £397,000 benefit in kind. Albert wouldn’t be happy with this and Maurice was thinking how to remove the deemed employment arrangement. One way could be for Albert to pay rent to the offshore company at market value, thereby avoiding any benefit in kind. However, UK tax would have to be payable on the rental income, and with a rental value of £500,000 per annum, this would also be a costly solution.
There is no point at this stage to create an interest bearing loan to reduce the rental income, since the loan has not been incurred for the acquisition of the property but on effectively refinancing it, and therefore the interest would not be tax deductible.
Another way of avoiding the employment relationship is for the offshore company to licence the property to the trustees who are the shareholders of the company. Albert could then sub-licence the property from the trustees, and although, in the absence of any licence fee being paid by Albert, this could be an effective distribution from the trust, this would not be a problem if the trust were what Maurice describes as a ‘dry’ trust i.e one without any income or capital gains In this case, any deemed ‘distribution’ could not be assessed to UK tax in the absence of any income or gains arising in the trust. Maurice made a note to ask Albert to let him have accounts of the trust for the past few years.
Sven Johanssen and a new property acquisition Maurice then considered his new client, Sven Johanssen, a likeable Norwegian who wanted to buy an expensive property in central London whilst his children were being educated.
Happily, the property has not yet been acquired and no trust or company structure has actually been put in place. Maurice contemplated the idea he had been developing of allowing Sven to buy the property in his own name so that he could enjoy the principal private residence exemption in the UK if he sells the property whilst still UK tax resident. Sure, there would be a potential inheritance tax liability since the property is UK situs, and it may be difficult to reduce his estate by internally generated loans since Section 103 (1) FA 1986 did not allow a deduction for inheritance tax purposes of a debt derived from his own property.
An interesting idea would be for Sven to put money into an offshore life assurance single premium bond which would represent clean capital prior to his becoming resident in the UK. He would have the status of resident, ordinarily resident but non domiciled, and could withdraw up to 5% of his original investment in the bond over a period of 20 years without any tax issues, the income and gains within the bond effectively being deferred for tax purposes until the bond is finally cashed in part or in whole. Since Sven is unlikely to be resident in the UK at that time (planning to be resident only for 10 years), he could therefore avoid tax on accumulated income and gains throughout his period of UK residence.
Maurice had discussed with the UK branch of an offshore bank whether an interest only loan from the bank to Sven could be arranged upon the security of both the property and the offshore bond, thereby ratcheting up the loan to value ratio in respect of the property. The interest could be serviced by the 5% capital withdrawals without UK tax consequences i.e. no constructive remittances to the UK. Sven could then sell the property whilst still UK tax resident, before moving back to Norway, enjoying the principal private residence exemption in the UK. Otherwise he would have to pay Norwegian tax on the sale of the property once he had resumed Norwegian residence. As regards whatever remaining inheritance tax liability there would be with the higher loan to value advance from the bank taken into account, it would be relatively inexpensive to insure Sven’s life for the limited ten year period. This whole arrangement would be a lot less expensivethen the trust and company structure, as well as being much more tax effective.
Alexander Nabakov and the hotel site
Maurice knew the Cypriot lawyers who were looking after Alex’s affairs for many years, and they had enquired whether a Cyprus company could own the potential hotel site in London, and what would be the UK tax consequences of ‘turning’ the site once planning permission had been granted. Maurice had already explained to them the provisions of Chapter 3 Part 13 ITA 2007 which is an anti avoidance section aimed at offshore companies owning UK real estate. The UK is rare amongst high tax jurisdictions in allowing offshore companies and individuals to own UK investment properties and realise tax-free capital gains from their disposal. Part 13 attempts to convert what would otherwise be a capital gain into a capital profit in the nature of a trade. As such, UK trading profits would be subject to UK tax, but if the owning entity is a company located in a jurisdiction with a double tax treaty with the UK, such trading profits would only be subject to tax if a permanent establishment were deemed to exist in the UK.
Maurice is aware that HMRC has tried to attribute permanent establishment status to any development site owned by an offshore company, but clearly this is inconsistent with the definition of a permanent establishment if the business of the offshore company is being conducted offshore; the site is only the place at which the business profits could be derived, but not through which the business is carried on.
Thus if a Cyprus company were to be created to acquire the site and it is clear that the Cyprus company has done so as a trading opportunity, then if the Cyprus company deals only with third party town planners and architects, there should be no permanent establishment created under the provisions of the UK-Cyprus double tax treaty. Thus the trading profits should only be taxable in Cyprus, but Maurice was aware that the sale of non Cyprus situated real estate by a Cyprus company would not be taxable itself in Cyprus under domestic law. He would suggest to the Cypriot lawyers that they obtain a tax ruling from the Cyprus authorities to this effect since Alexander didn’t like surprises, and another issue that he would have to consider is UK anti-avoidance legislation in the form of Section 720 ITA 2007.
This anti-avoidance section allows HMRC to tax an individual on (trading) profits enjoyed by an offshore company as a result of a transfer of assets to that company. Clearly Alexander has negotiated the purchase of the site and is transferring it into the name of the Cyprus company, and even though Alexander is non-domiciled in the UK, recent changes to UK tax law allow the UK authorities to penetrate the trust owning the Cyprus company if the source of the profits is UK (otherwise the remittance basis of taxation would still apply to foreign source income and gains). However, Section 720 ITA 2007 seems to be incompatible with EU law and indeed the European Commission had written to the UK overnment stating this in their notice of February 2011. After all, Section 720 would not apply had the property been acquired in the name of a UK company, and therefore should not apply if the property were acquired in the name of another European Union registered company. So Maurice made a note to write to the Cypriot lawyers advising them that they could go ahead with their proposals.
Jonathan Powell and the Worcester Office Development
Jonathan is a very cautious client who does not want to get into complex tax structures for what is a similar issue to that of Alexander Nabakov. However, Maurice has advised him that it may always be helpful to acquire the site in an EU resident but non UK company just for ease of flexibility for prospective buyers; they may themselves be non resident of the UK and may prefer to acquire a property in the UK through a foreign company. Moreover, there may be stamp duty land tax savings that could be achieved. Maurice was thinking of having a Maltese company owning the UK site and then eventually disposing of the shares of the Maltese company once planning permission has been granted so that Jonathan could enjoy Entrepreneur’s Relief on the capital gain at the rate of 10%. Jonathan had seemed very interested in this very much lower rate of tax than he was used to, and wanted to be sure that this was totally above board as regards HMRC.
Maurice had brought with him a note of the key elements of Entrepreneur’s Relief which are that the Maltese company must be a trading company in the 12 months at the date of its disposal, and Maurice wondered whether Jonathan would be able to comply with this from the moment of first acquisition through the planning process to the eventual sale. There was no problem with Jonathan owning at least 5% of the ordinary share capital of the Maltese company, and he could also be one of the directors of the Maltese company provided that the majority of the board were resident in Malta and all board meetings relating to the property were held in Malta; this would require Jonathan to travel a few times to Malta during the coming year but this was hardly an unpalatable prospect.
In the same way that Article 5 of the Cyprus-UK double tax treaty relates to permanent establishments, so Article 2 of the Maltese- UK treaty has a similar provision. A prospective purchaser may then like to create a UK subsidiary of the Maltese company for the purposes of the development itself, but perhaps the Maltese company could reserve for itself parts of the completed development which would remain in the Maltese company for investment purposes, so that the eventual capital gain would not be taxable in the UK and would suffer a maximum 5% tax in Malta.
Maurice then turned his thoughts to the forthcoming presentation on Luxembourg SPs for real estate investments in France, something which he had advised on many times because of the favourable LuxembourgFrance double tax treaty provisions. He contemplated thinking that in fact the Luxembourg securitisation vehicle he had recently advised on for a group specialising in intellectual property rights licensing, could also be useful for UK private home acquisitions, and whether this could be an alternative for Sven Johannson to consider. Well, that was for another occasion on a park bench.
And as the sun set over Regent’s Park, Maurice realised that he had been sitting down for a long time and was feeling a little stiff in his joints, and that Charlie hadn’t budged for hours. He hoped that neither of them were getting any older . . .