Private Funds CFO insights 2020
6 December 2019
On 6 July 2018, HMRC and HM Treasury issued a Summary of Responses to their consultation and an updated Policy paper. HMRC and HM Treasury launched their consultation document “Taxing gains made by non-residents on UK immovable property” on 22 November 2017 requesting responses by 16 February 2018. 120 responses had been received, primarily from the advisory profession and industry bodies. SANNE also responded to the consultation and we have been closely monitoring developments.
Chancellor Philip Hammond first announced the change within his Autumn budget. The key proposal was that from April 2019 gains realised from the disposal of UK commercial property by non-residents will be taxed, marking a change in policy which has stood for over 50 years.
The proposed rules would apply to both:
HMRC and HM Treasury subsequently issued a consultation on the subject, which outlined how the tax and calculations would work. Their consultation noted that the core features were fixed.
HMRC and HM Treasury have now issued their responses to the consultation submissions. It is important to note at this stage that some areas remain subject to further consultation and finalisation, but it is most welcome to note that “Officials from HMRC and HM Treasury met extensively with the industry to establish the impact of the policy and test the rules proposed in the consultation document,” and that the Government has welcomed the constructive input from the industry.
Concerns voiced within the consultation feedback
Having digested the proposals and the detail in the consultation paper, there were a number of key items which have been focused upon within the Real Estate industry, by advisors, investors and service providers. Below we discuss the key concerns and the outcomes at this time.
Exempt Investors & Collective Investment Vehicles | Exempt Investors - background:
Concerns were raised that the initial proposals would only see Exempt Investors, such as Pension Funds and Sovereign Wealth Funds, preserve their status through direct investment into the property. As previously drafted, indirect investment, including via collective
investment vehicles (“CIVs”), would result in these exempt investors indirectly suffering the tax.
Concerns had been raised by respondents that, as drafted, the proposals did not provide a parity of treatment between UK and Overseas CIVs, which would befit the policy objective. One recurring example provided, was that the initial proposals could result in the same gain being taxed multiple times within an overseas CIV (e.g. directly at a PropCo level and then indirectly when an investor disposes of their interest in the CIV). Respondents had also noted that it was not apparent how the Statutory Instrument (SI 2017/1204) which impacted Offshore Funds, reconciled with the proposals.
Exempt Investors & CIVs – current status:
The Government has noted that these were the two major areas of focus by respondents. The language in the Summary of Responses is encouraging. The Government have stated that they will continue to engage closely with the industry to produce rules that address these two issues. The Government has acknowledged the submissions that “it was normal for UK exempt investors, such as UK pension funds, to invest using offshore CIVs; not as a means of avoiding tax, but to retain their tax-free gains status when investing through subsidiary entities”. The proposals are thus noted to be relevant to both UK and Non-UK Exempt Investors.
The Government response notes two core proposals, which it believes will go most of the way to addressing the issues:
The Government has further recognised that Exempt Investors will be involved in structures which do not fit the definitions described above and has recognised that other solutions will need to be considered in these situations.
Although subject to finalisation, the updates from the Government are very welcome on these two very key areas. The Government should not have to compromise on its policy aims, but there is a clear desire to address the concerns raised by the industry. They have stated that they will continue to engage closely with the industry as legislation is finalised.
Indirect investment tests (Property rich and 25% ownership test) | Indirect investment tests - background:
To implement the tax for indirect disposals, the consultation introduced two new tests. The property rich test described how the tax would apply to a disposal of an interest in a structure which was property rich (75% or more of the underlying value derived from UK real estate). The 25% ownership test scoped out investors holding less than a 25% ownership in a structure, but included both a five year look-back and consideration of connected parties/acting together.
Respondents noted that whilst the property rich test would determine when to calculate the tax, the calculation itself would tax the gain on disposal in full (up to 25% of which might not derive from UK property). It was further highlighted that if the 25% ownership test was to apply to Funds, seed investors would potentially be caught and clarity was sought as to whether ‘acting together’ could unintentionally catch all investors in a Fund.
Indirect investment tests – the current status:
HMRC and HM Treasury have acknowledged that the property rich test will potentially tax non-UK property related gains, but have confirmed that the legislation will remain as drafted in this area, citing that alternative options would be more problematic. On the subject of the 25% interest test, updates have been announced:
Contrary to the initial proposals the option to use original cost rather than the April 2019 value will be available for indirect disposals.
Clarity has been provided by HMRC and HM Treasury and the updates are broadly welcome. The scope-out of the minority investor exemption from CIVs has been concluded upon owing to the potential to spark conflicting demands from investors in a CIV, now that the Government has provided the option to elect for transparency.
Other noteworthy updates: