The legislation evolution of UK tax impacting Real Estate
Simon Vardon, Director, Product Development – Real Estate
The evolution of legislation in relation to the taxation of gains arising from the disposal of UK commercial property by non-residents
On 7 November 2018 the UK Government published the 2018/19 Finance Bill, which had been eagerly awaited by the Real Estate industry, since it included the detailed draft legislation on the taxation of gains made by non-residents on UK immovable property.
In October 2017, in the previous UK budget, one of the most significant changes to the taxation of UK real estate was first announced. The Chancellor announced proposals to tax gains realised from direct and indirect investments in UK commercial real estate made by non-residents of the UK from April 2019.
What followed was a consultation whereby draft proposals describing how capital gains tax for non-residents (“NRCGT”) would work, including proposals relevant to investors holding property directly, indirectly and a section focused on investment through Collective Investment Vehicles (“CIVs”).
The consultation received over 120 responses, with consistent observations being made by industry bodies, investors and advisors within the UK real estate sector.
The UK real estate industry had been mobilised into action, because whilst the stated aims of the consultation launched by HMRC and HM Treasury were broadly accepted by the industry, the initial proposals described within the consultation were a cause for much concern.
Numerous observations were made by respondents, but two key concerns stood out:
- The consultation proposed measures which discriminated against overseas CIVs investing into UK commercial real estate; and
- Exempt investors, such as pension schemes and Sovereign Wealth Funds would only preserve their exempt status if investing directly into UK commercial real estate
In July 2018, HMRC and HM Treasury published their Summary of Responses, which encouragingly provided a positive sentiment on the two key topics. Whilst the detail as to how the legislation would work was not available, HMRC and HM Treasury outlined two proposals which they believed would go a long way in dealing with the concerns raised:
- Transparent offshore funds will be able to elect for transparency for the purpose of capital gains from the position of a non-UK resident investor (UK investors will retain their current treatment); and
- Offshore funds that are not closely held and which agree to reporting requirements, will be able to elect for a special tax treatment whereby gains by the fund or within its structure will not be taxable, but the investor will be taxed on disposals of their interest in the fund. This treatment would apply whether the fund was transparent or opaque.
Draft legislation published
The Finance Bill published on 7 November provides the draft detailed legislation.
The key highlights of the two new regimes central to that legislation are:
- Transparency regime: This is available to overseas CIVs, which are income tax transparent and UK property rich. Jersey Property Unit Trusts (JPUTs) which are UK property rich will meet this definition. With the consent of all investors (all unit holders for the JPUT), an election for transparency can be made in relation to NRCGT. NRCGT will consequently only be applied at the level of the investor. This election is irrevocable, even with a change in ownership of the CIV.
- Exemption regime: This is available to overseas CIVs, which are UK property rich and widely held. The election is made by the fund manager and the consequence of this, is that the CIV and all subsidiaries will be exempt from NRCGT on direct and indirect disposals. NRCGT will be applied at the investor level. Various reporting obligations come with this election.
For some 20 years, Jersey has been a jurisdiction of choice for overseas investors to structure investment into UK commercial real estate, with the JPUT being the primary structure used. With the largest Real Estate team across the Channel Islands, SANNE is well positioned to comment on the expected outcomes for Jersey arising from the changes to NRCGT and the two new regimes being introduced. Since the changes were first announced we have been speaking regularly with investors, fund managers and key stakeholders. The feedback is that both of the new regimes are expected to be widely elected into by existing structures which qualify.
The Transparency regime will most commonly be elected into by joint venture-type JPUTs where exempt investors are present. Exempt investors actively invest into alternative assets, including real estate and often do so alongside an asset manager, providing the majority of the capital into real estate projects. In scenarios like this, the election into the Transparency regime will allow the exempt investors to preserve their status, should a divestment of the units in the JPUT be made.
The Exemption regime offers overseas CIVs a comparable status to the UK REIT regime with regards to gains. The most attractive aspect of this regime is that it applies to all underlying subsidiaries as well as the CIV itself. Whilst this election can be revoked, it is unlikely to be in practice. Expectations are that overseas CIVs which are eligible will make the election into the Exemption regime.
The UK Government has announced an update to the UK REIT regime as a consequence of the finalisation of the Exemption regime. That update extends the exemption of UK tax for indirect gains arising from the sale of property rich subsidiaries, to the existing exemption for gains arising from direct asset disposals. This change delivers parity in the treatment of gains between the two regimes.
The outlook for Jersey and the JPUT
The draft legislation now provides parity in the treatment of gains arising from UK commercial real estate for UK and non-resident investors and in its application to UK and offshore structures. This position will be fully complete when the UK Government renegotiates certain tax treaties - the most noteworthy being with Luxembourg.
HMRC and HM Treasury were clear in their Summary of Responses that their proposals were not designed to encourage on-shoring to the UK.
Where regulatory considerations determine that the use of a structure such as the JPUT is favourable, then it should not be disadvantageous to structure using the JPUT as opposed to an onshore vehicle.
There now exists a broad menu of onshore and offshore vehicles that deliver consistent results with respect to the taxation of any gains arising from UK commercial property.
Given the flexibility of the JPUT and its familiarity of use within the industry, Jersey should be sanguine about the future of the JPUT and its continued use for structuring investment into UK commercial real estate.