Capital gains tax for non-residents disposing of UK residential property: final rules

Introduction

The UK Finance Act 2015 received royal assent on March 26 2015. This included final legislation for the introduction of a capital gains tax charge on non-residents who dispose of UK residential property. The new charge applies to such disposals made on or after April 6 2015.

This update outlines the government’s new rules for the taxation of capital gains made by non-residents disposing of UK residential property and considers potential issues and planning considerations arising from the new tax.

Summary of new rules

In brief, the new rules are as follows:

– The new capital gains tax charge on a disposal of a UK residential property interest by a non-resident focuses on “property used or suitable for use as a dwelling” (or in the process of being adapted or constructed for such use). Unlike the capital gains tax charge applicable to properties subject to the annual tax on enveloped dwellings (ATED), it includes residential property used for letting purposes.

– There are exclusions for certain types of property in communal use (eg, boarding schools, residential accommodation for members of the armed forces, residential homes for children, nursing homes and certain types of student accommodation).

– All residential properties within the definition are potentially within scope, regardless of their value. This distinguishes the new charge from the ATED-related capital gains tax charge, which limits the charge to properties for which the consideration for disposal exceeds a specified “threshold amount”. This decreased from £2 million to £1 million with effect from April 6 2015 for gains accruing after that date.

– The charge applies to non-resident capital gains made by individuals, trustees and closely held non-resident companies and funds that are not widely marketed. Companies that are not closely held and funds that are widely marketed are not caught and neither are most institutional investors.

– Principal private residence relief is available in appropriate circumstances. However, there is a new rule for principal private residence relief, applicable to both non-UK residents in relation to residential property in the United Kingdom and UK residents in relation to property overseas.

– Broadly, principal private residence relief is not available for a tax year unless either:

the person making the disposal (or his or her spouse or civil partner) was tax resident in the country where the property is located for that tax year; or

the person (or his or her spouse or civil partner) spent at least 90 days in that property in that tax year (the ‘day-count’ test). If a person (or his or her spouse or civil partner) has more than one property in a country in which he or she is not tax resident, he or she may aggregate the number of days spent in any of those properties in the relevant tax year in order to meet the day-count test. One of those properties may then be nominated for principal private residence relief.

– Under the new capital gains tax charge, the rate for individuals is either 18% or 28% according to their status as basic or higher/additional-rate taxpayers, respectively. The rate for trustees is 28%.

– The rate for companies within the charge is 20%, mirroring that for UK resident companies.

– Under the new rules, there is a mechanism for declaring non-resident capital gains tax losses and offsetting them against gains from the sale of UK residential property, where appropriate. Limited indexation allowance and pooling arrangements are available to non-resident companies and groups.

– A reporting and payment regime is being introduced with a deadline of 30 days to report the disposal using a non-resident capital gains tax return and, for persons that do not otherwise complete a tax return, also to make payment.

– ATED-related capital gains tax continues to apply, where relevant, and the rate continues to be 28%. Where both capital gains tax charges potentially apply, ATED-related capital gains tax will take precedence and any remaining gains will be taxed under the new rules.

– The new rules do not apply to gains relating to periods before April 6 2015. Taxpayers have three options, as follows:

Rebase to April 6 2015 (in which case any post-April 6 2013 gain may be liable to ATED-related capital gains tax, if relevant for that period);

Time apportion the gain unless the property is also subject to ATED-related capital gains tax; or

Compute the gain or loss over the entire period of ownership, mirroring the option under ATED-related capital gains tax.

Government consultation

The government reviewed and took into consideration the responses that it received to the consultations on the original proposals and the subsequent draft legislation published in December 2014. As a result, it has made a number of changes to the original proposals.

What falls within scope of new charge?

The new capital gains tax charge on non-residents is focused on “property used or suitable for use as a dwelling” – that is, a place that is, or has the potential to be, used as a residence. This includes property in the process of being constructed or adapted for such use, in line with the definition in the stamp duty land tax, ATED and ATED-related capital gains tax regimes. Disposals of building land are outside the scope of the charge, until a residential building is under construction.

A disposal of rights to acquire a UK residential property ‘off plan’ before construction is treated as if it were a disposal of an interest in a completed property.

Residential property used for letting purposes is included in the charge, as would be the case for UK residents. In this way, it differs from the ATED-related capital gains tax charge which (among others) provides a relief for property let to third parties on a commercial basis.

There are exclusions for residential property with a communal use, such as boarding schools, residential accommodation for members of the armed forces, residential homes for children and nursing homes. Purpose-built (including converted) residential accommodation for students (eg, halls of residence and flats) with at least 15 bedrooms is excluded from the new capital gains tax charge on non-residents, provided that it is occupied by students on more than half of the days in the tax year. However, smaller establishments – such as family homes converted or otherwise let out to students – are within the scope of the new charge.

Who falls within scope of new charge?

The new charge applies to the following persons:

– Individuals – non-UK resident individuals who own and dispose of UK residential property directly are liable to the new capital gains tax charge.

– Partnerships – although partnerships are to remain tax transparent, the new capital gains tax charge applies to disposals of UK residential property made by non-resident partners within the new capital gains tax regime to the extent that gains are attributable to them, as is currently the case for UK resident partners.
– Trustees – non-UK resident trustees are subject to capital gains tax on post-April 5 gains made on disposals of UK residential property. The new capital gains tax charge takes precedence over existing capital gains tax anti-avoidance provisions that seek to attribute trust gains to settlors and/or beneficiaries of non-resident trusts, to the extent that such gains are non-resident capital gains arising on a non-resident capital gains tax disposal.

– Non-resident companies – the new charge applies to gains made on disposals of UK residential property by closely held non-resident companies.

Closely held company test

A ‘closely held company’ test has been introduced to limit the scope of the new charge to non-resident companies that are the private investment vehicles of individuals, families or small groups of individuals or families. This should ensure that the extension of capital gains tax will not apply to disposals of UK property made by widely held or listed companies.

A ‘closely held company’ is defined in the legislation as one which is under the control of five or fewer participators, or one in which five or fewer participators together possess or are entitled to acquire, in appropriate circumstances, rights to the greater part of the company’s assets on a winding-up.

The legislation provides for a number of situations in which companies which otherwise would be regarded as closely held are not to be so regarded. Among others, these include where it is possible to do so only by including as a participator a company which is itself a diversely held company or qualifying institutional investor.

A ‘qualifying institutional investor’ is a widely marketed unit trust or open-ended investment company, the trustee or manager of a qualifying pension scheme, a company carrying on life assurance business or a person that is not liable to tax on grounds of sovereign immunity.

The definition of ‘qualifying institutional investor’ may be amended by Her Majesty’s Treasury through the issuance of regulations.

For protected cell companies, the test is applied to each cell or division of the company, rather than just at the level of the company.

Anti-avoidance provisions are also included to prevent arrangements which manipulate the control of a company at the time of a relevant disposal.

ATED-related capital gains tax

Despite many responses to the initial consultation suggesting that ATED-related capital gains tax would effectively be redundant once the new capital gains tax charge on non-UK residents was introduced and that it should be scrapped in favour of the new charge, the government decided that the two charges target different issues and has retained the ATED-related capital gain tax charge. It continues to apply at 28% – rather than 20%, the rate applicable to companies under the new capital gains tax charge.

To the extent that a gain is related to ATED, ATED-related capital gains tax applies in preference to the new charge. If any part of a gain post-April 6 2015 is not within ATED-related capital gains tax (perhaps because the property was rented out for a period), that part of the gain will be potentially subject to the new capital gains tax charge on non-residents.

Interaction with anti-avoidance provisions

Like the ATED-related capital gains tax charge, the new capital gains tax charge takes precedence over existing anti-avoidance provisions that attribute gains to UK resident members of non-resident companies.

Who is out of scope?

Persons that are classed as ‘eligible persons’ for the purpose of the new rules will be able to make a claim not to be chargeable to capital gains tax on non-resident capital gains. These include the following:

– a diversely held company (ie, one which does not fall within the meaning of a ‘closely held company’);

– a widely marketed unit trust scheme, open-ended investment company or foreign equivalent to an open-ended investment company. A ‘widely marketed scheme’ is one which meets the following conditions:

The scheme produces documents, available to both Her Majesty’s Revenue and Customs (HMRC) and investors, which specify the intended categories of investor and undertakes that the scheme will be widely available and marketed accordingly;

The specification of categories of investor, or any other terms or conditions of investment, does not have a limiting or deterrent effect; and

The units in the scheme are marketed and made available sufficiently widely to reach the intended categories of investor in such a way as to attract the relevant categories of investor, and a potential investor within the relevant categories can obtain information about the scheme and acquire units in it.

A scheme is not regarded as failing to meet this condition because it has no capacity to receive additional investments, unless its capacity to do so is fixed by the scheme documents and a pre-determined number of specific persons or groups of connected persons make investments which exhaust all, or substantially all, of the investment capacity;

– a unit trust scheme or open-ended investment company (or foreign equivalent) with a ‘qualifying investor’; and

– a company carrying on life assurance business where the UK land being disposed of was held for the purposes of providing benefits to its policyholders

Principal private residence relief

Under the rules before April 6 2015, principal private residence relief was available where a property was an individual’s main residence (this included trust beneficiaries in appropriate circumstances). The government was concerned that, under the then-existing terms of the relief, non-residents could have made an election for their UK property to be their main residence for the purposes of principal private residence relief and thereby avoid capital gains tax charge. To avoid this, a new rule has been introduced for properties located in a jurisdiction in which the individual is not tax resident.

This applies to both non-UK residents disposing of UK residential property and UK residents disposing of properties located outside the United Kingdom.

Under this rule, a residence is not eligible for principal private residence relief for a tax year unless:

– the person making the disposal, or his or her spouse or civil partner, is tax resident in the country where the property is located for that tax year; or

– the person, or his or her spouse or civil partner, spends at least 90 days in that property in that tax year (the day-count test). If a person (or his or her spouse or civil partner) has an interest in more than one property in a country in which he or she is not tax resident, he or she may aggregate the number of days spent in any of those properties (or ‘qualifying houses’) in the relevant tax year in order to meet the day-count test. One of those properties may then be nominated for principal private residence relief.

The nomination of a property by a non-UK resident individual is not effective unless the individual meets the day-count test for that tax year. If the day-count test is not met, the person is regarded as absent from the property for that tax year.

A day counts as a day spent by an individual (whether the person seeking to claim principal private residence relief or his or her spouse or civil partner) in a qualifying house for the purposes of the test if either the individual is present in the house at the end of the day (ie, midnight) or is present for some part of the day and the next day has stayed overnight in the house. The second alternative avoids the requirement for presence in the property at exactly midnight, which was a concern raised about earlier proposals.

While occupation of a residence by one spouse or civil partner counts as occupation by the other, double-counting days is not permitted.

Principal private residence relief is available to trusts where a beneficiary meets the relevant criteria for residence or the day-count test. This applies to both UK resident and non-resident trusts.

Subsidiary features of principal private residence relief – such as absence relief, lettings relief and final period relief – continue to be relevant. A transitional rule has been introduced in relation to absence relief for disposals by non-UK residents. Under this, if a period of absence began before April 6 2015, that prior period of absence is deducted from the amount of absence available for periods after April 6 2015.

For non-residents, a notice to treat a residence as their only or main residence is to be made at the time of disposal in the non-resident capital gains tax return.

Tax rates

The rates of tax for the new capital gains tax charge on non-UK resident individuals are the same as those for UK residents who pay capital gains tax at their marginal rate of income tax. Thus, the rate is 18% for taxpayers paying at the basic rate and 28% for those liable at the higher/additional rate. For non-residents, the rate depends on their total UK income and gains. The annual exempt amount for gains (£11,100 for tax year 2015/2016) is also available to non-residents.

For trustees, the rate is 28% and the annual exempt amount is available at half the rate for individuals.

The tax rate for companies is 20%, mirroring the rate paid by UK resident companies. Non-resident companies also have access to limited indexation allowance and group companies can enter into pooling arrangements to aggregate gains and losses on UK residential property across a group. There is a de-pooling charge for companies that leave a pooling arrangement.

Calculation of gains

The new rules do not apply to gains relating to periods before April 6 2015. The following options are available:

– The default option is rebasing to market value as of April 6 2015 (in which case any post-April 6 2013 gain may be liable to ATED-related capital gains tax, if relevant for that period).

– Time apportionment of the gain is available, unless the property is also subject to ATED-related capital gains tax.

– Taxpayers may compute the gain or loss over the entire period of ownership. This mirrors the position under ATED-related capital gains tax.

With regard to changes in use, where there are consecutive changes in use, straight-line time apportionment applies. For concurrent mixed use of property, the legislation provides for “a just and reasonable apportionment” to be made, which will be dependent on the facts of each individual case.

Losses

Losses on disposals of UK residential property are ring-fenced for use against gains on such properties arising to the same non-UK resident in the same tax year or carried forward to later years.

If a person’s residence status changes from non-UK resident to UK resident, unused UK residential property losses are transferable and available to be used as general losses against other chargeable gains.

Where a UK resident becomes a non-UK resident, he or she may transfer unused losses relating to UK residential property so that they are available to offset against future UK residential property gains.

Reporting and payment

A non-UK resident disposing of UK residential property must file a non-resident capital gains tax return with HMRC within 30 days of completion of the disposal to which the return relates. A single return is required where two or more disposals are made on the same day.

Generally, a non-resident capital gains tax return must include an advance self-assessment of the amount that is notionally chargeable for the tax year or an additional amount if a previous non-resident capital gains tax return for the year has been made. Payment of any tax due will be required on or before the relevant filing date.

However, such an assessment will not be required where the person is required to make a self-assessment return for the tax year in which the disposal takes place or the previous year, or if the person has made an ATED return for the previous period (ie, the period up to the preceding March 31).

A taxpayer may amend a non-resident capital gains tax return within 12 months of the normal self-assessment filing date for the tax year in which the disposal is made.

A non-resident capital gains tax return – and a self-assessment return, where appropriate – will need to be filed where there is a loss or no gain, or if any gains are made that are covered by the applicable annual exempt amount. A principal private residence relief nomination is also made by way of the non-resident capital gains tax return.

Planning considerations

The following considerations should be borne in mind:

– For UK residents disposing of UK residential property (and other assets), capital gains tax has always been an issue. Since the introduction of the ATED-related capital gains tax charge, it has also become a consideration for non-residents disposing of such property, albeit until now limited to companies and certain other non-natural persons.

– With the introduction of the new wider capital gains tax charge for non-residents with effect from April 6 2015, it is now much harder for non-resident individuals, trustees or closely held entities to avoid a potential capital gains tax charge on a disposal of UK residential property, except where such property may qualify as the main residence of an individual for the purposes of principal private residence relief.

– The new principal private residence relief rules mean that some non-residents may find it difficult to claim the relief in respect of a tax year without becoming UK tax resident for that tax year. This is because of the requirement to spend at least 90 days in their UK property or properties in a tax year in order to make the claim.

– Depending on the application of the statutory residence test to an individual’s circumstances, some individuals may be able to spend this length of time in the United Kingdom and remain non-resident under the test while doing so. Further, where an individual has a spouse or civil partner who may spend different periods of time in their UK properties over the course of a year, it may be unnecessary for the individual to spend the entire 90 days in their UK properties himself or herself. However, care will still need to be taken in respect of counting days and ties with the United Kingdom.

– Where this may be an issue, it will be important for an individual to ensure that he or she spends sufficient days in a home overseas to avoid becoming automatically UK resident under the relevant automatic residence test.

– If a property is likely to qualify for principal private residence relief under the new rules, this may make it preferable for an individual (or trustees) to hold it directly, rather than via a company. On an acquisition of a property directly by an individual or trustees, stamp duty land tax will be at standard residential rates. ATED will not be an issue. However, the property will be within the inheritance tax net unless other forms of inheritance tax mitigation are put in place.

– Lower-value properties may fall within a couple’s joint nil rate bands (£325,000 each or £650,000 jointly). If there are no other significant UK assets to consider, no additional inheritance tax planning may be necessary and such a property could be held directly, unless there are other considerations. Stamp duty land tax on an acquisition of a property within this range is also likely to be lower under the new rules.

– For inheritance tax mitigation purposes, a property may be purchased with a mortgage to reduce its value in a non-domiciled individual’s estate. Legislation introduced in 2013, which restricts the deductibility of liabilities for inheritance tax purposes in certain circumstances, may limit the effectiveness of such a strategy where it applies. However, in such circumstances other options for inheritance tax mitigation (eg, insurance) may still be available.

– For an individual wishing to invest in UK residential property generally rather than in any specific property, investing in a diversely held fund or non-resident company investing in property may be an alternative tax-efficient option.

– For non-UK resident individuals wishing to invest in a specific residential property for business purposes, it will generally be preferable to set up a non-resident company to make the investment, because of the lower rate of tax on gains (20%) compared with that for individuals (28%).

– Non-residents may also wish to register with HMRC for self-assessment in order to defer payment of the tax due on disposal until the self-assessment return date (which could be up to 18 months later).

– While there is no requirement in the legislation for a non-resident owner of UK residential property to have it valued as of April 6 2015, it may be sensible to consider doing so in order to establish a base cost for tax purposes for a future disposal.

Comment

Subject to the application of relief where available, the new capital gains tax charge for non-residents disposing of UK residential property after April 5 2015 catches gains on disposals of UK residential property of any value by individuals and most other closely held entities not within the scope of ATED- related capital gains tax.

The overall tax costs of holding a UK residential property for private use through a corporate envelope continues to be greater than doing so directly, to the extent that higher-rate stamp duty land tax, ATED and (at least for individuals taxable at 18% under the new capital gains tax charge) ATED-related capital gains tax may apply to an enveloped property.

However, the distinction between the respective tax costs of acquiring and owning high-value residential property through a company rather than directly has been reduced with the increase in the top rates of residential stamp duty land tax since December 2014.

While higher-rate stamp duty land tax for properties over £500,000 acquired for private use through companies and certain other entities applies at 15% for the whole of the purchase price, at the higher end of the property market, even standard rates of stamp duty land tax are likely to result in a significant stamp duty land tax charge.

The fact that capital gains tax potentially applies at rates of up to 28% to post-April 5 2015 gains on any disposal of UK residential property by a non-resident individual or trustee may further tip the balance back towards a corporate holding structure, where there are other advantages to such a structure.

These might include the inheritance tax advantages of holding a property through an offshore company, possible privacy reasons and practical advantages (eg, avoiding probate on the death of a property owner). Of course, careful consideration of all the relevant circumstances will be required to determine whether this may be the case.

It should also be borne in mind that the new rates of ATED which came into effect from April 1 2015 are a significant increase from the previous rates. Over time, if these annual rates continue to rise significantly, they will begin to reinstate – and possibly widen – the previously substantial differential in tax cost between acquiring and holding residential property directly and doing so through a corporate vehicle.