An article examining the current taxation position of non-UK domiciliaries who purchase UK property either as an investment or as a home, by James Quarmby, ATT, TEP, solicitor at the law firm of DMH, Brighton, East Sussex
Published in the January 2001 issue of "Tax Adviser"
This article examines the current taxation position of non-UK domiciliaries who purchase UK property either as an investment or as a home.
Still the most common means of ownership, it has the benefit of simplicity, but it is not without its pitfalls.
Capital Gains Tax
A UK resident non-domiciliary is liable to CGT on gains made on the disposal of UK property, unless the property in question is the sole or main residence of the taxpayer in the UK (Taxation of Chargeable Gains Act 1992, s.222).
Since investment properties do not qualify as business assets for the purposes of the Business Assets Taper Relief this means that for higher rate taxpayers the CGT liability will range from 40 per cent down to 24 per cent after ten years of ownership.
Of course, if the non-UK domiciliary is also non-UK resident then there will be no liability to CGT.
IHT will always apply to directly held UK property, regardless of the residence or domicile of the owner. Whilst every taxpayer has the benefit of the nil rate band it is obvious that where the property holdings are extensive the potential IHT exposure is massive. For this reason excluded property settlements or offshore companies are often used to mitigate the liability.
Any rental income will be UK source and therefore taxable on the owner. If the owner is non-UK resident then the tenant or letting agent, as the case may be, has an obligation to deduct basic rate tax before paying the rents to the landlord.
To improve cashflow a non-resident landlord will often apply for approval under the ‘Non Resident Landlords Scheme’ to receive the rents gross. Approval will be given in return for an undertaking to submit UK Tax Returns and pay any tax due.
Non-UK domiciliaries will often utilise offshore borrowings, in particular back-to-back loans, in order to generate ‘qualifying interest’ to set against the rental profits chargeable under Schedule A. However, one needs to be aware of the effect of the transfer pricing rules (see below).
Ownership by non-UK resident trustees
Ownership by non-resident trustees can overcome many of the problems of direct ownership. In addition it avoids the necessity to obtain a UK Grant of Probate on the death of the owner.
Capital Gains Tax
If the trustees are non-UK resident they will not be liable to CGT, even on the disposal of UK property.
The CGT anti-avoidance provisions aimed at offshore trusts (TCGA 1992, ss. 86-97) only apply to UK resident and domiciled settlors/beneficiaries. This means that using an offshore trust can be very advantageous.
For example, instead of purchasing UK property directly a UK resident non-UK domiciliary could fund an offshore trust, which will then be used to purchase the property. As the trustees are non-resident they will not be liable to CGT on the sale and as the settlor is non-UK domiciled the gain cannot be attributed to him, even if the proceeds of sale are remitted to the UK.
Ownership by non-resident trustees will not always overcome the IHT problems. This is because non-resident discretionary trusts are liable to IHT on any directly held UK assets in the same way as UK trusts (i.e. the ten-year anniversary and exit charges). Whilst life interest trusts can be used they are not always appropriate, for various reasons.
To get around the IHT problem trustees will often use offshore companies to hold any UK property, which means that no UK property is held directly. Furthermore, if the settlor was non-UK domiciled at the time the trust was created it will have ‘excluded property’ status (IHTA 1984, s. 48(3)) and will therefore be outside the scope of IHT. The importance of excluded property status is that it continues even if the settlor later becomes UK domiciled or deemed domiciled under UK law.
Non-resident trustees will be liable to income tax on the rents, at the rate applicable to trusts.
If the property is not rented out but is instead being used as a home by the settlor or one of the beneficiaries then one should be wary of the income tax anti-avoidance measures contained within ICTA 1988, s. 740. This is because the provision of rent-free accommodation is a ‘benefit’ received in the UK for the purposes of this section and can therefore lead to an income tax charge on the beneficiary concerned.
Ownership by offshore companies
As explained above a foreign company can be used as part of a trust structure to hold UK property, normally for the IHT benefits it bestows. However, companies can be used on their own as a means of holding UK properties.
Control and management of the Company
Care needs to be taken when using stand-alone foreign companies. It is important to be able to demonstrate that the company is being controlled and managed outside the UK by its non-UK resident directors. If the owner of the company is UK resident the Revenue may argue that the foreign directors are simply acting on the instructions of the shareholder in the UK. Such a person is known as a ‘shadow director’. It is important to note that you do not have to be a shareholder to be a shadow director, it can be anyone who, on the facts, is giving directions to the company. This means that even where the company is owned by non-resident trustees if, say, a UK resident settlor is giving instructions to the company there will be control and management in the UK. The principle was amply demonstrated in the case of R v. Dimsey and Allen  BTC 335, which is also considered below.
If the company is controlled and managed in the UK it will be treated as UK resident for tax purposes and therefore liable to UK Corporation Tax on its income and gains.
Capital Gains Tax
A non-UK resident company will not be liable to CGT on the disposal of UK property, unless the company is trading in the UK. In most cases such companies will only be holding properties for investment purposes, which is not a trade for these purposes.
Where the company is owned by a non- UK domiciled shareholder TCGA 1992, s. 13 (attribution of gains to members of non-resident companies) cannot apply. Once again, this provides a very useful planning opportunity to avoid CGT when compared to direct ownership.
As noted above, the major benefit of using foreign companies is that they can be used to ‘convert’ UK property to non-UK property for IHT purposes. This works not only for non-resident trustees but also for individuals and means that the value of the UK properties held by the company should be completely outside the scope of IHT.
It should be noted that the use of offshore companies for this purpose has now been somewhat curtailed by the new stamp duty rules (see below).
If the property is rented out the income tax position is the same as for direct ownership, except that the company’s liability to tax is restricted to the basic rate (22 per cent). This is in itself is a major advantage over direct ownership as individual owners are liable to income tax at the marginal rates, the highest being 40 per cent.
Income tax can further be minimised by the use of foreign borrowings, although once again transfer pricing needs to be considered.
R v. Dimsey – More Problems with Shadow Directors
If the property is to be used for providing rent-free accommodation to someone in the UK (i.e. a shareholder of the company or a beneficiary of the trust owning the company) then there is a significant potential problem.
If the person in occupation is a shadow director of the company then the Inland Revenue takes the view that the provision of rent free accommodation to that person is a benefit in kind under the income tax Schedule E provisions and is therefore taxable.
The Schedule E provisions were previously thought to apply only to actual directors and employees of companies but the Inland Revenue persuaded the House of Lords otherwise in the landmark case of R v. Dimsey; R v. Allen. As a consequence it is expected that such arrangements will face increased scrutiny by the Inland Revenue in the future.
The transfer pricing legislation was completely overhauled by the Finance Act 1998 and is now found in ICTA 1988, sch.28AA.
The application of transfer pricing to non-resident landlords has been a matter of some controversy and has yet to be resolved. The problem is that the Revenue is under the impression that where an offshore company borrows from a bank and the loan is supported by a guarantee or deposit made by its shareholder (whether an individual or a trust) then this is a transaction which is caught by the transfer pricing rules.
The purpose of this type of arrangement is to generate qualifying interest payments that the company can set against its UK rental profits. However, if the gearing is too high (i.e. 90 per cent – 100 per cent) the Revenue could disallow the loan interest for tax purposes. This will be argued on the basis that an offshore company would not have been able to secure a 100 per cent loan against a property on the open market without the benefit of the deposit/loan by the shareholder, who of course is connected to the company.
In the Revenue’s view a bank would only lend between 65 per cent – 80 per cent without the benefit of the guarantee or deposit. Thus any interest attributable to borrowings over this amount will not be allowable.
Whilst the general consensus amongst the profession appears to be that the Revenue’s view is incorrect it would be unwise to ignore this issue when advising clients on levels of borrowing.
Finance Act 2000 – New Stamp Duty Rules
Finance Act 2000, s.118 introduced a new rule affecting the transfer of UK properties to offshore companies. Previously, any gift of UK property would be free of stamp duty under the general exemption for gifts (unless the property gifted was subject to an outstanding mortgage). Under the new regime if an individual transfers UK property to a company that is ‘connected’ to him then the transfer will be treated as if it were a sale at market value. Given the high rates of stamp duty for valuable properties (four per cent on values over £500,000) this new provision is a serious impediment.
Despite the many changes to the offshore anti-avoidance legislation since 1998 it is clear that with the right planning non-UK domiciliaries, whether UK resident or not, can achieve significant savings in IHT, CGT and income tax. However, due to the recent changes in stamp duty such planning ought to take place prior to any property purchase.
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January 2001 by