When the tax man comes knocking

Will changes to the tax regime put foreign buyers off UK property, and what does this mean for structuring through the Channel Islands? Orlando Crowcroft investigates

With a general election looming and renewed public focus on foreign ownership of property in the UK in the face of spiralling prices in central London, it"s unsurprising that Britain has moved to tax foreign investors more in 2015 and beyond.

Chancellor George Osborne used his 2014 Autumn Statement to outline changes to stamp duty land tax (SDLT), which raises the cost for those buying property over £1 million, as well as making them liable for capital gains tax (CGT) from April 6. This comes on top of the annual tax on enveloped dwellings (ATED) charges brought in two years ago, which require foreign investors using offshore structures to pay a percentage of the value of the property each year to HMRC.

Jersey and Guernsey have both traditionally been heavily involved in creating structures for foreign investors to reduce their tax liability when investing in UK property, using either trusts or companies to purchase real estate and avoid taxes such as capital gains and SDLT, but the new reforms have made life more difficult.

“If we look back three years, I could have given advice to a non-UK resident buying UK residential property very quickly. We could create a tax efficient structure to own the property, which would be unlikely to create any adverse tax implications for that individual,” says Mark Lee, Head of Private Client and Trust at EY in Jersey. “Now, more than ever, there"s an incredible amount of complexity in various areas of the UK tax legislation that must be considered.”

The much-published changes to SDLT in the UK mean that for a property costing more than £2 million in the UK, a buyer will pay £165,750 rather than £147,000, although experts point out that for any purchase up to £937,000, the cost will actually be less. Meanwhile, CGT will now be payable at 28 per cent on residential properties sold after 6 April, providing an investor"s UK income is above £31,865.

The ATED rules already have some foreign owners paying up to £143,750 in tax annually, providing the property is worth more than £20 million, but this is set to become even more punitive, with the annual charge on the most expensive properties rising to £218,200 in 2015. In addition, the minimum threshold for an annual tax charge is being reduced from £2 million to £500,000 over the next two years. Finally, HMRC has done away with the capital gains relief on properties that foreigners use as primary dwellings if they spend less than 90 days at home.

Causing confusion

It"s no wonder experts are finding that clients are increasingly confused by the implications of all the changes.

“In terms of your local market, it"s made the laws more complicated, and means that people need to take more advice. It"s an opportunity from an adviser"s perspective, because you"re going to have to get these things right. The tax landscape is forever becoming more and more complex,” says Deborah Clark, Head of Private Tax and Trusts at Mills and Reeve in Manchester.

But could this be an opportunity for offshore service providers? Perhaps, say industry insiders, especially as, ironically, the tax reforms aimed at dissuading investors from buying properties through companies has actually had the opposite affect, argues EY"s Lee.

“The legislation that has been introduced is very complex and it layers on top of existing legislation. In some cases, owning the property personally might give you a far worse tax position than you would have if you continue to hold it through a structure,” he says.

He gives an example of a foreign investor not living in the UK who wants to buy a £10 million house as an investment that they would let commercially to an unrelated third party. The individual would pay the same in SDLT whether he used a company or not, but if he successfully let the house, he would face a 20 per cent tax rate on net rental income as a corporate owner and up to 45 per cent as an individual. Equally, the corporate rate of CGT clocks in at 20 per cent (instead of 28 per cent for a person). More crucially, ownership through a company could give protection against inheritance tax (40 per cent) for the foreign investor.

“There was a feeling in the islands that all these property tax changes marked the end for Jersey trusts and Jersey companies owning UK residential real estate, but I think that example shows it is anything but. In fact there is real opportunity for the islands,” he says.

The question remains, of course, whether the hike in taxes will put foreign investors off UK property altogether, but industry experts aren"t convinced. They point out that while the changes are major in the UK, they actually bring the country into line with most other property markets in Europe, the US and even Asia. Moreover, London property is considered one of the safest and most consistent assets around.

Steve Gully, Client Director at Barclays in Jersey, agrees, adding that recent events - from the Arab Spring to Russia"s rouble crisis - demonstrate to foreign investors that, a higher tax rate notwithstanding, it makes sense to have assets away from home. There"s even been an uptick in French property purchases in London, and many are using Channel Island structures for this.

“There will always be a desire to sensibly structure your affairs for investment into the UK, and that often isn"t for tax purposes. It can be for confidentiality, or it may be that individuals want to have asset structures so that they have a certain level of control. While UK tax changes may mean there"s a more level playing field, that isn"t always the driver,” says Gully.

One area that"s defied the general "boom town" perception of London property in 2014 and going into 2015 is the private rented sector, as rents and rental yields have struggled to keep up with the spike in house prices. As a result, the buy-to-let sector in London is not as prominent for foreign investors as it could be.

Simon Brown, Head of Private Client Lending at Investec Private Bank, says that rental yields in prime areas of London can be as low as two to 2.5 per cent, compared to as much as eight per cent in the northern cities of the UK. But he adds that we saw a similar trend emerge in 2006/07, and when the financial crisis hit in 2008, London house prices remained stagnant but rents still rose. As a result, rental yields improved and the buy-to-let sector began to pick up.

“When capital values plateau, you see rental yields increasing, and that can affect our lending. Lenders are always using rental income as the force of interest payment, so if rents are low then loan-to-value rates will also be low,” says Brown.

On the up

As far as the industry as a whole is concerned, our commentators unanimously feel that the tax changes in the UK were unlikely to put foreign investors off the British real estate market completely. Some argued that, at a time when prices were rising to unsustainable levels, a small correction wouldn"t be a bad thing.

“We"re seeing One Hyde Park being sold at £6,000 a square foot - it wasn"t so long ago that it was £2,000 and that was seen as breaking the ceiling,” says Brown.

“But tax-wise it"s no more expensive to buy a property in London than it is in Paris, New York, Singapore or Hong Kong. It"s now comparable. And I think that in itself will help slow down the London market.”

“These future charges will affect the desirability of UK property - but I think it will only be marginal,” adds Nigel Pascoe, Director of Lending for Skipton International in Guernsey, which recently launched a new mortgage product aimed at British expatriates living overseas and buying property at home.

“Foreign investors buy new buildings in London and the south east - from China, Malaysia, Singapore, Hong Kong and Abu Dhabi. A lot of these people are very wealthy and UK property is always going to have an appeal, irrespective of what that tax take is going to be.”