UK Residential Property

Ever-increasing complexity demands careful analysis of the factual background to transactions.

Since 2012, the taxation of residential property has become subject to a plethora of rules requiring detailed investigation not only of the property itself, but of who the purchaser is, what they intend to do with the property and how many properties they own.

Amid a political and popular backlash against rising property prices, seismic changes to the taxation of residential property have sought to target in particular property held otherwise than by individuals as a main residence. The higher rates of SDLT and capital gains tax, the annual tax on enveloped property and a proposed extension of inheritance tax combine to make structuring purchases of residential property highly complicated and fact-specific.

In order to understand quite how complex the position is in 2016, it is perhaps helpful to look back to 2012 and the position as it was before the changes of the last four years were introduced.

Key Points

•  Companies are subject to higher rates of SDLT and capital gains and the annual tax on enveloped dwellings.
• Buy-to-let landlords are subject to higher SDLT rates and restrictions on interest deductibility.
• Future changes may subject residential property to inheritance tax regardless of holding structure.

Position on 1 January 2012

Upon acquisition, the following rates of SDLT applied to the purchase of a residential property:

 

The rates applied on a "slab" basis, meaning the whole consideration was taxed according to which band it fell within, at the prescribed percentage. The rates applied to all purchasers whether the purchaser was a corporation or an individual, regardless of what the purchaser intended to do with the property and how many properties the purchaser already owned.

A purchaser could expect to pay tax on any rental receipts from the property, at a rate dependent on whether they were within the charge to income tax or corporation tax (on 1 January 2012, up to 50 per cent for income tax payers, or 26 per cent for corporation tax payers). There was also capital gains tax to consider (assuming private residence relief was not available) upon disposal of the property. Rates were dependent again on whether the seller was within the charge to capital gains tax or corporation tax, or perhaps not within charge at all if the seller was not a UK resident.

That, largely, was the end of the story, until March 2012. The Government then made a series of changes to the taxation of residential property, designed to reverse the use of so-called "envelopes", i.e. holding property in any way other than directly. The stated concern at the time was expressed to be future transfers of property without payment of SDLT.

From 2012

Against that background, from March 2012 the following changes were made:

15 per cent SDLT

 A 15 per cent charge to SDLT was introduced in Budget 2012, payable by purchasers who are "non-natural persons", acquiring "higher threshold interests".

While in 2012 a higher threshold interest essentially meant a residential property purchased for over £2,000,000, this has since been lowered to purchases of over £500,000. There are exclusions where the property is acquired for:           

1. property rental businesses, where the property is acquired for the purpose of letting to a third party at a rent on a commercial basis and the property is not occupied by any of the beneficial owner’s connected persons;      
2. development or redevelopment and resale in the course of a property development trade;
3. resale in the course of a property development trade;
4. making the property available to the public for at least 28 days a year;
5. provision to an employee of accommodation where the employee has less than a 5 per cent interest in the non-natural person and the provision of the accommodation is for the non-natural person’s commercial purposes; and
6. a number of specific other reliefs for particular businesses such as farming.

7 per cent SDLT

Although it has since been repealed, the Finance Act 2012 saw the introduction of a new 7 per cent rate of SDLT on properties valued at over £2,000,000, replacing the previous 5 per cent rate.

ATED

Introduced by Finance Act 2013, the annual tax on enveloped dwellings (ATED) was a tax introduced and directed at those who continued to hold high-value residential property through non-natural persons, the idea being that the prospect of an annual charge for the ability to do so would encourage those who owned properties in envelopes to take them out of those envelopes. Originally applying to property valued at over £2,000,000, the ATED, like the 15 per cent SDLT charge, now applies to residential property valued at over £500,000. The amounts charged per annum have increased significantly since the introduction of ATED, no doubt because of the revenues which it has attracted for HM Treasury from those that are willing to pay it in order to preserve their indirect holding structures for other tax reasons. The fee payable per annum is set by reference to the property value, and is currently chargeable at the following rates:

Reliefs are available, broadly in line with the reliefs from 15 per cent SDLT, but must be claimed annually.

Taxes on capital gains – ATED-related CGT

Coupled with ATED was the introduction of ATED-related CGT, where a charge to CGT is triggered when a property holder disposes of a property, currently for more than £500,000 (this was reduced from £1,000,000 on 6 April 2016 in line with 15 per cent SDLT and ATED). To the extent that ATED is chargeable on a residential property (i.e. no relief is available), the "ATED-related gain" that has accrued since April 2013 incurs a 28 per cent tax charge. These measures subjected non-UK non-natural persons to a CGT charge for the first time, and at the CGT rate applicable to individuals rather than at the lower corporation tax rates.

From December 2014

SDLT "slice" rates

Changes to the SDLT rates were made again with effect from 4 December 2014. Replacing the previous "slab" system described above, the new "slice" system means that the amount of value falling within each band is taxed at the prescribed percentage. The overall result is that the effective rate of tax is increased for higher value properties and decreased for lower value properties:

 

Non-UK resident CGT

In 2015, the focus of the Chancellor shifted away from residential property held in envelopes, to instead creating a "level platform" for UK and non-UK investors. Applying to all residential property regardless of value or holding structure in April 2015, the UK capital gains tax regime was extended to include disposals by non-UK residents. There is an opportunity for rebasing, which can be calculated either by reference to market value of the property on 6 April 2015 or a time apportionment exercise. The rates are the same as those applicable to individuals (up to 28 per cent) or companies (20 per cent), and relief is available for certain widely held corporate vehicles or funds. ATED-related CGT takes priority over the newer provisions, applying a penal rate of 28 per cent to high-value residential property held by a non-natural person (rather than the 20 per cent rate that would be charged under the new non-UK resident extended CGT principles).

2016 so far

In this year’s budget, there have been yet more changes to taxation of the sector. This time, the focus has been on residential landlords and those acquiring second homes:

Higher rates (+3 per cent) of SDLT

From April 2016, SDLT rates were increased further for purchasers acquiring buy-to-let properties or second homes, when they already own a residential property. This applies regardless of the property value to corporates and individuals alike. Broadly, where an individual purchases a property but already owns another residential property, he will pay an additional 3 per cent on top of the usual slice rates applicable to residential property, unless the property is purchased as a replacement for his main residence. For a company, the acquisition of any residential property will automatically attract these higher rates, unless the penal 15 per cent rate applies as described above (which is applied to the total consideration, not on a "slice" basis). 

 

Restriction on interest deductibility

The Government has announced that it will restrict relief on finance costs that individual landlords of residential property can claim to the amount of relief that would have been available to a basic rate taxpayer. The measure will be phased in from April 2017. This will apply regardless of property value. For example:        

Current Position 2016-2017

 

Position in 2020-2021

* assuming total taxable income for tax year exceeds £150,000.

Wear and tear allowance

From April 2016, the wear and tear allowance previously available to residential landlords (which allowed landlords of furnished properties to claim an annual allowance of 10 per cent of the rent received, regardless of actual expense incurred) has been replaced by a relief that only allows the deduction of the actual costs to replace furnishings. The stated aim of the change was to give "greater consistency and fairness across the residential property letting sector and reduce the number of tax rules applying to the residential property sector".

Inheritance tax - proposed changes

The last four years have therefore seen a great deal of amendments to the taxation position for the residential property sector. Not only have there been changes year on year, but changes to those changes. However, arguably the most destabilising change for investors in prime residential property is yet to come. Although details have not yet been published, the Government announced in July 2015 that it intends to legislate to ensure that all UK residential property owned by non-UK resident individuals is to be subject to inheritance tax even if the property is held indirectly through an offshore structure. Details of those measures are expected in a consultation at some point this year, to be then legislated for in the Finance Act 2017. If the Government proceeds with this seismic change, those offshore holding structures remaining in place which currently attract ATED may have little remaining benefit once HMRC is able to look through them for inheritance tax purposes.

Where are we now? How does the UK compare with other jurisdictions?

 

 

It is beyond doubt that holding residential property in the UK as an investment has become less attractive from a tax perspective, particularly for non-UK residents, although the volatility in value of sterling following the Brexit referendum, may make acquisitions cheaper for foreign investors. The Government’s stated direction of travel, particularly as regards inheritance tax, is only going to add to this. That said, the map above illustrates that London from a direct tax perspective continues to compare favourably with some of the major cities across Ashurst’s global network.

An individual holding residential property as a buy-to-let investment in the jurisdictions listed below could expect to pay the rates of tax shown in the diagram above on profits made respectively on:

• rental receipts; and
•  disposal.

^Notes

^{1. These figures do not include any church tax payable.}

^{2. Disposal proceeds may be realised tax-free if holding periods are observed.}

^{3. Figures are approximate and dependent on rounding and other considerations, including phase-out of certain deductions.}

^{4. Can be reduced to 35 per cent if the requisite holding period is met.}

^{5. These rates include a 2 per cent medicare levy only applicable to residents. Rates will fall to 47 per cent after 30 June 2017.}

^{6. Net income subject to ordinary progressive income tax (up to 45 per cent) plus exceptional contribution if high earner (3 per cent or 4 per cent) plus social contributions (15.5 per cent).}

^{7. Full exemption may be available if certain holding periods observed.}