The CGT and UK corporation tax consequences of “de-enveloping” UK real estate

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Historically, it was common for many non-UK residents to hold UK residential properties via non-UK companies. The primary reason for this was that the companies shielded the property from inheritance tax (“IHT”). The “enveloped structure” also enabled the law of their domicile to apply to the succession of the shares.  Often the shares were held by a non-UK trust or foundation. 

Most of the UK tax advantages of the corporate structure no longer exist.  The key changes were the introduction of the annual tax on enveloped dwellings (“ATED”) in 2013 and changes to IHT in 2017.  

From 2013 up and until 2019, non-resident persons became liable to capital gains tax (“CGT”) on disposals of UK residential properties, or the shares of the non-resident companies owning them. Since 2019, non-resident companies owning UK real estate are subject to UK corporation tax on rental and capital profits.

 The running cost and tax inefficiency of the non-resident corporate envelope caused most of their owners to dismantle them and instead own the UK residential properties directly. This process is commonly known as “de-enveloping”. This note focuses on the CGT and corporation tax implications of de-enveloping UK real estate held in a non-UK company whose shares are held directly by a non-UK tax resident individual. 

What is ATED-related CGT? 

ATED was introduced in April 2013 for all companies holding UK residential property valued at over a certain amount (£500,000 since April 2016). Simultaneously, ATED-related CGT was brought in to apply to any post-5 April 2013 gains on UK residential property to the extent that the taxpayer had been liable to ATED. From 6 April 2019 ATED-related CGT was abolished to be replaced by UK corporation tax, currently at a rate of 19% (see below).

If you come across a direct disposal by a non-UK company of UK residential property between April 2015 and April 2019, this may still be subject to both ATED-related CGT and NRCGT. ATED-related CGT applies to the period 6 April 2013 to 5 April 2015 at the rate of 28% and any remaining gains made after 5 April 2015 are subject to NRCGT at 20%. 

What is non-resident capital gains tax (“NRCGT”)?

NRCGT was introduced in April 2015 at the rate of 20%, and it continues to apply to non-UK tax resident individuals, landlords, trustees, and PRs making disposals of UK residential property from that date at a gain. From April 2019, there were three main changes to NRCGT as follows:

  1. It also applied to disposals of UK commercial real estate by non-resident individuals. 
  2. It applied to disposals of shares in “UK property-rich” companies by non-resident individuals.
  3. It ceased to apply to companies. Instead, these became subject to corporation tax. 

Different NRCGT rates apply depending on whether the property being disposed of is residential or not. 

What are disposals of shares in “UK property-rich” companies? 

Prior to April 2019, non-UK tax resident individuals disposing of shares in a company owning UK real estate would not have been exposed to CGT in respect of the disposal of those shares. Since this date, however, disposals of such shares standing at a gain over their 5 April 2019 value are taxable.

An “indirect disposal” occurs when a non-UK tax resident individual disposes of company shares deriving 75% of more of their gross asset value from UK land, and, at any point in the two years pre-disposal, the person making the disposal has an investment of at least 25% in that company.  

The gains on indirect disposals will be calculated using the value of the asset being disposed of (i.e., the shares in the company), rather than the value of the underlying UK land. Again, different rates apply depending on whether the underlying property being disposed of is residential or non-residential. 

When does corporation tax apply?

From 6 April 2019, corporation tax rather than CGT will be charged on gains relating to disposals of UK real estate or “UK property-rich” company shares realised by non-resident companies.

In respect of residential property which would previously have been subject to NRCGT, the standard approach for working out the gain is to use the market value on 5 April 2015. In respect of non-residential property, the standard approach is to take 5 April 2019. The rate of corporation tax is currently 19%. This is due to increase for most companies to 25% from 1 April 2023.

What if the disposal realises a loss? 

Firstly, the date and value for the base cost must be ascertained. The default base cost dates are:

Residential property: 5 April 2015 or later acquisition 

Commercial property or “property-rich” shares: 5 April 2019 or later acquisition

The base cost is the market value on the relevant date or the actual subsequent acquisition cost, 

For assets held on 5 April 2015/2019, the prior actual base cost can be used instead by choice.  

In the case of pre-6 April 2015 acquisitions of UK residential property, there is the option to elect for either the actual base cost or for straight-line apportionment. If the straight-line apportionment method is chosen, any overall gain is pro-rated between the period up to 5 April 2015 and that from 6 April 2015 to the date of disposal, with only the latter being taxable.

If the property is mixed use, the residential element can be re-based to April 2015 and the non-residential element can be rebased to April 2019. 

How can any losses be utilised? 

A loss realised by a non-UK tax resident is not allowed unless, had the disposal generated a gain, that gain would have been taxable. 

There are special rules for any losses incurred in disposals subject to NRCGT or corporation tax on disposals of UK real estate or UK property-rich company shares. Such losses are usually restricted to being offset against gains of the same nature realised in the same or subsequent UK tax years. Any losses not relievable in this way are in effect wasted, unless the person disposing of the asset changes residence status from non-tax resident to UK tax resident in which case, they can offset such losses against all chargeable gains realised once UK resident. 

In addition, a non-UK trustee’s loss could be used by a recipient beneficiary, who would otherwise have a CGT liability on any subsequent disposal of the property, if the following conditions are met: 

  • The trustee’s loss must be allowable in principle. 
  • The UK property must be transferred to the beneficiary outright because a life interest ends and there is no further life interest, a contingent interest vests or trustees of a discretionary trust resolve to transfer the UK property to a beneficiary.
  • The trustee must not have used the losses itself.
  • The beneficiary can only use the loss to offset gains later realised by him on the asset transferred to him by the trustees. 
  • The loss must be claimed within four years after the end of the tax year in which it arose. 

What are the compliance and reporting requirements? 

In outline, the requirements for NRCGT are:

a) Submit a NRCGT return if you’ve disposed of UK property or land up to 5 April 2020; or
b) From 6 April 2020, you need to report and pay your CGT using the CGT on UK property service.

From 27 October 2021, you have 60 days from completion to report and pay the CGT. Prior to this, you had 30 days. Missing these deadlines could result in penalties and interest. These deadlines apply even if there is no tax to pay and/or if the person is already registered for UK self-assessment. There are a few exceptions from the requirement to file a return, the main one being a transfer between spouses. 

If you need to complete a self-assessment tax return you must still fill in the CGT section of your tax return for the year of the disposal unless the gain is exempt due to principal private residence relief. Any allowable costs (including costs of renovation, protecting title and of acquisition and disposal), losses and the availability of any CGT annual exempt amount should be checked and claimed. 

Filing will require any UK agent to have a government gateway account and for the person with the CGT liability to set-up their own account, so that the two accounts can “link” and the person can authorise the agent to submit the return on their behalf. If the person with the liability is a trustee, they will also need to have registered with HMRC’s trust registration service within this 60-day period.

In respect of corporation tax, if the company does not already submit a corporation tax return, it must register within three months of the disposal. For a non-UK company which only pays corporation tax on a one-off transaction, HMRC allows such a company to pay the tax within three months and 14 days of the disposal. If the company is already registered with HMRC for corporation tax (for example because it receives UK rental income) it can report the disposal within its usual corporation tax return. In contrast to individuals, there is no requirement for a company to submit a return where no chargeable gain or allowable loss arises.

Could there be an element of double taxation? 

Until recently, it was usual that disposals by non-UK residents of UK residential properties or of “UK property-rich” company shares stood at a loss compared to their market values on 5 April 2015 and April 2019 respectively. Recent rises in UK residential property prices are starting to result in gains over values on those dates. This can give rise to the potential for double taxation on a de-enveloping. The following worked example is based on the circumstances of some actual recent cases:

  • A non-UK tax resident trust was set-up many years ago by a non-UK tax resident settlor. The potential beneficiaries of the trust are all non-UK tax resident. 
  • The trust owns 100% of the shares in a non-UK tax resident company which, in turn, owns a UK residential property worth £8million on 5 April 2015 and currently worth £10million. 
  • The shares in the company were valued at £5million in 2019 and £6million now (due to liabilities including shareholder loans, which partly offset the value of the UK property which it owns). 
  • Due to the ongoing administration and ATED costs of running the structure and that is no longer offers any IHT benefit, the client wishes to liquidate the company. 

Two disposals will occur because of the proposed liquidation; (1) on disposal by the trust of its shares in the “UK property-rich” company, and (2) on disposal of the property by the company. Ignoring any deductible costs:

  1. The first disposal triggers 28% CGT on any increase in value of the shares over that on the 6 April 2019, being £173,600 ((£6million - £5million - £380,000) x 28%). 
  2. The second disposal triggers 19% corporation tax on any increase in value of the property over that on the 5 April 2015, being £380,000 ((£10million - £8million) x 19%).

There is no relief here for double taxation, as the two gains arise to two different taxable persons on the disposal of two separate assets for UK tax purposes. The tax liability would be higher on an eventual disposal if the property continues to increase in value, especially as corporation tax rates go up from April 2023 and CGT rates may well also increase in future.

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