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23 Mar 2016

CAPITAL letters - Budget Special - more pain, no gain


Our Chancellor has decided to give property investors and those with interests in EBTs a real caning in this Budget. He says he wants to cool the property market and open it up to first time buyers, but does he really think that introducing a new tax on property every five minutes will achieve this aim? Existing investors have some hard choices to make and potential investors are left wondering whether it's best to avoid this sector altogether.

If there is one category of people he dislikes more than property investors then that's tax avoiders, specifically those who have used EBTs. In this edition I will examine the retrospective taxation measures introduced in the Budget to punish people who have taken loans from EBTs.

Property tax

SDLT surcharge – clearly 12% SDLT is not high enough, so we will see a 3% surcharge on property investors and people with two or more homes, bringing the top rate to an eye-watering 15%. There will be no relief for 'large' property investors – an idea mooted in the consultation document but clearly dismissed by the Chancellor as being insufficiently cruel.

Interest restrictions – the government will press ahead with a gradual reduction on the deductibility of mortgage interest payments and by 2020 the maximum credit will be 20%. This means that if you are a non-corporate investor (and that's most of the market) you will be paying, in effect, a 25% tax on losses. It's obvious that landlords will pass on some of that burden to their tenants, thereby pushing up housing costs for 'hard working families'.

Commercial property SDLT – I have written before that commercial property seemed to be stuck in a time warp, with rates never changing, whilst residential property raced ahead at unholy speed. Not any longer. The rate of SDLT on commercial properties will rise to 5% on properties costing more than £250,000.

Disclosure of beneficial ownership – we already have measures on the disclosure of the beneficial ownership of companies, contained in the clumsily named Small Business, Enterprise and Employment Act 2015. However, someone high up has realised that one way for property investors to maintain their privacy is to hold UK property through an offshore nominee company, as these are not caught by the SBEE Act. Well that's all going to change as it is proposed that you will no longer be able to register land at HM land Registry unless you disclose the beneficial ownership of the offshore vehicle in question. I suppose that the disclosures will be helpful to HMRC when trying the enforce the expanded IHT charge on UK properties to be introduced from 2017 (see below).

CGT rates – many people were punching the air at the happy news that CGT would be reduced from 28% to 20% for higher rate taxpayers and from 18% to 10% for basic rate taxpayers, only to have their celebrations cut short, mid-punch, with the Chancellor's clarification this reduction would not apply to property investors.

IHT reforms – the Budget provided no more clarity on the proposed reforms in 2017, which will see a look-through for IHT purposes for all UK property held by offshore structures. It looks increasingly likely that we will not see anything meaningful from HMRC until much later this year (I'm talking November or December here), leaving us with the prospect of an orgy of desperate de-enveloping for clients in the last quarter of the tax year, reminiscent of the introduction of the disguised remuneration rules in 2011. I can't wait.

As I'm sure you know already, the plan is that there will be a complete look-through of all offshore vehicles to the UK properties underneath, thereby exposing trusts and individuals to IHT charges that were previously avoided. I've been wondering how HMRC could possibly enforce this new tax, given the incredibly reactive way IHT works. At the moment 90% of IHT is paid as part of the probate process, which involves PRs completing IHT returns and paying any tax due before they get the clearance necessary before they can take out a grant of probate. Without a grant of probate the deceased's property is effectively frozen, so HMRC can afford to sit back and wait for the IHT forms to come tumbling in. For this reason IHT is the cheapest tax ever to collect. Fast forward to life after 2017; let's say you have a UK property owned by an offshore company, owned by six brothers in Saudi Arabia. The shares are held by nominees. One of the brothers dies and, under sharia law, his shares automatically pass to his wife and two children. No probate is required anywhere, let alone in the UK, as the nominees will simply continue to hold the shares, this time on trust for his family. How does HMRC even know about the death or go about collecting the tax? Yes, the property is in the UK, but it is owned by a company (not the deceased) and is still 5/6th owned by people not liable to IHT; so how will HMRC get its money even if it was aware of the death? I can’t wait to see the answer.

UK property developers - new rules

I wasn't expecting this innovation as we have had no advance warning from HMRC, which tells us that they think this problem is 'serious' and that by giving notice the people involved will do something to try and forestall the effects. As if!  The new rules will come into effect from Report Stage of Finance Bill 2016 and will apply to all profits realised from that date, meaning it will catch existing structures, no matter how fabulously well-constructed they may be.

There will be new legislation to create an "UK property trade", whether or not undertaken by a UK permanent establishment, which will be taxed at corporation tax rates. This will effectively override any double tax treaties, which is something we are not supposed to do. Of course, large property structures are already caught by the Diverted Profits Tax, which itself overrides any tax treaties, so the government has form here. This new legislation will catch all property developers, large and small.

There have been consequential changes to the tax treaties with the Channel Islands and the Isle of Man in order to preserve the UK's taxing rights over UK land. Normally the renegotiation of a tax treaty takes many years, so heaven knows how they did this so quickly and quietly. Perhaps the Treasury kidnapped the respective First Ministers of these islands until they were persuaded to comply?  There will also be a targeted anti-avoidance rule (TAAR) to prevent people from forestalling the new rules.

But what does this mean for property investors and what, if anything, can they do about this? If you have an existing structure then you have a real problem – it's no good trying to sell your land to a related company in order to bank the gain (which was my first thought) as this will be caught by the TAAR. The definition of an UK property trade will include cases of 'flipping', so if you sell on your development site before completion then you will still be caught.

However, these rules do nothing to change the distinction between trading (which is an income tax event) and investment (which is a CGT event). So, if you buy or develop land or property with a view to an onward sale then you will be caught, regardless of the existence of a taxable PE or a relevant tax treaty. However, if you acquire land with the intention of holding for the longer term gain then you are not trading but investing. Non-resident investors in commercial land will therefore pay no tax.

There is a lot of interesting case law on the distinction between trading and investing and I expect lawyers across the land will be blowing the dust off their volumes of the All England Reports to hone their skills.

The only silver lining that I can see is the reduction of the rate of corporation tax. It was already slated to be reduced to 18% by 2020 but it will now be lowered to 17% by the same date. If your property company is in Northern Ireland (still part of the UK, of course) then your CT rate will only be 12.5% from 2018. I wonder if we will see a rash of property companies being set up in or transferred to Northern Ireland?

Employee Benefit Trusts

The Chancellor announced two new measures which will affect EBTs. The first was to close down a planning opportunity that was so obscure that I didn't even know it existed, so that didn't upset me greatly. The second is a shameless (and possibly unlawful) retrospective measure targeting loans. The plan is to tax anyone who, on April 2019, has an outstanding loan from an EBT, even if the loan was made prior to April 2011 (which is when the disguised remuneration rules were introduced). Bearing in mind that loans taken before 2011 were not actually taxable at that time (because it took the Finance Act 2011 to change the position) one wonders how the Chancellor can defend this blatant retrospective measure. What amounts to justification in the Budget papers is pretty thin stuff; we are told that HMRC's views about loans from EBTs were well known prior to 2011 through the publication on their website of a 'spotlight' saying how much they hated EBTs. So it seems that a whingeing opinion piece from HMRC, buried away in their website, now has the status of legislation.

The implication of this announcement is huge: there are hundreds, possibly thousands, of people with outstanding loans from EBTs. In most cases the monies lent have been spent. In many cases there has been no settlement with HMRC under the 'EBT Settlement Opportunity' and HMRC are out of time to make an assessment. So what happens in 2019? We are told that there will be a tax charge if the loans have not been repaid. I know that most clients don’t have the money to repay. How will HMRC levy a charge in 2019?  No loan would have been made in that year, so no chargeable event under Part 7A occurs. They will have to concoct a fictitious chargeable event in order to precipitate a charge under Part 7A or invent some new tax charge for outstanding EBT loans. Whichever route they choose, be in no doubt, this is truly retrospective legislation which has no place in our tax system. HMRC has every right to legislate against tax schemes they do not like and they have not been shy of doing that. But to go back many in time and tax people on transactions that were perfectly lawful at the time and re-characterise them as taxable is plain wrong, a denial of legitimate expectations and a breach of human rights.

I would refer the Chancellor to the interesting case of Yukos v Russia, where the Russian authorities sent in the tax police to the offices of Yukos and basically invented a whole bunch of tax charges and penalties, mostly retrospective, with the specific aim of stripping the assets of the company and putting its controversial owner, Mikhail Khodorkovsky, into prison. I'm not imputing such motives to our Chancellor, but make the point that retrospective taxation, regardless of the motive, is always wrong. Period.



James Quarmby

James Quarmby

T:  +44 20 7809 2364 M:  +44 7958 776 759 Email James | Vcard Office:  London

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