Update on Non - Residents Investing in Commercial Property

This post covers legislation for the taxation of capital gains of non  - residents investing in UK property, including gains from assets deriving 75%+ of their value from UK land where a non  - resident investor has a "substantial indirect interest" in that land.  Statutory references are to TCGA 1992 unless other - wise stated.  HMRC's draft guidance on the legislation is included as appendices 14&15 to the CGT manual.  My original post on the consultation is here.

Overview

Original consultation suggested charge to tax on UK property gains of non  - residents would apply to non - resident collective investment vehicles (CIVs).  If implemented this would have made non - UK resident CIVs unsuitable as property investment vehicles for UK life insurance companies.  This is because the proposed rules would have resulted in an inappropriate tax charge for pension business investment in UK property via an offshore CIV as there would be no recovery of the non  - resident CGT charge in the CIV for the pension investor. And for BLAGAB UK property investment via an offshore CIV there would be double taxation, once in the collective on its property investments and again in the I-E tax computation which, probably via the deemed disposal rules in Section 212, would tax the gain on the holding in the CIV.

This issue was raised during the consultation period and HMRC have responded by allowing non  - resident CIVs to elect out of the non  - resident CGT charge on UK property.  Accordingly, offshore "UK property rich" CIVs such as JPUTs remain appropriate for UK property investments of life insurance companies.  There might, however, be difficulties if the non  - resident UK property rich CIV cannot make either of the two elections or chooses not to make an election.  But presumably it will be possible to confirm the UK tax status of an offshore UK property rich CIV, with the fund manager.

However, to balance the relief provided to offshore UK property rich CIVs from UK CGT,  non  - resident investors in property rich CIVs are more likely to be caught by the legislation than was proposed in the consultation.  This is because the rules that tax gains on assets deriving 75% or more of their value from UK land (Section 1A (3) (c) and, for companies, section 2B (4)(b)), apply where the taxable person has a "substantial indirect interest" in that land.  Generally a person only has a substantial indirect interest if they dispose of rights in a company and they held a 25% investment in that company at a point in the two years prior to the sale. (Schedule 1A paragraph 9). However, for investments in UK property rich CIVs, the 25% holding rule does not apply and therefore all gains of non - residents from such vehicles are within the charge to UK CGT.  This applies to investments in UK vehicles such as PAIFs and REITs as well as non  - UK resident CIVs.

One group of non  - residents seemingly impacted by the rules are non  - resident life insurance companies.  These companies may be brought within the UK charge to tax on corporate gains if they have investments in UK property rich CIVs.

Layout of the Legislation

FA 2019 introduces a new TCGA Section 1A (Territorial Scope) which brings gains to individuals on, UK residential land, and assets that derive 75% of their value from UK land where the person has a substantial indirect interest in that land, into the charge to UK CGT.

Section 2B applies equivalent rules to disposals by UK companies.  

Schedule 1A  Contains the rules for determining when an asset derives 75% of its value from UK land and what constitutes a "substantial indirect interest" in land.

Schedule 4AA  Contains certain computational provisions, and

Schedule 5AAA Includes detailed rules for CIVs, but

For rules on reporting non  - resident gains you need to go to FA 2019 schedule 2

Detail on Rules for Property Rich Collective Investment Vehicles

There is specific legislation for property rich collective investment vehicles (CIVs) in Schedule 5AAA.  This schedule defines CIVs as Collective Investment Schemes, Alternative Investment Funds, UK REITs and offshore structures equivalent to UK REITs (The legislation doesn't use the phrase offshore REIT, but this is apparently what it is trying to target).  The basic rule (paragraph 4)  is that other than for partnerships (which remain fiscally transparent) offshore CIVs are companies for CGT purposes.

Accordingly, sales by a participant in a UK property rich CIV are within the charge to UK CGT as they are assets deemed to be shares that derive 75%+ of their value from UK land.  Additionally paragraph 6(1)(b) of schedule 5AAA states that where a disposal has an "appropriate connection" to a CIV the person making the disposal has a substantial indirect interest in UK land.  Accordingly, the 25% holding requirement in Schedule 1A(8) is not relevant for disposals which have an "appropriate connection" with a property rich CIV.  There is some fiendishly complex legislation around what constitutes an "appropriate connection" but the basic point is that the sale of an interest in a UK property rich CIV by a non  - resident is likely to be in charge to tax for CGT / tax on corporate gains.

Part 5 of Schedule 5AAA gives the Treasury power to make regulations allowing the managers of property rich CIVs to elect to both supply information on disposals by non  - residents and to withhold amounts of UK CGT / corporation tax due on such disposals.  From an exchange of emails with HMRC it would seem that a decision has not yet been taken over whether such regulations will be brought forward and in any event it seems the intention is that it will allow rather than require reporting and deduction.

In the absence of reporting and deduction by the managers of property rich CIVs non  - resident investors in such schemes will be within the reporting rules in schedule 2 of Finance Act 2019.  In short this requires disposals to be reported, and an estimate of the tax due paid, within 30 days of completion.

Life Company Specific Legislation 

I have picked up the following specific references to life insurance companies in the legislation.

Schedule 4AA paragraph 2 (4). 

This paragraph sets out persons who are only chargeable to non - resident CGT on residential property disposals from 6 April 2019 and includes "a company carrying on life assurance business (as defined in section 56 of the Finance Act 2012) where the interest in UK land was, immediately before that date, held for the purpose of providing benefits to policyholders in the course of that business."  

I think the point here is that the general rule for non  - resident gains on UK property is that only gains arising after 6th April 2019 are taxed but for residential property the start date for CGT is 6 April 2015, as residential property sales by non residents were already within the charge to UK CGT from that date.  However, certain non  - resident investors including life insurance companies were able to elect out of the UK residential property CGT charge  (See Section 14F now repealed).  There is (at least as far as I can make out) no equivalent "opt out" for non  - resident life insurance companies from the 2019 legislation but this section ensures their liability to CGT is on property gains arising from 6th April 2019 onwards even on residential property (subject to an election to calculate the gain over the life of a holding).

Schedule 5AAA Paragraph 10

This paragraph relates to one of the two exemptions for offshore CIVs from the UK non  - resident CGT regime, the transparency election.  The transparency election allows non  - resident CIVs that are transparent for income to be treated as partnerships for gains so that the CIV is exempt from UK CGT but the participants pay tax on their share of gains on the underlying assets.  I think the expectation is this election will be of relevance to CIVs with a small number of investors most of whom are tax exempt and might include investments by UK life insurance companies.  Paragraph 10 provides:

"The election is treated as having no effect for the purposes of this Act in relation to any units in the vehicle which are held by an insurance company for the purposes of its long-term business."

The point here is that if an insurance company does invest in a CIV that makes the transparency election and if a portion of that investment was referable to BLAGAB it would be necessary to calculate the capital gain on each underlying asset held by the CIV which might be a significant compliance burden.  Accordingly, where the transparency election is made it does not apply to a UK life insurance company, which for BLAGAB will continue to calculate capital gains as before (probably under deemed disposal legislation).

Schedule 5AAA paragraph 33.  

This paragraph exempts UK property gains from the non  - resident CGT charge where:

"An exemption has been made under Schedule 5AAA for a qualifying fund or company, and

A participant in the fund disposes of a unit, and

The participant is a company which is wholly owned by one or more investors listed in paragraph 33."

If these conditions are met any gain accruing on the disposal is not a chargeable gain.  

The investors listed in paragraph 33 (4) include "a company carrying on life assurance business where, immediately before the disposal, its right or interest in the participant is an asset which, applying the rules in section 138 of the Finance Act 2012, is wholly matched to a liability of its life assurance business that is not BLAGAB." and

"A company carrying on long-term business none of which is BLAGAB where, immediately before the disposal, its right or interest in the participant is an asset held for the purposes of its long-term business"

It seems that what this section is trying to deal with is the situation where an investor that is exempt from UK tax uses a wholly owned vehicle as an intermediary to invest in an offshore property rich CIV which has made an election to be exempt from UK CGT.  Although both the investor and the CIV are exempt from CGT the intermediary company is not and might not be able to make an election under Schedule 5AAA paragraph 12. This legislation ensures there is no non  - resident CGT charged on the intermediary corporate investor and includes wholly owned subsidiaries which are non  - BLAGAB linked assets or owned by insurance companies with no BLAGAB.

The circumstances here are sufficiently esoteric that, presumably, some life insurance companies do use intermediary corporate structures for pension investment in UK property rich CIVs.