Reflecting the move of many governments globally to try and balance the books, the UK has seen the introduction of a variety of new property taxes, particularly targeting the residential sector.
The private rented sector (PRS), fulfilling a genuine commercial need in the UK, supporting London’s position as a global centre by accommodating its international visitors, has suffered less overall and in some cases, benefited. However, in general we have seen a situation where the non-resident and non-domiciled investor/landlord is now liable to the same taxes as UK landlords, removing some attractive benefits and in the Government’s rhetoric, “levelling the playing field”.
With careful tax planning, it may be possible to mitigate the impact of these new taxes and you should seek professional advice. However, there is also a move by the Government to encourage the role of property investment companies and institutional investors in the private rented sector. Whilst tax legislation is subject to change, quoted companies such as LCP’s property funds, are specifically exempted from the taxes below or, are unaffected. They therefore provide a very tax efficient alternative to direct investment when accessing the Prime Central London market.
By now, some of the new taxes have become familiar but below is a summary of some of the changes.
Annual Tax for Enveloped Dwellings (ATED)
ATED was introduced in April 2013, primarily levied on individuals using corporate wrappers, to acquire residential property for personal use. The ATED regime has three tax charges, an increased SDLT cost (15%) when acquiring property, an annual charge and also ATED related CGT. If ATED is applicable, then all three apply.
At the time, it was aimed only at residential properties having a value or cost in excess of £2m. However, ATED has since been extended to apply to properties over £1m from April 2015 and it is being extended again, to properties exceeding £500,000 from next April. The charge currently ranges from £7,000 to £218,000, with the introduction of a new £3,500 charge for the £500,000-£1m band from April 2016. For the purposes of the tax, the value of the property that is taken into account is the property value as of April 2012, or, if acquired or substantially improved post April 2012, its value at purchase or improvement.
Whilst ATED imposes an annual charge on each property, there are exemptions. The relevant one for PRS investors is based on a property being let to an unconnected third party on commercial terms. Nevertheless, an annual ATED tax return still has to be submitted for any property whose value falls within the ATED bands in order to claim exemptions.
The new SDLT Landscape
In December 2014, the Chancellor announced a belated overhaul of Stamp Duty Land Tax (SDLT), changing it from a slab tax to a graduated tax. As a result, almost all properties under £1.125m have benefited, paying less SDLT than under the old system. Above this, it all starts to get more expensive, hitting £1m of SDLT on a property purchase for just over £9m, significantly more than under the old 7% slab rate.
This has undoubtedly caused buyers at the top end of the market to pause for thought but it is unlikely to be a long term deterrent. It is at least an expense which can be taken into account at the point of purchase and it will probably be factored in as the cost of entry into a world class market.
The Chancellor has also done his homework on the levies so the tax is not out of kilter with other international centres such as Hong Kong or Singapore. The impact on the market at the top end may also be limited, given that Land Registry statistics recorded only 59 purchases above £10m in the last year.
It is also a fact that almost 60% of all properties in Prime Central London transact under £1m. Given that most properties acquired to target the PRS fall below this price point, these investors have actually benefited from the new tax legislation.
Capital Gains Tax for non-residents
In April 2015, non-resident CGT was finally introduced on both company and privately owned property – bringing offshore buyers in line with UK resident investors.
The new non-resident CGT is realised only on profit made on divestment, and gains made before April 2015 are ring-fenced.
There are a number of different rates. Lower rate individual tax payers (with an income under £42,385 p.a.) pay 18% of the gain, whilst higher rate tax payers are charged at 28%. If the property is rented and held in a corporate wrapper, it is 20%, which will reduce to 18% by 2020, in line with the reduction in UK corporation tax.
The good news is that there are a number of allowances which can be deducted in calculating the gain chargable to CGT. Broadly these are:
- The Annual Exempt Amount: £11,100 for the current tax year 2015-16; all individual joint owners can use their exemption.
- Stamp Duty Land Tax, VAT, fees or commission for professional advice or services, for example, legal and estate agency fees.
- Improvement costs to increase the value of the property.
- Any other capital losses realised on the disposal of other assets in the UK in the same or previous years.
- For corporate vendors, an indexation allowance for inflation
The implementation of this non-resident CGT is not expected to have significant impact on the property market. As a tax realisable only on gains, the absence of CGT has been a bonus for international buyers, not a fundamental driver. The advance warning last year did not have a negative effect on investors’ appetite and seems to have been accepted with resignation.
However, investors may be interested to know that there is an exemption for widely held or listed companies. Residential properties which have genuine diversity of ownership, such as LCP’s quoted property investment companies, will not be liable to the new non-resident CGT.
Mortgage interest relief
In the summer Budget of July 2015 it was announced that the level of interest relief for Landlords with buy to let mortgages would be restricted on a staged basis from 2017. This was justified as addressing an apparent anomaly with owner occupiers who do not enjoy tax relief on their mortgages.
Currently, individual landlords can deduct a variety of costs from their rental income before they pay tax. This includes 100% of their mortgage interest, resulting in preferential tax relief at 40% and 45% for individaul landlords in the higher tax brackets (i.e. due on income over £42,385 p.a.)
From April 2017, the level of tax relief will be gradually reduced as follows and by April 2020, it will be 20% for all individuals:
- 2017-18: the full deduction of mortgage interest from property income at the higher rates of tax will be restricted to 75% of finance costs, with the remaining 25% attracting tax relief at the basic rate of tax at 20%.
- 2018-19: the full deduction of mortgage interest will be restricted to 50% and 50% will attract tax relief at the basic rate of 20%.
- 2019-20: the full deduction of mortgage interest will be restricted to 25% and 75% will attract tax relief at the basic rate of 20%.
- From 2020: all mortgage interest will attract tax relief at the basic rate of 20%.
Whilst many UK based PRS investors will see tax relief on their mortgage interest reduced, foreign buyers who own a single buy to let property or a small portfolio are unlikely to be affected by the new regime as the new relief restrictions primarily impact those subject to higher rate UK income tax.
Landlords who generate net income below the basic rate band, after all other allowable expenses, will not be affected, but additionally those making losses may find it difficult to carry forward unused interest relief in future due to the way in which the new rules operate. Allowable expenses include letting and management fees, other professional fees, service charges, replacements, repairs and maintenance, both at acquisition stage and on an ongoing basis. Income tax can also be mitigated by having joint owners, each of whom enjoys the interest relief. In any event, as a ‘commercial asset class’ any increased cost to the landlord is likely to be reflected in increased rent.
Finally, those who own properties through a corporate wrapper will remain unaffected as they already pay income tax at the basic rate. As corporate structures, this will apply to LCP’s funds which are therefore not affected by the new income tax regime.
Non-Domicile Inheritance Tax (IHT)
Another change announced during the Budget was that from April 2017, IHT will be payable on all UK residential properties owned by non-domiciles, including property held through off-shore structures. There will be a consultation period to determine how this is implemented.
Property owned by non-domiciliaries in SPVs will now be subject to UK inheritance tax laws. IHT is chargeable at 40% but again, there are ways of mitigating the tax. A loan taken out to acquire the property may provide shelter from IHT, as IHT is only chargeable on the equity component. There is also an exemption, currently £325,000 per individual holding the property. As with the introduction of the new income tax regime, landlords should definitely consider broadening the ownership base amongst the family.
The government says that there is no intention to change the IHT position of non-doms generally or in relation to any assets other than UK residential property. Consequently, like the new non-resident CGT, there is expected to be an important exemption from non-dom IHT for widely held or listed companies. LCP’s funds, which have genuine diversity of ownership should again be exempted from non-dom IHT.
General Market Impact
Whilst the medley of new taxes may cause some landlords to sell, we expect the net effect in Prime Central London to be minimal.
The shortage of stock and its global desirability is likely to continue to drive demand. With only about 3,500 sales (just 68 a week) under £1m transacted in the calendar year to Q2 2015, the lack of supply is likely continue to underwrite price growth.
The PRS is likely to be ‘business as usual’, particularly in Central London which still provides capital returns far higher and more stable than most other asset classes.
For individual investors, there are often ways to mitigate the new taxes with careful planning.
As an alternative, LCP’s latest property fund, London Central Apartments III (LCA III), is probably one of the most tax efficient ways of investing in the market. Whilst tax legislation is subject to change, it is exempted from ATED, non-dom IHT, NRCGT and is unaffected by changes in mortgage relief and SDLT. In addition, in benefits from buying power, management expertise and diversification. LCA III, is now taking subscriptions. Click here to find out more information on LCA III
For professional tax advice, you can contact Pankaj Shah at Lubbock Fine, Chartered Accountants, Paternoster House, 65 St Paul’s Churchyard, London EC4M 8AB. Telephone: 0207 490 7766. E-mail: firstname.lastname@example.org