Finance Act 2019 has introduced two significant changes to the taxation of non-resident companies in respect of property income arising in the UK:
- From 6 April 2019 – Disposals of direct or indirect interests in UK land are brought into the charge to corporation tax, and
- From 6 April 2020 – Income from a UK property business is brought into the charge to corporation tax rather than income tax.
Certain existing rules are also abolished. Given this and the transitional way in which these amendments have been introduced – which has created unique compliance requirements – there are a number of potential pitfalls in this area that are waiting to catch out the unwary.
In this article, we seek to provide clarity as to the position by delving into the details of these changes from a technical and compliance perspective.
Road to reform
The objective of the amendments was to improve fairness in the UK tax system by ensuring that, in respect of income derived from UK property, UK residents and non-UK residents are both subject to broadly the same treatment.
As is the current approach for important legislative changes, the tax industry has been provided with a good deal of notice and opportunity to comment on the details of these amendments. After the policy was first announced at Autumn Budget 2017, an initial consultation was held before draft legislation was produced in July 2018. This was followed by a second period of technical consultation before the legislation was finalised for inclusion in Finance Bill 2018-19, published in November 2018, which progressed through Parliament to become Finance Act 2019 on 12 February 2019. The hope is that this extended and more collaborative approach to law-making leads to improved legislation that delivers the policy objectives of Government in a targeted way. The wording of the two relevant Schedules in this case was very nearly unchanged as the Bill passed through Parliament, illustrating the effect of the work done to get the legislation right before it is put forward.
Income from a UK property business
Position for individuals
We begin our technical analysis by considering income from a UK property business and recapping the position for individuals. Individuals are subject to UK income tax on net profits from renting property in the UK. This applies whether or not the individual is UK resident. The normal statutory residence test is not used in this case, and instead an individual is regarded as a non-resident landlord if they live abroad for 6 months or more per year.
A collection of UK properties is treated as one business for the purposes of working out the overall profit or loss of the activity. Revenue expenses (not capital) incurred wholly and exclusively for the purposes of renting out the properties are generally deductible. Certain exclusions apply however, for example a restriction on deduction of finance costs such as mortgage interest to the level of basic rate tax is presently being phased in. A number of allowances are also available such as the £1,000 tax-free allowance for property income which was introduced in 2017. Tax is charged according to the income tax band for the amount of taxable income, starting at 20% and increasing to 40% at the higher rate and 45% at the additional rate.
To defeat widespread non-compliance, HMRC legally require that letting agents withhold basic rate income tax from payments of rent to non-resident landlords. Such landlords may however apply to receive rent without deduction of UK tax by making themselves known to HMRC – essentially promising to play by the rules – via a form NRL1.
Position for companies
Taxation of UK resident companies in respect of income from a UK property business has remained stable, with profits forming part of profits chargeable to corporation tax. Corporation tax is currently charged at 19%, to be reduced to 17% from 1 April 2020. Details of such income will be included on a Company tax return form CT600 which must be filed electronically within 12 months of the end of the relevant accounting period. Tax residence for companies in most countries is determined based upon the place of incorporation, however many including the UK also apply an additional test based upon the place of central management and control. See Statement of Practice 1 (1990) for details of HMRC’s view on company residency.
Non-UK resident companies are presently subject to income tax in respect of property income arising in the UK. Such companies are required to complete an annual Tax return for a non-resident company liable to Income Tax form SA700, due by 31 January following the end of the relevant tax year. Tax is chargeable at the basic rate of income tax.
With effect from 6 April 2020 however, non-UK resident companies are being brought into the charge to corporation tax rather than income tax in respect of property income. Finance Act 2019 has brought about this by introducing an amendment to the existing Territorial scope of charge provisions at CTA 2009 s5. Profits and losses will accordingly be drawn up under corporation tax principles according to the rules of CTA 2009 Part 4. Loan relationships or derivative contracts that the non-resident company is party to for the purposes of its UK property business are also brought into the charge to corporation tax.
Transitional provisions apply where a company period of account straddles this date, with the period being treated as two notionally separate periods, thereby requiring apportionment of income and expenses per the accounts. UK property business income tax losses carried forward at point of transition are grandfathered, and will be deductible under corporation tax rules against future income of the property business without considering the loss restriction (the normal rules for carried forward property business losses is that they are offset against total profits under CTA 2010 s62, subject to the loss restriction). Capital allowance balances will transfer between the two regimes in such a way as to produce no balancing allowances or charges.
Given the transition has been designed to be seamless, and the benefit of a lower headline rate of tax, non-resident landlords may view being moved to corporation tax as welcome. However, there are additional considerations to be borne in mind. Non-resident landlords will be required to register with HMRC for corporation tax and complete a form CT600, preparing their tax return under a different set of rules and becoming subject to mandatory online filing and XBRL tagging (including tagged accounts – there has been no indication from HMRC that non-resident companies with UK property business income are not going to be subject to the normal requirements); a change of compliance requirements and processes which will take some time to adjust to. For bigger businesses, payments of tax will fall due significantly earlier than before under the quarterly instalment payment provisions for large and very large companies (although it should be noted that these payment regimes are specifically switched off in the legislation for the first accounting period following transition). Certain other aspects of the corporation tax rules may also unexpectedly come into play, with the corporate interest restriction being a key example for any highly geared companies.
Disposals of UK property
One year before the UK property business changes take effect however, the rules for disposals of UK property by non-residents are changing and, here, recent history is more complicated as successive Governments have introduced piecemeal amendments to the area.
Taxation of UK residents has again remained stable; upon disposing of property, UK resident individuals are subject to capital gains tax and companies are subject to corporation tax.
For individuals, total taxable gains are derived by summing together any gains (proceeds less allowable costs) from each disposal and deducting any allowable losses. An annual exempt amount – £12,000 for the tax year 2019-20 – is then deducted to arrive at the amount chargeable. The rates of capital gains tax are 10% for basic rate taxpayers and 20% for higher or additional rate taxpayers, although these rates are uplifted in the case of disposals of residential property to 18% and 28% respectively.
For companies, gains and losses are determined broadly under standard capital gains tax principles although there are certain computational differences such as the absence of an annual exempt amount, or the availability of indexation allowance for assets acquired before 1 January 2018.
Before considering disposals made by non-residents, it is relevant at this point to recap the basics of the Annual Tax on Enveloped Dwellings (ATED). Introduced in April 2013, this is an annual charge on UK residential property owned through a corporate structure. The barrier to entry was originally set at properties with a value of more than £2m, but this has since reduced and has been £500,000 since 2016-17. Commercial properties are not classed as a dwelling and so are not included in the charge. As well as offices and factories and the like, this exclusion will also cover properties such as hotels and hospitals.
Subject to any reliefs and exemptions available, the amount chargeable is determined using a banding system based on the value of the property, ranging from £3,650 up to £232,350 for properties with a value of more than £20,000,000 for 2019-20.
An ATED return must be submitted to HMRC by 30 April following the tax year along with payment of the charge. ATED continues unchanged following Finance Act 2019.
In addition to the annual charge, gains on disposals of properties within the scope of the charge were brought into the capital gains tax regime. This applies whether or not the company making the disposal was UK resident. Rebasing was available from April 2013 for the purposes of calculating the chargeable gain or allowable loss. ATED CGT was charged at a flat rate of 28%, and a return was required by 31 January following the tax year of disposal.
The recent introduction of ATED CGT aside, the UK historically has not taxed non-residents on gains arising from disposals of UK assets. The relevant legislation for individuals (TCGA 1992 s2) and companies (CTA 2009 s5) included residence conditions which limited the scope of capital gains tax and corporation tax on disposals to UK residents only. This unfairness in the tax system – when compared to UK resident individuals and companies who were taxed on such gains – was targeted in the 2014 Budget.
Non-resident capital gains tax (NRCGT) was duly introduced by Finance Act 2015. This brought into charge disposals of UK residential property interests made by non-residents – both individuals and companies – from 5 April 2015. Rebasing was available from April 2015 in this case, and a return was due along with payment of tax within 30 days of the disposal.
Finance Act 2019 reforms
Following Finance Act 2019, and with effect from 6 April 2019, the concepts of both ATED CGT and NRCGT are removed from the legislation. The principle of NRCGT however is retained in a new and extended format.
In tax law rewrite fashion, the entirety of TCGA 1992 Part 1 has been replaced to primarily restate the existing rules in an updated structure. The key changes for non-residents have made their way in however with the new s1A now defining the Territorial scope as including both UK residents and also non-UK residents who make either a direct disposal of an interest in UK land, or an indirect disposal. The term “interest in UK land” for these purposes is defined by a new s1C which confirms that buildings and structures are included as well as the land itself. Indirect disposals are disposals of shares in a company that derives at least 75% of its value from UK land, provided that the person making the disposal has an investment of at least 25% in that company.
The scope of taxation for non-residents has therefore been extended from targeting UK residential property specifically, to now including commercial property and disposals of shares in so-called ‘property rich’ entities. New s2B continues to bring companies into the charge to corporation tax, rather than capital gains tax, in respect of disposals.
Rebasing again applies from either April 2019 or April 2015 depending on whether or not the asset was previously chargeable within the NRCGT rules.
Registering for corporation tax
Non-resident companies who dispose of UK property or land from 6 April 2019 will be required to register with HMRC for corporation tax self-assessment. HMRC have published the following page which provides specific guidance on this process:
Businesses are required to register with HMRC within 3 months of becoming chargeable to corporation tax, being the date of the disposal (there are a limited number of types of disposal – broadly where no chargeable gain or allowable loss arises – which are exempt from the registration requirements). HMRC will issue a new Corporation Tax UTR and the business will then be required to register for HMRC online services in order to submit an electronic tax return.
In respect of the accounting period of the return, the HMRC guidance confirms that where the business has no other activities in the UK, the return will be for a one day accounting period covering the date of disposal. Any subsequent disposals will then require further one day accounting period returns. XBRL tagging is required for these submissions, but accounts do not need to be attached.
Tax will be due according to the normal rules, which due to the unintended application of the quarterly instalment payment provisions for very large companies (the threshold on taxable profits of £20m divided by 365 days means that gains over £54,795 will be caught) may be on the date of disposal. However, HMRC say that they will apply concessionary treatment in these cases and tax will be due 3 months and 14 days after the end of the one day accounting period.
From April 2020 – at which point UK property business income is also brought into the charge to corporation tax – the position should become more straight-forward for many non-resident companies with an annual tax return becoming due, including details of both UK property business income and any property disposals for the accounting period as a whole.
The combined effect of these changes represents a significant shift in regulatory requirements for non-resident companies holding an interest property in the UK. With the complexity of the rules that already existed, and the staggered way in which reform has been introduced, we are presented with a challenging landscape for taxpayers and advisors to navigate over the next few years.
Action should be taken sooner rather than later to understand the details of how the new rules will affect particular businesses, and the relevant timelines, in order to plan effectively. Particular attention should be paid to the obligations a business has to HMRC, including notification of chargeability.
At Tax Systems, we are experts in compliance technology and our software has been helping clients to stay ahead of changes to the tax system for more than 25 years. Our market leading corporation tax solution Alphatax deals with all aspects of company taxation including non-resident property income and chargeable gains. Contact firstname.lastname@example.org to find out more.