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Expat Briefing Editorial Team
07 February, 2014
For non-residents, one of the main attractions of property investment in the United Kingdom was that traditionally, it could be done mostly free from taxation. All this seems to be changing as a result of recent government measures, however.
Governments across the world, but particularly in Europe, are still seeking to close budget gaps by increasing taxes, and as dwellings and other types of property are considerably less mobile than personal and corporate incomes, they have become a tempting target for finance ministers. Ireland, Greece, Cyprus, France and Germany are among the countries that have raised or tightened property taxes in the last year or so.
Meanwhile, some governments are using higher or additional property taxes to cool real estate markets, including Hong Kong, Singapore and China where there are fears of a property bubble.
Undeniably, the UK Government is using recent property tax hikes to assist its deficit reduction and anti- tax avoidance efforts. However, with the country’s property market recovering much faster than expected and anxieties being expressed that prices are rising too fast, especially in London, it could be said that the new tax hikes are also serving to apply the brakes to the market, even if this policy intent is implied rather than explicit. Prices in prime central London ended last year 7.5% higher, according to estate agency Knight Frank, with some areas of the city seeing home values rise by 15% in 2013.
Either way, the wisdom of these tax hikes (outlined below) aimed primarily at non-resident investors has been called into question at a time when the government is attempting to encourage foreign investment.
Tax on “Enveloped” Dwellings
Previously called the Annual Residential Property Tax, the Annual Tax on Enveloped Dwellings (ATED) was first announced in the 2012 Budget and is designed to deter “non-natural persons”, i.e. companies, from being used as “corporate envelopes” to avoid Stamp Duty Land Tax, payable when a property is purchased in the UK, at a level dependent on the property’s value.
In force since April 1, 2013, the ATED applies to dwellings situated in the UK valued at more than GBP2m on April 1, 2012 and owned completely or partly by a company, a partnership where one of the partners is a company, or a collective investment vehicle, for example, a unit trust or an open ended investment company. The tax applies at the following rates:
GBP2,000,001 to GBP5,000,000
GBP5,000,001 to GBP10,000,000
GBP10,000,001 to GBP20,000,000
GBP20,000,001 and over
Relief from the ATED is available for working farmhouses and exemptions for properties open to the public and for those either owned by or held on behalf of charities.
In tandem with the ATED, the government has also increased the rate of SDLT for enveloped properties to 15% and extended the capital gains tax regime to include the disposal of UK residential property by non-resident, non-natural persons for more than GBP2m.
David Gauke, Exchequer Secretary to the Treasury, said of the measures that: “The government is determined to take action against those who attempt to avoid paying their fair share of tax on residential property. While most people pay their taxes, there are some who try to avoid paying their fair share. We are determined to clamp down on tax avoidance of all kinds and by introducing these two changes, we are taking action to ensure that everyone pays the tax they owe when buying and selling high-value residential property.”
About 90,000 properties are estimated to be affected by this enveloped dwellings tax. But, despite the government’s best intentions, the measure has inevitably attracted much criticism.
Patrick Stevens, tax partner at Ernst & Young, said that while stamp duty avoidance on high value home purchases had been “rife”, the government’s response was nevertheless “draconian”.
“Many people will be able to understand the reason for these changes. However some people hold property through companies for reasons completely unconnected with tax. For example, for people who come from certain other countries who have forced heirship rules, it is the only way of passing on their assets as they wish to do so. For others it is important to maintain privacy about their assets. In these and other cases these rules will have difficult side effects.”
Paul Emery, real estate tax director at PwC picked up on the extension to the CGT regime, noting that the rationale for this measure “was never clear, given that the aim of the measures was apparently to encourage the sale of bricks and mortar (subject to Stamp Duty Land Tax) and discourage sales of the property owning company (tax free). These measures make it even more expensive to transfer bricks and mortar compared to shares in companies.”
Another big problem faced by non-doms when "de-enveloping" out of corporate ownership, says Emery, is that without further planning, houses will usually then fall within the scope of UK inheritance tax. “The decision to de-envelope can therefore be finely balanced,” he added.
Furthermore, there is doubt among property owners as to whether an SDLT charge arises when the property is transferred out of the company. “HMRC will not help taxpayers to determine their tax position prior to them undertaking a de-enveloping, leading to considerable uncertainty," said Emery.
UK tax experts giving evidence to a House of Lords committee last year also criticized the tax, with one warning that the legislation is too weak to succeed in its aims.
Richard Murphy, who heads Tax Research UK, explained that the legislation is predicated on knowing the name of the "beneficial owner" of a property, but that it will not be possible to get this information in the case of offshore holdings without stronger legislation making it obligatory to identify ownership in the UK.
Bill Dodwell of the Chartered Institute of Taxation expressed the view that the government had suspended its tax policy approach in launching the legislation, and he argued that problems with SDLT avoidance were down to past poor enforcement by HMRC that had "got out of control."
Capital Gains Tax
Although the measure had been foreshadowed for some months, the confirmation that from April, 2015, capital gains tax at 28% will apply to gains made by non-residents on the sale of residential property in the UK still came as something of a shock when it was announced by Chancellor of the Exchequer George Osborne in his Autumn Statement last December.
The Chancellor's justification for this was that it is "not right that those who live in this country pay capital gains tax when they sell a home that is not their primary residence – while those who don't live here do not."
However, it was thought that the whole point of leaving the CGT exemption in place for foreign buyers while heavily taxing “enveloped” properties was to encourage more direct ownership of UK real estate by foreigners, which the new measure will clearly not encourage.
Unsurprisingly, a number of concerns have been raised about this proposal. Firstly, it is unclear how the tax will be administered and enforced.
“It is possible a withholding will be required by purchasers, in line with the position in the US,” observed Patricia Mock, a tax director in the private client services practice at Deloitte. However, she cautioned that “numerous complexities” will have to be considered by the government, “not least the interaction with already existing beneficiary charges in respect of trusts. Needless to say, the period of consultation is welcomed.”
Secondly, while aimed at rich foreigners – the proposal has already been dubbed the “oligarch tax” – the charge will hit all non-residents including people who retire abroad and keep their UK property to rent it out.
And thirdly, the proposal seems out of kilter with the government’s slogan that the UK is “open for business.”
“The tax can be easily avoided - the owner just retains and never sells the property,” argues Rosalind Rowe, real estate tax partner at PwC. “It is unlikely to dampen the heat of the housing market and the costs of policing and collection will result in a potential net loss of revenue for the Exchequer. It also gives the wrong message - is Britain really open for business?"
Craig Kemsley, partner and London head of private client tax at Grant Thornton believes that the tax could create a level playing field between UK and overseas investors, but warns that “there is a risk that any changes will create more of an administrative burden for the Government with little additional tax being raised ... [and] by trying to make it more difficult for overseas investors to invest into UK property we are potentially jeopardizing the significant other economic benefits they bring when investing in UK real estate, which should not be underestimated."
The new measures announced by the government over the past year mainly target foreign buyers of high-end UK property (predominately, it has to be said, in London). It has so far resisted the temptation to tax valuable properties owned by resident individuals, but a “mansion tax” is supported by the opposition Labour Party and by the Liberal Democrats, who form the minority in the current coalition government.
The two parties claim that a 1 percent levy on properties worth more than GBP2m would raise between GBP1.7bn and GBP2bn annually, before taking account of exempted properties. However, the proposal has been dismissed, by both the Conservative Party and the property industry.
According to a report by Knight Frank, as many as one in ten properties defined as "mansions" would be one- and two-bedroom flats, and that to meet revenue targets the threshold would have to be lowered to as little as GBP1.25m. This would more than double the number of properties liable to pay the levy, from 55,000 to 140,000. It also warned that if the GBP2m threshold is not increased in line with inflation, properties currently valued at GBP540,000 would be affected by 2038.
Revenue may also be lessened by homeowners dividing properties into less valuable units, and there may be further economic consequences as homeowners avoid making home improvements that add value to a property.
Knight Frank also highlights the plight of those who are cash-poor but equity-rich. The Liberal Democrats have suggested that for older people the tax could be deferred and paid from their estates after their death, but Knight Frank suggests that interest charges would create a "significant increase" in the overall charge over twenty years.
Senior Conservative figures in the government seem firmly against the idea of a mansion tax, making its introduction unlikely for the foreseeable future at least.
Empty Homes Tax
However, as homes becoming increasingly unaffordable for the vast majority of ordinary Londoners, the clamour for extra taxation on those buying up property but not using it has intensified recently, stoked by Conservative Mayor Boris Johnson’s revelation that he would "welcome" a new empty homes tax.
In the wake of a media report showing that some properties bought for investment purposes in London's most expensive street are dilapidated, it has been suggested that a 150 percent council tax surcharge should apply to homes that remain empty and unused for long periods.
Johnson recently raised the issue of empty houses owned by the super-wealthy during last month's Mansion House London Government Dinner. He said that foreign buyers should either live in or rent out their London properties, which should not be seen as "blocks of bullion in the sky." However, he also warned the Government not to "slam the door" on foreign buyers.
Since April, local governments have had the power to impose an empty homes premium of up to 50 percent on properties that have been unoccupied and unfurnished for 2 years or more. According to the government this premium, along with other measures introduced since 2010, had brought 40,000 properties back into use.
Unsurprisingly, the Labour Party has called for even tougher sanctions, with one MP suggesting that councils should be able to treble rates for unoccupied properties. But even the architect Richard Rogers, who has advised Boris Johnson, has entered the fray, suggesting a "severe" new tax for properties that are empty for more than six months to reinforce the principle that "owners of buildings have a social responsibility as well as an economic one".
For some however, the idea of the state telling an owner how to use his or her property goes fundamentally against the grain of the British tradition, which has a long history of upholding the rights of private ownership.
Trevor Abrahmsohn, whose estate agency Glentree International focuses on prime properties in northeast London accused councillors of politicizing town planning, and argued that as the UK is a free country owners should have the right to keep their properties vacant if they so wish.
Anthony Harris, chairman of UK200Group member firm Critchleys was more strident in his criticism of these proposals, calling the philosophy of Rogers “frightening”.
“Some people are looking at all sorts of ways to raise taxes. Next week it will be on the pair of shoes that you haven’t worn for six months,” Harris retorted.
“If someone owns something, being a house or a pair of shoes surely it is up to them to decide when and how often they will be used? If the government start interfering in the way suggested, it is social engineering on an incredible scale and where will it end? Do I have to pay an extra tax because no one has slept in my spare room for the last six months?”
Like the so-called mansion tax, the empty homes tax is unlikely to find favour with a Conservative-led government which professes to be economically liberal and on the side of investors. But then why the ATED and the “oligarch tax”? The former is understandable given the government’s unprecedented crack down on tax avoidance, and the latter may well dampen demand for London property, with Knight Frank predicting price growth slowing to 4% next year. Then again, neither measure is expected to raise much in additional revenue, and according to Knight Frank, tax is “not the overriding concern” for overseas buyers in London. Nevertheless, the succession of recent tax changes has still unsettled some buyers and is indicative of regulatory uncertainty, which is precisely the opposite of what the government is trying to achieve. If nothing else though, as bankers continue to behave badly, such “bash the rich” measures are popular at the moment, and a general election is looming on the horizon in 2015. So the reasons for these new taxes are as much political as fiscal or economic.
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