Recent tax changes and their impact on real estate finance
A number of recent and proposed tax changes are likely to have an impact on the world of real estate finance – this blog post provides a summary of some of the key changes. If you would like to discuss how these may affect you, please get in touch – it would be great to hear from you.
1. Offshore property trades subject to tax
In a reaction to perceived tax avoidance involving offshore property development structures, the Chancellor's Budget 2016 announced significant changes to the current rules in this area which, as announced at the Committee Stage of the Finance Bill 2016, apply from 5 July 2016. An anti-avoidance rule applies from 16 March 2016 to counteract arrangements that aim to avoid the new rules.
Before 5 July 2016 there was no UK tax for an offshore propco unless:
(a) it was UK tax resident (and no applicable double tax treaty overrides that residence);
(b) it was trading through a permanent establishment in the UK (having regard to any applicable double tax treaty);
(c) it had UK source trading profits (having regard to any applicable double tax treaty); or
(d) diverted profits tax anti-avoidance legislation applied.
HMRC believes offshore property development structures are not effective to avoid UK tax and has said it will investigate these, but is seeking to put the position beyond doubt with the new rules. The new rules go much further than simply blocking avoidance structures, however.
In summary, the new rules:
Remove the territorial restriction where a company has a trade of:
(a) dealing in land; or
(b) developing land,
regardless of whether the company has a permanent establishment in the UK and of the tax residence of the company.
Corporation tax or income tax will accordingly be applied on profits of the UK property trade. Importantly, no tax avoidance motive is necessary: this bites on any offshore property trading or trade of developing UK land.
The basic rule is backed up with:
(a) anti-fragmentation rules (e.g. using a two company dealer/devco structure to syphon value away from the tax charge);
(b) anti-enveloping rules (putting a corporate wrapper around the property); and
(c) a TAAR (targeted anti-avoidance rule).
Because this new rule changes the longstanding and well-understood tax position and can apply to what might be considered innocent transactions, great care is now needed in relation to any transaction involving UK property trading or development land being held offshore.
2. Tax deductibility of corporate interest
As part of the implementation of the OECD BEPS project, new rules restricting interest deductions in certain circumstances are due to take effect from 1 April 2017. In board terms, the rationale for the new rules is that interest expense deductibility encourages (for example) loading interest expense in the UK to fund expenditure in lower tax jurisdictions (and seeking a UK tax deduction against UK profits) and to combat a perception that high gearing is bad for the economy and distortive borrowing is unfair.
The new proposal is for:
(a) a Fixed Ratio Rule restricting interest deductions to 30% of taxable EBITDA in the UK;
(b) a Group Ratio Rule restricting deductions based on net interest to EBITDA ratio for worldwide group; and
(c) a de minimis of £2m net UK interest expense per annum.
The de minimis threshold will mean this issue does not apply to many borrowers, but where it applies, it will likely affect highly geared businesses (such as real estate based businesses) and its application is likely to be complex. In such cases, any tax modelling carried out in relation to a financing transaction would need to be revisited.
HMRC has launched a consultation on the detailed design policy and implementation of the new rules. The 90 page document demonstrates that the new rules are highly complex and subject to change prior to implementation – HMRC sought views on a number of questions and the consultation has now closed. It will be interesting to see how this develops.
3. Corporate loss relief
Budget 2016 also announced "modernisation" of the loss relief rules. Currently, companies can generally carry forward 100% of historic losses to use against future profits. However, losses can only be used against profits from the same income stream. The two key expected changes will change this position such that:
(a) for losses incurred after 1 April 2017, carried forward losses may be used against profits from other income streams or from other companies within a group; and
(b) where a company or group has profits in excess of £5 million, from 1 April 2017 only 50% of profits can be offset through losses carried forward.
The first change is positive for businesses and should reduce the headache of trapped losses. The second change is not so welcome and will, where it applies, reduce the value of carried forward tax losses. Whilst the first change only applies to losses incurred after 1 April 2017, it should be noted that the second change will apply to all existing carried forward losses.
These changes could impact any tax modelling carried out in the context of asset finance.
HMRC has launched a consultation on delivery of the new corporate loss relief rules. The consultation seeks views on some of the practical aspects of the proposed regime. Those wishing to respond to the consultation should do so by 18 August 2016. Let us know if you intend to respond or have comments.
4. Consultation on the Double Tax Treaty Passport ("DTTP") scheme
The DTTP Scheme allows foreign lenders who are entitled to a double tax treaty exemption (or partial relief) from withholding tax on interest paid to them to register and follow a simplified withholding tax exemption/relief process for each UK loan that lender enters into.
HMRC has published a consultation aimed at (i) checking the Scheme remains fit for purpose; and (ii) improving the scheme and possibly extending it to lenders who are not currently eligible to use the scheme (for example partnership and pension funds).
A review of operation of the DTTP Scheme, particularly in the context of transparent LLCs as well as partnership borrowers and lenders is to be welcomed.
Further details about the consultation are available on HMRC's website – the consultation closes on 12 August 2016. If you would like to contribute to our response to this consultation, we would be pleased to hear from you.