UK Budget 2021: issues and impact on non-resident landlords

The Chancellor made various announcements on 3 March in his Budget, which impact on the taxation of UK real estate. Recent years have also seen significant changes to the way in which non-residents investing in UK real estate are taxed.

The changes announced will be of interest to Channel Island structures investing in UK real estate and we've summarised below the key developments:

Taxation of income

For non-UK resident company investors in UK property, the taxation of UK property business income transitioned from UK income tax to UK corporation tax from 6 April 2020, and an increase in the rate of corporation tax to a rate of up to 25% from 1 April 2023 was announced today.

In addition to different tax rates, the transition to corporation tax means differences in how the taxable profits are computed. In particular there may be additional restrictions on the deductibility of interest, restrictions on deductions related to hybrid mismatches and restrictions on the amount of losses or even the availability of brought forward from earlier periods that can be offset.

Corporation tax returns are prepared by reference to accounting periods (generally ending on the date to which accounts are prepared rather than the fiscal year ending 5 April) and the dates on which tax payments are due have changed. For periods commencing after 6 April 2020, tax payment dates depend on the size of the company (by profitability). Where the profits for an accounting period are more than £1.5 million (reduced proportionally based on the number of 51% group companies, and the length of the accounting period if less than 12 months), the corporation tax payment date is accelerated. Under the quarterly instalment payment rules, up to four instalment payments may be required, all four of which may be due within the accounting period. For a 12 month accounting period ending 31 December 2021, the first payment on account may be due 14 March 2021.

The Corporation Tax main rate for the financial year ended 31 March 2021 is 19%.

It was announced on 3 March that the rate of corporation tax will increase from April 2023 to 25% on profits over £250,000. The rate for small profits under £50,000 will remain at 19% and there will be relief for businesses with profits under £250,000 so that they pay less than the main rate. These upper and lower limits will be proportionately reduced for short accounting periods and where there are associated companies. Where the accounting period of the company does not end on 31 March 2023, taxable profits will be apportioned for the purposes of applying the increased rate.

Non corporate investors continue to be subject to income tax on their UK property business income. The basic rate of income tax is 20%, and there are no proposed changes to the rates of income tax. Two instalment payments of income tax are due on 31 January during the tax year and on 31 July following the tax year, with a final payment due on 31 January following the end of the tax year.

Capital Allowances

From 1 April 2021 until 31 March 2023, companies investing in qualifying new plant and machinery assets will benefit from a 130% first-year capital allowance. This upfront “super-deduction” will result in a tax-saving of up to 25p for every £1 spent. Investing companies will also benefit from a 50% first-year allowance for qualifying special rate (including long life) assets. This will have effect in relation to qualifying expenditure from 1 April 2021 and will exclude expenditure incurred on contracts entered into prior to 3 March 2021.

However, there are a number of exceptions to the expenditure that will qualify for this “super-deduction” and the 50% allowance, including plant and machinery that is used for leasing (whether in the course of a trade or otherwise). Therefore, whether investors in real estate will be able to benefit significantly, directly or indirectly, as a result of this announcement, remains to be seen.

Subject to these changes, the main rate of capital allowances on plant and machinery continues to be 18% with the special rate relating to integral features also unchanged at 6%. As announced on 12 November 2020, the temporary £1,000,000 limit for the Annual Investment Allowance will be extended by one year.

Structures and Buildings Allowances are available on qualifying expenditure incurred on or after 29 October 2018. The annual rate of allowances was increased from 2% to 3% (from 1 April 2020 for corporation tax purposes and 6 April 2020 for income tax purposes).

Extended loss carry back

For property investors, there is no ability to carry back property-business losses and offset these against taxable income in earlier accounting periods. Companies may carry back excess non-trade deficits (e.g. interest deductions) in certain circumstances, although this is unlikely to apply in the case of a non-UK tax resident company.

In cases where activities are treated as a trade for tax purposes (e.g. a trade of dealing in or developing land), it was on 3 March today that the trading loss carry-back rule will be temporarily extended from the existing one year to three years. This will be available for companies (including non-UK tax-resident companies subject to UK corporation tax on their trading profits) as well as other taxable persons (unincorporated businesses) as follows:

Unincorporated businesses and companies that are not members of a corporate group will be able to obtain relief for up to £2 million of losses in each of 2020-21 and 2021-22.
Companies that are members of a corporate group will be able to obtain relief for up to £200,000 of losses in each of 2020-21 and 2021-22 without any group limitations.
Companies that are members of a corporate group will be able to obtain relief for up to £2 million of losses in each of 2020-21 and 2021-22, but subject to a £2 million cap across the group as a whole.

Hybrid and other mismatches

The hybrid mismatch rules, which apply to UK tax resident companies and non-UK companies which are subject to corporation tax (eg those carrying on a UK property business or carrying on a trade of dealing in or developing UK land) are aimed at counteracting arrangements that exploit the differences in tax treatments between jurisdictions. In particular, these rules may impact on real estate funds. Following lobbying by industry bodies, and a consultation process, there have been changes to the rules to try to ensure that they work proportionately and as intended.

The proposed changes were first announced in a policy document issued by HMRC on 12 November 2020 that was then subject to further consultation. A further policy document was issued today confirming the changes which were only slightly amended compared to the November announcement.

The following changes should make compliance with, and managing the, UK hybrid rules significantly more simpler for partnership fund structures.

There are three main provisions which should make the analysis simpler in relation to tax deductible payments (which are predominantly interest) to transparent fund vehicles (eg partnerships, contractual funds and Unit Trusts etc):

New provisions will be introduced such that any counteraction is disapplied where they arise in respect of participants who hold investments of less than 10% in those funds (note: the wording of this has changed slightly since November, such that it appears to no longer be a change to “acting together” but is now a simple reduction in the counteraction). This may mean that funds where some investors hold more than 10%, but those investors collectively do not meet the 25%/50% thresholds for each chapter to apply, may now be in the rules. However, in November the policy document stated these rules would be restricted to partnerships, in today's announcement, it now appears the relief is extended to all tax transparent funds.)
No counteraction will apply on hybrid entity mismatches which are not taxed at fund level if the recipient is a Qualifying Institutional Investor within the SSE rules.
Imported mismatches – payments through an equivalent regime (including ATAD2 countries) will turn off these rules.

For structures with US taxable investors/owners who have made check the box elections to treat the UK property holding structure transparent, a significant issue has been the application of the rules regarding double deductions. There are, again, 3 significant changes which should help the analysis going forward:

The 10% rule outlined above should still apply so there would be no counteraction for US taxable investors owning less than 10%.
Dual inclusion income – There will be a UK grouping system going forward, and a widening of DII for disregarded payments from the US. Therefore the quantum of available dual inclusion income against which double deductions can be offset should be increased.
Where amounts have been disallowed under the double deduction rules, in most cases, the ability to carry forward these amounts to future periods when future dual inclusion income may be earned was often eliminated by specific rules regarding the use of the losses in the US by the investor. These rules are now being restricted so it is expected that many more restrictions may now be carried forward and not permanently lost.

Taxation of non UK tax residents on capital gains on direct and certain indirect disposals of UK property

Since 6 April 2019, non-UK residents have also been subject to UK tax on capital gains on direct and certain indirect disposals of UK property. Non resident companies (including certain collective investment vehicles (“CIVs”) which are deemed to be companies) are subject to UK corporation tax. Other non-UK resident investors are subject to capital gains tax.

In addition to a sale, gift or transfer, a disposal (which includes a part disposal) may also be triggered in a number of other ways. These include the grant of a lease, the grant of an option over land, and the receipt of a capital sum (e.g. compensation for “rights of light” and payments made on the variation or early surrender of leases).

The indirect disposal rules apply where a person makes a disposal of an entity, in which it has at least a 25% interest (or any interest in the case of a disposal with an appropriate connection to a CIV), where that entity derives 75% or more of its gross asset value from UK land.

No further changes were announced in today’s budget, but regulations were laid yesterday following an earlier consultation.

One key change resulting from these regulations is that overseas life insurance companies and offshore CIV’s (which are either non-close or meet the GDO condition), and also meet the non-UK real estate condition (i.e. broadly, by reference to its prospectus the UK property is not expected to comprise more than 40% of its investments), will be outside of the scope of the charge where they have a disposal of a less than 10% stake in a UK property rich CIV which is a company. This change is retrospective to 6 April 2019.

This change is welcome, but targeted in its application and will depend on the particular facts and circumstances in each case.

UK withholding tax on interest payments

UK withholding tax may apply, inter alia, to yearly interest payments made by a UK tax resident company or a non-UK tax resident company which carries on a UK property business if that interest is regarded as “UK source”.

It was announced on 3 March that the provisions relating to the EU interest and royalties directive will be repealed.

The repeal will have effect in relation to payments made on or after 1 June 2021, unless the payments are made in “disqualifying circumstances”. Broadly, a payment will be made in “disqualifying circumstances” if it is made with the main purpose, or a main purpose, of securing the provisions being repealed by this clause (that is, to enable a payment to be made without withholding tax on the payment). In such cases the effect of the repeal will take effect in relation to payments made on or after 31 March 2021.

The repeal of these provisions will ensure that companies resident in EU member states will cease to benefit from UK withholding tax exemptions now that the UK no longer has an obligation to provide relief. As a result, EU companies will no longer receive more favourable treatment than companies based elsewhere in the world, and the UK’s ability to impose a withholding tax on cross-border payments of annual interest and royalties will be governed solely by the reciprocal obligations in double taxation Agreements.

Stamp Duty Land Tax (“SDLT”)

SDLT applies in relation to acquisitions of property in England and Northern Ireland. Different rates apply depending on the value of the property and whether the property is residential or non-residential.

Extension of the SDLT holiday

On 8 July 2020, the Chancellor announced an immediate SDLT holiday until April 2021 on the first £500,000 paid for a residential property in England or Northern Ireland. This has resulted in SDLT savings on residential property costing £500,000 or more of £15,000. The Government had originally stated that this holiday would not be extended. However, following lobbying by stakeholders, the Government has agreed to extend the £500k holiday until 30 June 2021. In addition, the nil rate band will not immediately revert to the previous level of £125k from 1 July 2021; instead the nil rate band will be maintained at £250k until 30 September 2021, after which it will revert to £125k.

In addition, the existing 3% additional dwelling supplement for buyers of second homes, corporate buyers and other property investors will remain. Further, the additional 2% foreign buyers surcharge will apply to residential property acquisitions from April 2021 (see further below).

Non-UK resident SDLT surcharge

As previously confirmed, a 2% SDLT surcharge will apply to non-UK residents purchasing residential property in England and Northern Ireland from 1 April 2021.

The additional 2% SDLT will apply to both non-resident individuals and non-natural persons (e.g. companies, trusts, partnerships), and will apply in addition to the existing SDLT rates of up to 15%.

A new residence test has been introduced for the purpose of the charge, which will apply in addition to the existing residential SDLT rates of up to 15%, so that the top SDLT rate for non-residents could be as much as 17%.

It will apply to residential properties such as apartments or houses (not including student accommodation), but will not apply to non-residential or mixed use land. It will not therefore apply where six or more dwellings are acquired and the purchaser elects to treat the acquisition as non-residential and so apply the 5% SDLT rate.

Where there are a number of joint purchasers, the surcharge will apply where only one of them is non-UK resident (with an exception for married couples or civil partners).

Individuals will be UK resident if they are present in the UK for at least 183 days during the period beginning 364 days before the date of transaction and ending 365 days after the date of the transaction (except for certain cases where it is an individual purchaser’s residence in the 12 months before the transaction which determines their residence).

UK company residence is broadly determined according to existing direct tax rules (i.e. UK incorporated or centrally managed and controlled in the UK). However, a UK tax resident close company (other than an OEIC or a UK REIT) which is controlled by non-residents will also be treated as non-UK resident for the purpose of these rules.

A company does not include a partnership or, for this purpose, a unit trust. Consequently it is the residence position of the partners and the trustees of the unit trust schemes that will be relevant for these entities.

Timely consideration of the rules will be needed given that the filing deadline for the SDLT return and payment is 14 days from the date of completion for most residential purchases.

VAT

A number of VAT changes were announced on 3 March.

The 5% reduced rate of VAT for tourism and hospitality will be extended to 30 September 2021. To transition back to the standard 20% rate, a 12.5% rate will apply for the subsequent six months until 31 March 2022.

The VAT registration threshold is to be frozen at £85,000 until 31 March 2024.

Any business that took advantage of the original VAT deferral on VAT returns from 20 March to 30 June 2020 can now opt to use the VAT Deferral New Payment Scheme to pay that deferred VAT in up to eleven equal payments from March 2021, rather than one larger payment due by 31 March 2021, as originally announced.

A new regime for late VAT returns and payments will be introduced from 1 April 2022.

The new late submission regime will be points-based, and a financial penalty will only be issued when the relevant threshold is reached. The new late payment regime will introduce penalties proportionate to the amount of tax owed and how late the tax due is. The government will introduce a new approach to interest charges and repayment interest to align VAT with other tax regimes.

Business rates

The Chancellor has extended the existing rates relief available to tenants. The reliefs are available for eligible retail, leisure and hospitality businesses until July 2021 and will continue to discount business rates bills in these sectors by up to two thirds after this, until March 2022.

The extension of relief is tailored and primarily targeted at smaller and medium sized businesses who have been forced to close, being capped at £2m of relief for businesses that were required to be closed on 5 January 2021, or £105,000 per business for other eligible properties. However, where the property is vacant and the liability to pay business rates falls on the landlord, no specific reliefs apply.

Freeport tax sites

A number of tax reliefs have been announced to encourage investment in Freeport tax sites. These include an enhanced 10% rate of Structures and Buildings Allowance for constructing or renovating non-residential structures and buildings, an enhanced capital allowance of 100% for companies investing in relevant plant and machinery, relief from Stamp Duty Land Tax on the purchase of land or property within Freeport tax sites in England and Business Rates relief in Freeport tax sites in England, once designated.

Other changes and consultations previously announced

Construction Industry Scheme (CIS)

New rules from 6 April 2021 require businesses that are not a mainstream contractor to monitor construction expenditure more regularly. When the cumulative spend on construction operations exceeds £3million within the previous 12 month period, the business will have to register for the Construction Industry Scheme ("CIS") as a contractor and begin operating the CIS on their next payment to a sub-contractor for construction operations. This is a change from the current rules that are based on a look back at the end of the accounting period and depends on how long the business has been trading.

Developer Levy and residential property development sector tax

Last month, the Housing Minister announced measures designed to raise revenues to fund the removal of unsafe cladding. There are two main aspects to these proposals.

Firstly, the 'Gateway 2' developer levy, which “will be targeted and only apply when developers seek permission to develop certain high-rise buildings in England...". Mr Jenrick indicated that the levy would be introduced through the Government's Building Safety Bill, which was first published in draft last July. The words used by Mr Jenrick appear to suggest that the levy will be introduced on a prospective basis, rather than based on developer profits generated over the last decade, as proposed by Sadiq Khan in December 2020.

The second aspect of the proposals is a UK residential property development sector tax, described as a new “tax” for the “UK residential property development sector” in 2022, which "will raise at least £2bn over a decade to help pay for cladding remediation costs”. A consultation on the policy “design” was promised in “due course”.

Review of the UK funds regime

The government has previously announced that it will undertake a review of the UK’s funds regime.

The first aspect of the review is the ‘Asset Holding Company consultation', which closed on 23 February 2021. This consultation is considering, amongst other things, whether there is a case for changes to the tax treatment of companies used by funds to hold assets to make the UK a more attractive location for these companies.

The second aspect is the broader 'Review of the UK funds regime', which is a wider ranging call for input covering direct and indirect tax and relevant areas of funds regulation.

Further information

If you would like to discuss this further, please do not hesitate to contact any of the individuals listed below or your usual PwC contact.