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Country - England & Wales
Taxes
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A. AVAILABLE INVESTMENT STRUCTURES
Which legal structures are available for an investment in real estate in the UK?
Investors who wish to invest in real estate in the UK have a number of options: direct acquisition of the real estate; indirect acquisition via a tax transparent vehicle, for example, a form of partnership; indirect acquisition via a partially tax transparent vehicle, for example, a non-UK resident unit trust and indirect acquisition via a resident, or non-resident, corporate vehicle holding the real estate.
B. TRANSFER TAXES, NOTARY FEES AND OTHER ACQUISITION COSTS
How is the purchase of a real estate asset taxed?
The following indirect taxes may apply:
Asset deals:
- Stamp duty land tax is payable at a rate of up to 4% when a buyer acquires an existing interest in real estate.
- Stamp duty land tax is also payable if the buyer is granted a new lease: up to 4% is payable on the price of the lease, with a separate 1% charge on the net present value of rent payable under the new lease.
- VAT is payable at the rate of 17.5% (unless the purchase is a transfer of a business as a going concern).
Share deals:
- Stamp duty at a rate of 0.5% is payable if the company is a UK company. No stamp duty is normally payable on the sale and purchase of shares in non-UK companies.
Which taxes apply depends on the terms of the transaction and the type of interest acquired. For example, if a buyer acquires an interest in a partnership with property investments, stamp duty land tax applies at the 4% rate. If the buyer acquires units in a non-UK unit trust holding real estate, no stamp duty land tax or stamp duty applies.
VAT may be recoverable from the UK tax authority.
Do any specific rules for transfer taxes apply if the asset is a shopping centre or another asset used for retail activities?
No.
In practice, 4% stamp duty land tax normally applies to the direct purchase of a shopping centre. This would usually be regarded as the transfer of a business as a going concern so VAT does not apply.
How is the purchase of shares in an SPV holding real estate taxed?
A 0.5% stamp duty may apply to the consideration given for the purchase of shares in a UK company.
No VAT is chargeable.
Who normally pays the transfer taxes, the buyer or the seller?
The buyer pays stamp duty land tax.
Where stamp duty applies there is no legal requirement as to who pays it. However, in practice, it is almost always paid by the buyer.
Are notary fees determined by law or should they be negotiated?
There are no notary fees.
Are there any other costs related to the purchase of real estate assets or SPVs?
Other costs include the fees of professional advisers.
Where the buyer acquires an interest in real estate, this will need to be registered in the UK Land Registry. Relatively small fees apply depending on the value of the real estate interest acquired.
C. TAXATION OF RUNNING INCOME
How is income generated from the letting of real estate taxed in the UK?
(a) Direct investment through a permanent establishment ("PE")
If the real estate is held by a non-resident company which carries on a trade in the UK through a PE, and the land in question is held by, or for the benefit of the PE, then UK corporation tax is payable at a rate of up to 30% (reducing to 28% from April 2008).
All non-UK investors pay UK income tax at rates of up to 40% on income generated from the letting of UK real estate, regardless of their connection with the UK.
Tax is payable on profits, calculated after the deduction of costs relating to the investment. Although subject to thin capitalisation rules, permitted deductions include interest. In addition, the real estate owner may be able to claim some tax depreciation allowances (rates are set by UK legislation and not determined by the accounting treatment of the asset).
Withholding tax applies to any payments of rent to persons outside the UK. Tax is withheld at the rate of 22% of the gross amount of the rents. However, it is possible to avoid withholding tax by making an appropriate claim to the UK tax authorities. If the claim is accepted then the recipient of the rents is required to self-assess and pay its annual UK tax to the UK tax authorities.
(b) Direct investment without a permanent establishment
A non-resident corporate investor without a UK PE pays income tax on profits at the rate of 22%.
As stated above, non-UK individuals pay UK income tax at rates of up to 40%. In practice, if the withholding tax of 22% is paid on the rental income, then the UK tax authorities normally do not impose any further taxation on this income, even where the 40% tax rate (on profits) may have applied.
(c) Indirect investment through a corporate entity (a non-transparent entity)
If the corporate entity is UK resident then UK corporation tax is payable on profits at a rate of up to 30% (reducing to 28% from April 2008).
If the corporate entity is non-resident but carries out business in the UK through a PE, and the property is held by, or for the benefit of the UK PE, then UK corporation tax is payable on profits at a rate of up to 30% (reducing to 28% from April 2008).
If the corporate entity is non-resident and does not have a UK PE then income tax is payable on profits at the rate of 22%.
(d) Indirect investment through partnership (a transparent entity)
With very few exceptions, all types of partnership are considered to be transparent for income tax purposes. Any profits generated by the partnership are treated as the profits of the partners and taxed accordingly.
How can income generated by investment be transferred to a foreign investor?
(a) Direct investment through a permanent establishment
Once tax has been paid on the income, no further taxation applies to its transfer to a foreign investor.
(b) Direct investment without a permanent establishment
As above.
(c) Indirect investment through a corporate entity
Dividend distributions to shareholders
Dividends can be distributed to shareholders with no additional tax payable by the company distributing them.
Taxation at the level of the shareholder
Dividends paid by a UK company are subject to tax at the level of the recipient, in accordance with the tax regime of the shareholder's home jurisdiction.
If the recipient is another UK company no further UK tax applies. Where the recipient is a UK individual, UK income tax is payable at an effective rate of up to 25%.
Where the recipient is not UK resident, no further UK tax applies.
(d) Indirect investment through a partnership
Because partnerships are tax transparent, each partner is taxed directly on their share of the profits. No further tax, therefore, applies to distributions made by the partnership.
Are there local taxes on the possession of real estate assets?
The owner and/or occupier of real estate in the UK is liable to pay either business rates or council tax, as well as rates for the supply of water. The amounts payable depend on the property's location.
D. DEPRECIATION
What are the basic rules for the depreciation of real estate assets?
Any person liable to pay UK tax relating to the ownership of UK real estate may be able to claim a depreciation allowance, depending on the type of building or structure, and any relevant fixtures.
Depreciation allowances are available in a number of cases, including hotels, industrial buildings, and plant and machinery permanently fixed to a building.
The rules are very complicated and do not allow depreciation to be claimed on the full cost of an item:
- In relation to hotels and industrial buildings, the current annual allowance (as at April 2007) is 4% of the original cost of the building. However, allowances on buildings will be phased of out so that they will no longer be available from April 2011.
- In relation to allowances on plant and machinery permanently installed in buildings, an annual allowance of 25% (occasionally 40%) can (as at April 2007) be claimed on the amount of unclaimed allowance which could have been claimed previously. If someone buys a "second-hand" building including plant and machinery, a claim can be made on either the amount of allowance which could have been claimed by former owners, or the amount they paid for the plant and machinery, whichever is smaller. However, the rates of allowances available on such plant and machinery will also reduce from April 2008.
Can land be depreciated?
No.
Can a participation in an SPV holding real estate be depreciated?
Not if the SPV is a corporate body. If the SPV is tax transparent then anyone holding an interest in it may be able to claim tax depreciation allowances as if they held an interest in the real estate itself.
E. VAT
Is the purchase of real estate assets subject to VAT?
The purchase of a heritable interest in a new commercial building is subject to VAT at the rate of 17.5%, unless the purchase amounts to the transfer of a going concern. A building is classified as new for the first three years after its completion.
The sale and purchase of any other interests in UK commercial real estate are exempt from VAT unless the seller has opted to waive the VAT exemption. In this case, the purchase is subject to VAT at the rate of 17.5% unless it amounts to the transfer of a going concern.
The purchase of residential properties or certain properties for charitable use may either be VAT exempt or subject to VAT at the zero rate.
How can VAT paid on the purchase price be recovered?
A buyer is entitled to recover VAT paid if the property is used by him for the purposes of his VAT taxable activities. If the building is used for a non-business purpose, or in connection with the supply of VAT exempt goods or services (such as the sale of real estate not subject to VAT), VAT cannot be recovered.
In practice, most commercial property investors will rent a property out. Provided the investor has opted to waive the VAT exemption, so that VAT is payable on rent, they will be using the property for a VAT taxable activity and will therefore be able to recover any VAT incurred.
VAT can be recovered by means of a, mostly quarterly, VAT return to HM Revenue & Customs. Recoverable input VAT can be offset against output VAT and a refund may be claimed if the former exceeds the latter.
F. LEVERAGE, THIN CAPITALISATION RULES
If interest payments are to be tax deductible, is it necessary for the financing to be taken out simultaneously with the purchase of the asset?
Not necessarily. However, the interest cost must often relate to the real estate investment activity. Different rules apply depending upon the investment vehicle.
Are there rules which limit the deductibility of interest for third party (bank) financing?
The UK's thin capitalisation and transfer pricing rules limit the full deductibility of interest incurred on loans from connected parties if the loan is not made on an arm's-length basis.
Interest payable to an unconnected third party should be fully deductible. However, restrictions can still apply where a third party lends part or all of the amount to someone other than the borrower (on the basis of a guarantee or other arrangement), since this amounts to a loan which is not on an arm's-length basis between the third party and the borrower.
The UK also applies other anti-avoidance legislation in relation to interest deductions.
Are there thin capitalisation rules in the UK and if so, how do they work?
The UK's transfer pricing rules cover all transactions between connected parties and include thin capitalisation rules.
Costs incurred, including interest payments, are not tax deductible if the terms differ from those which would have been agreed between unconnected parties.
Does the UK apply any withholding taxes on interest paid to foreign financing banks or to foreign shareholders?
Any interest paid on a UK source loan to a non-resident person is generally subject to UK withholding tax at the rate of 20%. The requirement to withhold tax applies regardless of the country of residence of the person paying the interest.
However, there may not be a requirement to withhold tax if the recipient of the interest is eligible for relief under the terms of a double tax treaty.
G. TAXATION OF CAPITAL GAINS
How are capital gains deriving from the sale of real estate assets taxed in the UK?
(a) Real estate assets held by foreign investors directly without a permanent establishment in the UK
A non-resident investor without a PE, branch or agency in the UK is not subject to UK tax on capital gains.
(b) Real estate assets held by foreign investors through a permanent establishment in the UK
UK tax on capital gains is only payable by UK residents, or non-residents who have a PE, branch or agency in the UK which carries out business in the UK and who hold the property for the purposes of that PE, branch or agency.
In practice it is unlikely that the above conditions will apply to non-residents interesting in English real estate and therefore UK tax would not be payable on capital gains.
How are capital gains deriving from the sale of shares/interests in a corporate entity taxed in the UK?
UK tax on capital gains is only payable by UK residents or non-residents who carry out business in the UK through a PE, branch or agency, and who sell assets relating to that trade. If a non-resident sells shares in a corporate entity holding real estate there is no UK tax on capital gains.
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