Corporation tax for non-resident landlords

10 Jan 2020

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From 6 April 2020, non-resident landlord (NRL) companies that are currently within the charge to UK income tax will fall within the charge to UK corporation tax. This will change the rate of tax they pay, how taxable profits are calculated, and how NRL companies report their tax liabilities to HM Revenue & Customs (HMRC).

This change follows one in April 2019, as a result of which corporation tax (rather than non-resident capital gains tax) now applies to gains on the disposal of UK property.

Impact on corporate structures

A common structure for holding UK property that is used for the purposes of a trade or business has been to have a non-UK resident property company (propco) owning the property and a UK trading company (opco) carrying on the trade or business activity, with the propco renting the property to the opco.

The opco will be subject to UK corporation tax on its profits in the normal ways (with a tax deduction for the rent paid to the propco), and the propco will pay UK income tax on its net rental profits. The main advantage of this structure has been that any capital gain on a sale of the property has been outside the scope of UK tax.

In April 2019 this advantage ceased to apply once capital gains on UK property held by a propco became subject to UK tax from that date. Property interests are rebased to April 2019, so only the element of any gain accruing from that date is taxable. Tax will be due at the same rate as an equivalent disposal by a UK resident (so, for example, a non-resident company disposing of a property in June 2020 will pay tax on any gain at the prevailing corporation tax rate).

The traditional propco/opco model may therefore no longer be as effective as it once was.

Tax relief on interest

Interest on loans to buy a property has always been subject to the transfer pricing rules, and potentially restricted to the amount that would have been payable on a loan from an independent finance provider acting entirely at arm’s length (without, for example, guarantees or a backing deposit from a controlling person). Typically, reference to a third-party loan to value lending ratio is necessary to determine the allowable amount.

From April 2020, NRL companies will be subject to the same tax rules as other companies. The arm’s length transfer pricing principle continues to apply, but so does the corporate interest restriction. The restriction imposes a fixed ratio of 30% of EBITDA on the amount of interest that can be claimed as a tax deduction. An election can be made to use the group ratio (based on a group’s external borrowing), which may be beneficial for more highly geared companies.

A public infrastructure exemption is available, recognising that such property assets are usually highly geared.

The impact of interest restrictions on post-tax returns may affect whether a property acquisition will provide the level of return investors expect.

Capital allowances

Capital allowances provide tax relief for qualifying capital expenditure on fixtures such as electrical and heating systems. They are the tax deduction given in place of depreciation, which, except in a few specific circumstances, is not tax deductible.

These rules will apply in the same way for corporation tax purposes, but with the new restrictions on interest relief, capital allowance claims may become more important.

The ability to claim allowances on second-hand buildings depends on what expenditure has been “pooled” and what claims have been by past owners. It will usually require a joint election by the buyer and seller under section 198 of the Capital Allowances Act 2001. An important part of the enquiries to be made on a property purchase will be the capital allowances history.

The Structures and Buildings Allowance (SBA), introduced in October 2018, provides tax relief for capital expenditure on structures or buildings. This allowance will continue to be available to companies once they become subject to corporation tax.

The SBA is a flat 2% writing down allowance, calculated on the amount of original construction expenditure. It is intended to ensure that the cost of construction and renovation will be relieved over the average life of buildings. The amount eligible for relief will not be increased where a structure or building is purchased and where it has appreciated in value, as this does not represent a cost of construction.

Loss relief

NRL companies will be subject to the restrictions on the carry forward of corporation tax losses that have applied to UK companies since 1 April 2017. The amount of carried-forward losses that may be deducted in an accounting period is limited to 50% of profits over an annual allowance of £5 million. This restriction may delay tax relief for losses for some companies, and accelerate tax payments.

Tax rate

The rate of income tax that NRL companies have paid in recent years has been 20%. The rate of corporation tax is currently 19% and was due to be reduced to 17% from 1 April 2020. However, in its election manifesto, the Conservative Party stated that this planned reduction will be put on hold.

Reporting

NRL companies will need to file a self-assessment income tax return for the year ending 5 April 2020. Thereafter, they will be required to file corporation tax returns. They will cease to be within the self-assessment payment on account regime and will instead pay their tax on the corporation tax due date, which is nine months and one day after the end of the company’s accounting period.

Certain companies that have profits above £1.5 million will be required to pay their tax in quarterly instalments. The £1.5 million threshold is reduced where there are associated companies.

Companies which sell property during the year ending 5 April 2020 are required to file a corporation tax return to report the gain arising, in addition to the income tax return reporting any rental profits.

Action from HMRC

In January and February 2020, HMRC will contact NRL companies to let them know their corporation tax Unique Tax Reference (UTR) number and to set out the actions they need to take. The generation of UTRs will be carried out through an automatic process based on information provided in the 2017-18 non-resident company income tax return.

HMRC will set up a corporation tax record with a default accounting period ending on 5 April 2021, so companies that have a different year end will need to let HMRC know so that the correct period can be set up.

David Humphrys, Director

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