UK commercial property can be an attractive investment option, but it is important to understand the tax consequences. This factsheet outlines the key points which should be considered, from purchase through to disposal.
Recent years have seen a number of changes to the taxation of UK property. However, the majority of these have been focused on residential property and do not affect commercial property. A significant exception to this was the announcement in the 2017 Autumn Budget that the non-resident capital gains tax regime is to be extended to commercial property disposals from April 2019.
For these purposes, commercial property includes business premises – shops, offices, warehouses etc – but also other categories specifically excluded from the residential property rules. This includes care homes and some student accommodation. Advice should be taken to ensure that you have considered all the tax issues relevant to your particular property.
Buying the property
Purchases of UK property are subject to Stamp Duty Land Tax (SDLT) if situated in England, Wales or Northern Ireland and Land & Buildings Transaction Tax (LBTT) if situated in Scotland. In addition, from 1 April 2018, SDLT will be replaced in Wales by a devolved Land Transaction Tax (LTT).
SDLT on commercial property starts at 2% for transactions over £150,000 and increases (on a ‘slice’ basis) to 5% for transactions over £250,000.
The same rates of SDLT apply to individual, trustee and corporate purchasers. SDLT applies to the VAT inclusive transaction value, where VAT is payable.
A note on LBTT and LTT
LBTT and LTT are both, in broad terms, very similar to SDLT: the regimes are not, however, identical. This factsheet does not consider the differences, and anyone contemplating a Scottish (or, from April 2018, Welsh) property purchase should ensure that they take appropriate advice on the position.
Other considerations on purchase
A purchaser should also review the capital allowances position, and consider making a section 198 election (see further below). They should also establish the VAT position of the property and whether VAT will be payable on its acquisition or whether the property can be transferred as a VAT exempt ‘transfer of a going concern’ (TOGC). This will depend on whether the sellers have opted to tax for VAT purposes; this may, in part, depend on whether their tenants are able to recover any VAT charged on rents. To qualify for TOGC treatment, the purchaser will need to register for VAT.
If shares in a company owning commercial property are purchased, rather than the property itself, there should be no SDLT, but stamp duty of 0.5% will be payable on the consideration given for shares in a UK company. There are commercial and tax risks of buying a company (and inheriting its history) and full due diligence should be undertaken.
Renting the property
Income from let commercial property is subject to tax. Deductions are available for revenue expenses, such as interest and letting agents’ fees. The tax rates applicable will depend on whether the lessor is an individual, trust or company.
If an individual lets UK commercial property they are subject to income tax at their marginal tax rates, ie up to 45%, on the net rental income, regardless of their UK residence status.
Both UK and non-UK resident trustees will be subject to income tax at 45% on their net rental income.
A UK resident company will be subject to corporation tax on the net rental profits (19%, reducing to 17% from 1 April 2020). Deductions are generally available for revenue expenses, but from 1 April 2017, a restriction applies to the amount of interest and other finance costs that a company can deduct in calculating its profit. In broad terms, this will mean that interest cost will be restricted to 30% of EBITDA, subject to a de minimis threshold of £2 million. The detailed rules are outside the scope of this factsheet, but are complex, and should be considered where the company (or the group of which it is a member) has an interest cost over the threshold.
Under current rules, a non-UK resident company will be subject to income tax at 20% on its net rental profits. The position will change from April 2020, when non-resident companies will move into the corporation tax net (17% corporation tax), and will be subject to the corporate interest restriction outlined above.
Attribution of profits to UK individuals
If the shareholder/s of the non-UK resident company are UK resident, or a settlor-interested trust where the settlor is UK resident, the underlying UK source income may be attributed to the shareholder/settlor so that additional tax at up to 45% is due (with a credit for the 20% tax paid by the non-UK resident company).
The Annual Tax on Enveloped Dwellings (ATED) and related charges do not apply to commercial property, meaning that companies are generally an appropriate acquisition vehicle for commercial properties.
Non-UK resident landlords (individual, corporate and trustees) are subject to a 20% withholding tax on rents received unless an application is made to HM Revenue & Customs (HMRC) under the non-resident landlord scheme for rents to be paid gross. The 20% withholding does not discharge the non-resident’s tax liability: rather it is used as a credit against that liability.
The UK tax system does not allow a deduction for depreciation. Instead, capital allowances are available on qualifying assets.
Qualifying assets are allocated to a capital allowances pool, with allowances of 18% or 8% (reducing to 6% from April 2019) depending on the nature of the assets available on a reducing balance basis.
When the property is purchased, it is possible for the vendor and purchaser of the property to jointly elect to fix the portion of the purchase price to be allocated to fixtures qualifying for capital allowances (a section 198 election). The value of any transferred allowances, and whether an election needs to be made, should be considered as part of the sale/purchase negotiations.
Previously no capital allowances were available on buildings although the Chancellor announced in the 2018 Budget the introduction of a new 2% capital allowance – the Structures and Building Allowance – available on qualifying expenditure on new non-residential structures and buildings incurred on or after 29 October 2018.
Ownership of UK commercial property: inheritance tax
UK inheritance tax (IHT) applies to UK assets which are directly owned, regardless of the residence or domicile status of the owner.
IHT is chargeable on death at 40% in relation to assets held at death. IHT also applies to any gifts made within seven years prior to death, although there is a tapering of the IHT rate.
Transfers of UK property into trust will attract a 20% IHT charge and the UK assets will broadly be subject to a 6% IHT charge every 10 years, with a pro-rated 6% IHT charge on any distributions from the trust. Where the settlor of the trust retains an interest in the trust, in addition to these charges, the property will remain in their estate for IHT purposes.
An individual who is not domiciled in the UK and is not deemed to be domiciled in the UK can shelter the value of the commercial property from IHT by owning the property through a non-UK resident company. For IHT purposes they are treated as owning the non-UK situs shares (this is not be the case with UK residential property from 6 April 2017).
Disposal of property
Historically, non-residents (individuals, trustees and companies) have not been subject to UK tax on the disposal of commercial property held for investment purposes. Specific rules apply where a property is or becomes a development property, which are outside the scope of this factsheet.
The government has announced that the position will change from April 2019. From this date, all disposals of UK property by non-residents will become subject to CGT, as will disposals of indirect interests in such property (for example, the sale of shares in a ‘property-rich’ company. Gains on commercial property and indirect interests in all types of property will be rebased to April 2019, so that only the element of 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 commercial property in June 2020 will pay tax on any gain at 17%).
UK resident individuals are subject to capital gains tax (CGT) on gains realised on the disposal of UK commercial property at 10% or 20%, depending on whether the individual has any basic rate band remaining (after calculating their income for income tax purposes).
UK resident trustees are subject to CGT at 20% on gains realised on disposal.
A UK resident company is subject to corporation tax (at 19%, reducing to 17% from 1 April 2020) on gains realised on the disposal of commercial property.
From 6 April 2019 a return will need to be filed within 30 days in relation to any disposal of UK commercial property by a non-UK tax resident. The payment date for any tax due will also be 30 days following the date of disposal. These obligations and deadlines are scheduled to be extended to UK tax residents for disposals arising on or after 6 April 2020.
The choice of holding structure can have a significant impact on tax liabilities from acquisition through to ultimate disposal of UK commercial property. It is generally recommended to use a company for the purchase, but both the appropriate holding structure and the taxation of the property over the life of the investment should be considered prior to purchase.
Please speak to your usual Saffery Champness partner or contact E: [email protected] if you are contemplating a property purchase and would like more information on the tax issues.
This factsheet is based on law and HMRC practice at 31 October 2018.
UK property taxes
You can find out more about the taxes that apply to UK property purchase, ownership and disposal, depending on the purchaser’s residence status, using the checklist below: