The Budget contained a number of tax hikes that will affect UK real estate investors and developers. In summary:
- an increase in the top rate of commercial SDLT to 5%;
- doubling the rate of SDLT on commercial leases to 2% where the net present value of the rent exceeds £5m;
- the extension of the additional 3% of SDLT on residential property to all investors, with no exemption for large scale investors;
- new rules targeted at non-resident companies that develop or trade in UK real estate;
- confirmation that from April 2017 the UK will limit the interest that is deductible for corporation tax purposes to a fixed percentage of 30% of EBITDA; and
- confirmation that the hybrid mismatch rules will apply from 1 January 2017.
There was some mixed news in relation to the use of carried forward losses.
With effect from 17 March, SDLT on commercial property is changing to a progressive (rather than slab) system, with a new top rate of 5%.
The new SDLT rates on commercial property will be:
|Consideration||Applicable rate to that part of the consideration|
|£150,0001 - £250,000||2%|
All freehold and lease premium transactions below £1.05 million will save SDLT under the new system but purchasers of more valuable properties will pay more.
Also from 17 March, the SDLT rate on commercial leases will increase to 2% on the net present value of rent in excess of £5m.
Contracts exchanged before 17 March should not be caught (provided that they are not amended or assigned). Purchasers and tenants will need to claim the benefit of this grandfathering – it is not automatic.
From 1 April 2016 higher SDLT rates will apply to certain purchases of residential property. Although these were originally aimed at individuals purchasing second homes and buy-to-let properties, the government has decided not to provide any exemption for institutional investors. Even the first purchase of a single residential property by a corporate or fund will be caught.
Where the rules apply the rates of SDLT payable will increase by 3% (except where the consideration is less than £40k). The rates are set out in the table below:
|Band||Existing residential SDLT rates||New higher SDLT rates|
|Up to £125k||0%||3%|
|£125k - £250k||2%||5%|
|£250k - £925k||5%||8%|
|£925k - £1.5m||10%||13%|
However, under the current SDLT rules, where six or more dwellings are purchased together it is treated as a commercial transaction subject to the commercial rates of SDLT. This treatment appears to have been preserved in the draft legislation, thus giving an effective relief for larger investors in some situations. However, it is not clear whether this is intended given that the earlier consultations considered a specific relief for bulk purchases of fifteen properties. We will be monitoring the development of the legislation closely.
Multiple dwellings relief (MDR) will still be available for properties that are subject to these new higher rates. Absent MDR, the purchase of a portfolio of residential properties would result in the usual SDLT rates being charged on the aggregate consideration. That would mean more of the purchase price being taxed at the higher SDLT rates (up to 15%), which means more tax overall. MDR effectively allows more of the consideration for each property to be taxed at the lower rates in the way it would have been had the property been bought on its own. This means more of the consideration can be taxed at lower rates, lowering the overall SDLT bill. It is simply that all the applicable rates will be 3% higher than they are now (up to 15%).
The new rates will apply to purchases completed on or after 1 April 2016 (unless they complete a contract exchanged before 26 November 2015 and not amended since).
Offshore traders and developers
Profits generated from a non-UK company developing UK real estate for sale are already subject to UK corporation tax if the development is carried out through a UK permanent establishment (PE) and the profits are attributable to that PE. A number of structures have been developed which are designed to allow a UK development to be carried on from offshore without giving rise to a UK PE, or at least minimise the amount of profit attributable to any UK PE.
Many of these offshore trading structures may already be caught by the diverted profits tax introduced last year. However, HMRC clearly remains concerned that some profits from such structures will escape UK tax. It is, therefore, planning to introduce new rules that will charge corporation tax on all of the profits derived from dealing in UK land or developing UK land with a view to disposing of it, regardless of whether this is done through a UK permanent establishment.
The legislation will be added to Finance Bill 2016 when it reaches the report stage in Parliament (expected to be June 2016) and will apply from that date. Anti-avoidance provisions will apply with effect from 16 March which will prevent land being “rebased” and any other arrangements designed to avoid the new charge.
The UK’s tax treaties with Jersey, Guernsey and the Isle of Man will be amended with effect from 16 March to put beyond doubt that they do not override these new rules.
One of the outcomes from the OECD’s base erosion and profit shifting (BEPS) project was a proposal to limit interest deductions to a fixed percentage of EBITDA. This is intended to counter the use of debt to shift profits into low tax jurisdictions.
The UK will introduce such a restriction with effect from 1 April 2017, capping interest deductions at 30% of EBITDA. The rules will apply to third party as well as intra-group debt and are intended to operate alongside existing transfer pricing rules. However, the existing worldwide debt cap will be abolished.
Recognising that some groups may have high external gearing for genuine commercial purposes, the UK will also implement a group ratio rule that allows interest to be deducted up to the net interest to EBITDA ratio for the worldwide group. There will be a de minimis of £2m net of UK interest expense. The government also intends to introduce some form of exemption for private financing of certain public infrastructure projects.
The Budget papers do confirm that the restriction will apply for corporation tax. There is currently no suggestion that it will apply to income tax payers such as offshore landlords.
As expected, the UK will implement the BEPS anti-hybrid rules with effect from 1 January 2017. There will be no grandfathering so existing structures may be affected.
There are two types of hybrids – hybrid financial instruments and hybrid entities. Hybrid financial instruments are loans, shares, derivatives etc. that are treated differently for tax purposes in different jurisdictions. For example, certain debt instruments issued by Luxembourg companies are treated as debt in Luxembourg but equity in the US. A hybrid entity is one that is treated as tax transparent in one country but opaque in another. For example, a UK company that is subject to a “check the box” election in the US.
Both hybrid instruments and entities are commonly used in structures for financing and holding real estate investments and developments. Often their use will bring tax benefits in the form of a payment (not necessarily finance) being tax deductible for the payer without the payment being taxed in the recipient’s hands. It is that kind of arbitrage that the rules are designed to stop. Generally, this will be done by denying the payer a tax deduction for the payment. However, where the payer’s jurisdiction has not implemented equivalent anti-hybrid measures the recipient’s jurisdiction may tax a payment that would otherwise be tax exempt.
The rules will also prevent a group using back-to-back arrangements to shift the tax arbitrage to countries that have not implemented similar anti-hybrid rules. Thus it may be that the UK operation is very plain vanilla and does not directly involve payments under any hybrid instruments or to any hybrid entity. However, if a hybrid arbitrage is used elsewhere in the group’s structure that could still affect the tax deductibility of payments made by the UK operation.
Not all structures will be affected – there needs to be some other relationship between the parties other than that which gives rise to the payment. However, outright control or full consolidation may not be necessary. A shareholding as low as 25% may be sufficient, as may acting together with others that do have control. And any “structured arrangements” designed to secure the tax arbitrage or where the tax benefit is shared between the parties may also be caught.
A number of significant changes will be made to the business rates system over the next five years. As well as permanently doubling small business rate relief, from April 2020 all rates will be cut by switching annual indexation from RPI to CPI.
The government will also revalue properties more frequently and introduce measures to improve its administration and make it easier to pay.
Carried forward losses
The government will modernise the corporation tax rules allowing losses to be carried forward from past years to be deducted from taxable profits in later years. However, there is good and bad news. On a positive note the rules will allow greater flexibility of the types of taxable profits that can be reduced by carried forward losses. This will affect losses incurred on or after 1 April 2017. In contrast to the current position, carried forward losses will be capable of reducing profits of further types of income. Significantly, this will extend to income of other companies in a group. This should help the problem of trapped losses in the situation of companies with losses but insufficient profits. The problem arises because currently losses can be surrendered within a group on a current period basis only. Now for the bad news. The government will restrict the amount of taxable profits that can be offset through loss carry forward to 50% of profits arising on or after 1 April 2017, which will affect carried forward losses whenever incurred. This measure will affect larger groups as it will not apply to the first £5m of taxable profits in a group. Helpfully, the group will be given discretion on how to allocate the £5m within the group. This discretion may be something to consider in a joint venture context or in the context of a share sale. The Government will consult on this reform in 2016.