Tax considerations for overseas buyers of UK residential properties

For the foreign purchaser of UK residential property, the question often arises as to how they should own it. Formerly, buying in the name of a trust or an offshore company (or a combination) would have been part of the answer for properties at the higher end of the market; but the tax landscape has been transformed over the last 10 years. We now have a range of taxes to consider – ATED, SDLT, CGT or corporation tax on chargeable gains, IHT as well as income tax or corporation tax if the property is being rented out.

Let’s deal with those taxes in the above order:

ATED - Annual Tax on Enveloped Dwellings

A residential property held in a company is an enveloped dwelling ie it is held via a corporate entity (envelope). If the value of the property is over £500,000, then it will come within the scope of ATED. ATED is a banded tax, with the rate of ATED depending on the value of the property on acquisition or at a point in a five-year cycle. For the year starting on 1 April 2022, the rates are:

There are certain reliefs from ATED, the most common one being full relief (ie no ATED payable) in the event that the property is part of a property rental business, let out on commercial terms to an unconnected third party (ie, not family members of the owner of the company). The relief also applies where steps are being taken to let it out commercially (eg, marketing it with a property letting agent).

SDLT – Stamp Duty Land Tax

Back in the mists of time (before 2003), stamp duty was a tax on transfer documents and was a modest 1 per cent of the consideration. In relation to real property, it was overhauled in 2003 and recast as stamp duty land tax, with different rates applying to residential and commercial property. As far as residential property is concerned, the rates of SDLT are banded according to the consideration (price paid) and have got higher and higher. The standard rate of SDLT for residential property is currently up to 12 per cent, with a banded system applying as set out below.

If the purchaser (or their spouse) has another residential property anywhere in the world, then there is a 3 per cent surcharge on top of these standard rates of SDLT. If the purchaser is non-resident for SDLT purposes (which is a day count test), then there is an additional 2 per cent surcharge, which can increase the total rate to 14 per cent for the foreign purchaser with no other residential property; 15 per cent for the resident purchaser with another residential property; or 17 per cent for the purchaser who has another residential property and is non-resident. The rates for the second home buyer are shown below, also showing the effective rates if the buyer is not resident for SDLT purposes.

* Combined with second home rates

Where the purchaser is a company or a trust, the rate of SDLT is usually a flat 15 per cent, or 17 per cent if the company or the trustees are non-resident. For a corporate buyer that can come within the ATED relief for property letting, SDLT is banded, so that the 15 per cent or 17 per cent rate does not apply to the whole of the consideration, ie, representing a modest SDLT saving.

To give correct advice on a particular transaction, SDLT analysis now requires a thorough understanding of both the property subject matter itself (as in some limited circumstances, it may be possible to apply partial relief, or indeed favourable, commercial rates at no more than 5 per cent); and a detailed understanding of the buyer’s own circumstances.

CGT – Capital Gains Tax

Until 2013, non-residents generally did not pay capital gains tax on the gains realised on the disposal of UK assets. From 6 April 2013, ATED-related CGT applied to disposals of UK residential property caught by ATED. Fortunately, that was scrapped when the CGT charge was extended to apply to all UK residential property from 6 April 2015. (From April 2019, CGT or corporation tax applies to all UK real estate disposals – at 28 per cent for individuals and 19 per cent, rising to 25 per cent for companies). The position is that, unless the property in question is the main residence of the owner (or, in certain cases, the main residence of the principal beneficiary of a trust), the gain will be subject to CGT or corporation tax , whether it is the property being disposed of or the shares in the company that holds the property.

It is possible for a non-resident individual to benefit from the main residence relief but this is probably academic in most cases because of the risk of becoming UK resident for general tax purposes in the process.

IHT – Inheritance Tax

All directly held UK assets are within the scope of IHT (at 40 per cent), whether the owner is domiciled in the UK or abroad. UK assets held in non-UK companies are protected from IHT where the owner has a foreign domicile and is not deemed to be UK domiciled as a result of residing in the UK for over 15 tax years out of the previous 20. The same applies where the shares in the non-UK company are held in a trust made by a settlor neither domiciled nor deemed domiciled in the UK.

Since April 2017, where the asset in question is UK residential property, it will come directly or indirectly within the scope of IHT. If the property is held in an offshore company, the shares in that company come within the scope of IHT. If the property is acquired with debt, then the benefit of the debt (ie, the loan itself) comes within the scope of IHT. As regards debt, if the loan comes from a commercial lender, it effectively falls outside the scope of IHT but not, as a general proposition, if it comes from a family trust, a closely held company or another individual. 

Since July 2013, for all practical purposes for a debt to be deductible against the estate of an individual domiciled outside the UK (thereby reducing the value on which IHT is charged), it has to be incurred in the purchase. A debt taken out after the purchase (unless it is to improve the property) is not deductible unless the sums borrowed remain within the scope of IHT. In other words, it is not possible for a foreign domiciled individual to borrow against the property to reduce its taxable value and place the sums borrowed outside the UK. The same goes for properties held in trust.

It is therefore increasingly common for overseas buyers whose wealth remains outside the UK to purchase using mortgage finance rather than cash, or to consider life insurance written in trust to foot a potential future IHT bill. 

Income tax

Net rent from a UK property rental business will always be taxed in the UK first and foremost. Where the purchaser is an individual, the extent to which interest costs can be set against the rent for income tax purposes is limited to a basic rate tax. Subject to this, the rental profit is taxed at the individual’s top rate of income tax, ie, up to 45 per cent. Even if the individual is resident outside the UK where his or her aggregate net UK rental income exceeds £150,000, the marginal rate of tax is still 45 per cent.

However, where the individual buys the property through a company, the net rent is subject to corporation tax rates – currently 19 per cent but scheduled to rise to 25 per cent in 2023. If the individual is UK resident and the company is non-resident, there is no net benefit to using the company because the income is attributed to the shareholder and subject to his or her marginal rate of tax (45 per cent maximum). If, though, the company is UK resident, the liability is capped at the corporation tax rate of the company, though the shareholder will be subject to income tax on the dividend at up to 39.35 per cent. If the shareholder is resident outside the UK, the dividend from the company is not subject to UK tax, so there is a relative advantage to using a company to buy a property in these circumstances.

Planning considerations

Broadly speaking, there is no one option to remove the value of a residential property from the scope of IHT. Whether it is held directly, in trust or a company, it will be within the scope of IHT, so no “structure” recommends itself above direct ownership. If the property is held in a company, corporation tax or CGT will be due on the gain, whether on the disposal of the property or the shares in the company (assuming it’s a property rich company). The main residence relief from CGT only applies (if it applies at all) to direct ownership or ownership by trustees where the beneficiary occupies the property as his or her main residence “under the terms of the settlement”. However, given the IHT issues surrounding trust ownership of a UK residential property, trust ownership is likely to be the preferred option only by way of exception.

Property development aside, ownership of a residential property through a company is likely to increase the overall tax unless the property is being let commercially to unconnected third parties as part of a property rental business.

Planning options

The best option for buying the property will depend on the circumstances in each case, so the following are general remarks only.

When deciding how to structure the purchase, the key question is what the property will be used for. If it is intended to be occupied by the individual or members of his or her family, then it is best to dispense with a company and own the property directly. This should reduce the very highest rate of SDLT; avoid ATED and possible benefit in kind charges; and (if the property can be occupied as the owner’s only or main residence) ensure that the gain is free from CGT on a later disposal.

If the property is to be rented out, the ultimate owner already has a residential property and is UK resident, then there might be a benefit to using a UK resident company to acquire the property but the decision will be very fact-specific. If the ultimate owner already has a residential property and is non-resident, a non-UK company would be a suitable vehicle for the purchase as the SDLT rates will be the same as those for an individual; there will be no ATED; the CGT position is the same but the main benefit is that the net rent will be more lightly taxed (at corporation tax rates).

Similar logic applies when acquiring shares in a company that already holds a UK residential property. In addition, there are the conflicting considerations of there being no SDLT on purchase of the shares in a non-UK company, on the one hand, but, on the other, the company will hold an asset which may have an inbuilt capital gain and a share purchase will require additional due diligence and risk. In many cases, the short term saving on the SDLT is outweighed by the latent capital gain and poor corporate records, meaning that while it is worth full analysis and running the maths, it can still be more advantageous for the individual just to buy the property and take the SDLT hit. If the ultimate owner is non-UK resident and the underlying gain (since April 2015) is not too significant, it might be tempting to buy the shares in the holding company (saving the SDLT), then liquidate the company (suffering a manageable CGT liability) but beware this needs careful thought, particularly if mortgage finance is involved, as it could still result in a liability for all the SDLT as if the individual had acquired the property directly – a double whammy.

The main means to mitigate IHT would consist of the following:

• The spouse exemption – either buy the property as joint tenants with one’s spouse or civil partner or have a will that ensures that he or she benefits on the first death.
  
  
• Use debt to offset the value of the property – there is quite a bit of anti-avoidance legislation but, broadly, the property should be acquired with a mortgage. Where the buyer has a foreign domicile, buying with cash then borrowing against the property won’t mitigate the IHT exposure. The loan ought to be from a commercial lender as, otherwise, the benefit of the loan could itself be treated as a taxable asset for IHT, even where the lender is based outside the UK. Specifically, debt from an individual, a trust or closely held company (whether underlying the trust or not) is likely to expose the lender to an IHT charge.
  
  
• Life or term assurance, written in trust – this doesn’t reduce the IHT but provides a fund for meeting the liability. Some individuals take out life or term assurance but many consider the cost outweighs the benefit. Again, this depends on individual circumstances.
  
  
  
• Split the beneficial ownership of the property – except as between spouses and civil partners, shared ownership results in the beneficial interests being discounted typically by 10 per cent -15 per cent, resulting in a commensurate IHT saving. From an IHT perspective, it might be worth exploring pushing some – but generally not all - of the value of the property down a generation. A word of caution: beneficial shares in the property held for the members of the younger generation will belong to them, so will be exposed to IHT on their deaths and third party claims (including in the event of a divorce). In addition, they might also have the ability to force a sale of the property. So it will not be every family where this is a suitable option.

In conclusion, as a general rule, the simpler the structure (or absence of one), the better as the individual will avoid a range of taxes (and running costs) during the course of ownership as well as having the potential to dispose of the property without CGT.

If you require further information about anything covered in this briefing, please contact Nick Dunnell for tax advice, Laura Conduit for residential property transaction advice or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, November 2022