Concrete Analysis

UK tax changes alter property strategies

Tax changes which take effect next April call for rethink of value of using purchase vehicles

PUBLISHED : Wednesday, 05 December, 2012, 12:00am
UPDATED : Wednesday, 05 December, 2012, 4:15am

In its budget in March, the British government announced several key changes to the taxes payable on residential property, some of which are already in effect with others to kick in by next year.

Regardless of their domicile, these measures affect existing owners and new buyers, especially those who hold properties via corporate vehicles or trusts.

There are four key changes regarding British residential properties valued at more than £2 million (HK$ 24.8 million) that will need consideration.

As of March this year, an individual had to pay 7 per cent (up from 5 per cent) stamp duty land tax (SDLT) on a property purchase; and corporations had to pay 15 per cent SDLT. Pending legislation, corporations that own property will have to pay an annual charge of between £35,000 (HK$435,000) and £140,000 a year, depending on property value. This is likely to become effective next April.

And pending further legislation, a non-UK property owner, including offshore companies and trusts, will have to pay capital gains tax (CGT), likely to be set at 28 per cent, upon the sale of a property. This is also likely to become effective in April next year.

British properties valued at more than £325,000 are subject to an inheritance tax of 40 per cent; so on a property valued at £2 million, the tax is £670,000 - no small amount. The inheritance tax remains applicable only to properties owned and inherited by people, while the CGT and annual charge will apply only to companies and (in the case of CGT), trusts.

These changes mean that current owners and prospective buyers will need to review their options on whether to hold a property personally or via another vehicle.

Consider the following scenario: buying a £5 million property through a corporate vehicle means paying SDLT at 15 per cent (£750,000); an annual charge of £35,000; and a CGT of 28 per cent upon sale of the property - as well as some inevitable company administrative costs. On the other hand, purchasing the same property in one's own name would mean paying SDLT at 7 per cent (£350,000); and an inheritance tax of £1.87 million based on the value of the property today.

Which scenario is more beneficial?

That, of course, depends entirely on a buyer's circumstances. For example, the elderly, or people who plan to sell in the near term may want to continue to hold their properties in companies and pay the annual charge. Young homeowners or long-term investors, on the other hand, may prefer holding the property directly in order to benefit from a lower SDLT and avoid the annual charge or CGT.

Under the latter scenario, one question remains. How does one mitigate the inheritance tax?

One way of doing this is for the owner to borrow money against the value of their property because only the non-mortgaged amount is subject to inheritance tax. In this scenario, the owner has to pay interest to the lender, but may elect to borrow money from a connected offshore company, effectively paying interest to him or herself.

While this appears an attractive option, the tax man may well close this loophole in the short to medium term.

Another alternative is to take out insurance and place the policy into a trust so that the proceeds can be used to pay inheritance tax. For example, a 45 year-old male non-smoker who buys a property valued at £5 million can take out a 20-year term insurance policy to cover an inheritance tax liability of £1.8 million, and pay a premium of just £6,915 a year.

This compares favourably with the £35,000 a year charge that would apply if one were to hold the same property through a company or trust.

Another factor to keep in mind is that it makes a difference whether buyers and owners are considered "UK-domiciled" or "non-UK domiciled". The worst scenario for a UK-domiciled individual is to buy through an offshore company, in the hopes of avoiding inheritance tax.

In fact, individuals in this situation get all the tax disadvantages: SDLT at 15 per cent, an annual charge, CGT, and inheritance tax on the shares of the company holding the property.

Unless a person in this situation plans to lose UK domicile status, or starts giving properties away to reduce the assets subject to inheritance tax, it is best to simply hold the property in one's own name and set up an insurance policy in trust to cover the inheritance tax.

Non-UK-domiciled local Hong Kong people, on the other hand, face the same taxation rules as other non-UK domiciled property owners.

Before making a purchasing decision, there are three factors to consider: for how long is the property likely to be held? What is the intention of the purchase - is it for short-term investment or for eventual self-use? And finally, buyers should ask themselves if it is preferable to hold the property in a company vehicle and be subject to an annual charge and CGT.

Generally, as long as the buyer is in reasonably good health, it is likely to be more favourable to hold the property personally, and take out an insurance policy to pay the inheritance tax.

The draft legislation in relation to the annual charge and CGT charges is expected to be released this month, but one tip to keep in mind is that CGT will apply to the total gain accrued during the property ownership, so it is still possible to transfer a property from one company to another to reduce the capital gains that will apply next April.

Each situation is unique and owners of British residential properties should seek advice from their tax adviser or lawyers to take the necessary precautions as soon as possible before the proposals become law in April.

Brendan Harper is a technical services manager at Friends Provident International