Real Estate
Structuring real estate funds for overseas investors
Paul Windsor, of WSM Property, provides an insight into the key considerations to be given to structuring UK commercial property funds for overseas investors.
Fund managers are currently raising cash from overseas investors with a view to re-entering the UK commercial property market as the bottom is being called; however some managers find it difficult to understand why there is a need for complex tax structuring around the holding of UK real estate assets.
Physicality
One of the most obvious but often forgotten things about real estate as an asset class is that it is ‘real’ and has a physical presence upon the shores of the United Kingdom. This is one of the factors that gives the asset tangible value – but it is also the factor that gives the asset its need for protection against the ravages of UK tax legislation.
Tax leakage
One of the best remembered fundamental principles of UK tax legislation is the right of taxpayers to arrange their affairs to minimise legitimately their obligations to contribute to the exchequer.
Hence our starting point for this examination is the desire by fund managers to maximise the return for their investors by minimising the potential tax leakage from the asset class.
Transaction tax
UK tax starts with a hefty 4% of the asset value being charged to tax in the form of Stamp Duty Land Tax (SDLT). This is a full seven times greater than the modest 0.5% stamp duty on other asset classes such as the transfer of shares in the UK.
The easiest and most obvious way to move from a 4% to a 0.5% regime is to give the chargeable asset a corporate wrapping so that upon a subsequent sale, shares in the corporate entity are transferred whilst the property asset remains under the constant ownership of the company.
For international investors the news is even better as there is no SDLT on the transfer of shares in non UK resident corporate entities – creating a full 4% saving on the transaction.
Tax on rental income
Non resident landlords are liable to UK tax at 20% of the excess of rental income over tax deductible expenses. In order to maximise investor returns most UK property assets will have some degree of gearing – although bank caution in the current economic climate means that achievable gearing levels are considerably lower than they were two years ago. Nevertheless, structuring the investment to maximise the deductibility of loan interest as well as other expenses remains a crucial part of tax planning.
Individual investors resident in the European Community have a further opportunity to minimise their annual tax liability on UK rental income as they are individually entitled to a UK tax-free annual income tax allowance, worth £6,035 in the tax year ended April 5, 2009. Many EC fund managers have used a partnership structure in recent years to acquire and hold UK real estate assets which enables each individual member partner to shelter their share of the annual rental income behind their personal tax allowance – in many cases avoiding the UK income tax net altogether.
Tax on increases in value
Often the most important element of the investment is the capital appreciation of the asset. Capital Gains Tax (CGT) generally only arises in the UK on the disposal of an asset and not on a revaluation. There is however a rather unusual rule embedded in the UK tax legislation that non UK residents are not liable to CGT on the disposal of UK property. This makes the proper structuring of UK property funds for overseas investors particularly important – as well as making them even more attractive as an asset class.
For example, it is usually an important step in the planning process to ensure that the vehicle owning the property is registered or incorporated overseas, and is then genuinely controlled and managed in an offshore jurisdiction to enable the non resident investors to benefit from this relief from CGT and enjoy minimum tax leakage.
As a further finesse, limited partnership structures, which are ‘see through’ for tax purposes, are often inserted beneath the fund to hold the target property asset to ensure that there is a clear separation between the UK ownership and the non resident decision making.
Maximising returns
What I hope has become apparent in reading this article is that understanding the complexities of UK tax legislation and planning to take maximum advantage of it is crucial in maximising returns for investors. Complex tax structuring it may be – but essential in the armoury of any fund manager looking at real estate as an effective asset class for clients.
Paul Windsor is a partner at specialist UK real estate tax adviser WSM Property (www.wsmproperty.com)
