A raft of HMRC initiatives is impacting the real estate industry. We consider how these initiatives are likely to affect your real estate business.
Making Tax Digital for VAT
Making Tax Digital (MTD) will fundamentally change the administration of the UK tax system. It is part of the government’s plan to improve the ease and speed at which tax and admin-related tasks can be completed. MTD means an end-to-end VAT return process and digital record-keeping will be mandatory.
In a nutshell, HMRC is introducing MTD in two separate steps:
- Submission of VAT return numbers to HMRC using a piece of software known as an API – VAT periods starting on or after 1 April 2019 or 1 October 2019;
- Fully digitalised VAT return process - VAT periods starting on or after 1 April 2020 or 1 October 2020.
Given most businesses are likely to be required to make changes involving systems and software, we recommend giving MTD attention now to ensure compliance. Smith & Williamson has been engaging with clients about MTD for VAT: offering reviews of current VAT return processes, providing advice on what additional software might be needed and also on how this may be implemented.
For more guidance on MTD and the potential solutions available for your business, see our S&W session on MTD for VAT here.
From 6 April 2020, updates on the new IR35 legislation are due to come into force, affecting businesses who engage with workers through Personal Service Companies (PSCs). This could have a significant impact on construction and real estate businesses and their supply chains, which often make use of individual contractors operating through PSCs.
On 5 February, the House of Lords Finance Bill sub-committee called for written evidence regarding the impact of the proposed changes on businesses, to which we provided input. It can be challenging in some cases to determine whether or not the IR35 rules apply and, when they do, there is likely to be a lengthy review process. Consulting contracts can cause particular problems, notably regarding which entity in the chain is the end user of the PSC and therefore responsible under the rules. Construction and real estate businesses must also pay particular attention to the interplay of IR35 with the Construction Industry Scheme.
Smith & Williamson is helping businesses review arrangements to ensure compliance before the April 2020 date. While businesses have focused on this date, it is key that they have robust, ongoing HR and procurement procedures in place to ensure that they apply the correct employment status. – We have a wealth of experience advising in this area and how these procedures will mesh with other reporting rules.
The most recent amendment to the EU Directive on Administrative Cooperation (DAC6) continues the current international trend towards increased tax transparency. These rules require intermediaries, and sometimes taxpayers, to report on cross-border arrangements that meet any of five prescribed hallmarks. Reporting may involve careful coordination with other UK and EU intermediaries to meet strict submission deadlines. Penalties will be imposed for failing to report and it is important that organisations can demonstrate they have implemented reasonable procedures to ensure compliance.
The UK regulations implementing DAC6 in domestic law were finalised in January 2020 and will come into force from July. They require UK intermediaries and taxpayers to look back and disclose information from 25 June 2018. The final guidance from HMRC is expected to be published later this year. DAC6 updates and further information can be found here on our website.
Smith & Williamson has worked with HMRC on these new regulations and can assist clients with understanding the rules, analysing current and past arrangements and implementing processes to ease the burden of future reporting.
Taxation of Gains on Disposals of UK property by Non-Resident Companies
All disposals of UK real estate, both commercial and residential, by non-resident companies were brought within the charge to UK corporation tax from April 2019, as well as indirect disposals of interests in ‘property rich’ companies.
The Finance Act 2019 widened the cases in which gains accruing to non-resident companies were brought within the charge to include both residential and commercial UK property. From 6 April 2019, any disposal of UK property by non-resident companies has been subject to corporation tax, currently charged at 19%, rather than capital gains tax.
Indirect disposals of UK property will also be subject to the new rules. Broadly, a sale of an interest in an entity will be within the scope of UK tax where 75% or more of the gross asset value of the entity is derived from UK property (a ‘property rich’ entity) and the investor has an interest of at least 25% in the entity. An exemption applies where all, or almost all, of the UK property is used or was acquired for the use in the course of a qualifying trade. There are special rules and exemptions for ‘property rich’ collective investment vehicles.
The application of UK taxes to UK property has been widened significantly over the last few years. All non-residents holding UK real estate either directly or through structures should review their future plans for their UK property to consider the potential impact.
Non-resident Landlords and the Transition to Corporation Tax
Non-UK resident companies that carry on a UK property business or have other UK property income will be chargeable to corporation tax from April 2020, rather than income tax. This will transform the way Non-resident Landlords (NRLs) handle their UK tax affairs. These changes have been introduced by the Finance Act 2019.
The profits of a UK property business of a non-resident company will be subject to corporation tax at 19% from the start of the new tax year (6 April 2020). The rules for calculating profits for UK property businesses under the corporation tax regime are broadly the same as under the income tax regime. The most significant change will be the way in which relief for interest expenses and finance charges is given. The deductibility of financing costs will now fall within the provisions relating to corporate debt. It is possible that non-resident companies will see the level of deductible interest significantly reduced. There will also be a much heavier compliance burden under the corporation tax regime and corporate non-resident landlords will need to factor in additional costs.
IFRS 16 – lease accounting
IFRS 16 is a change to accounting standards effective for accounting periods beginning on or after 1 January 2019. It brings about significant changes for lessee accounting with associated tax implications. The new accounting rules require nearly all existing and future operating leases to be brought onto the balance sheet as right-of-use assets, along with an associated lease liability.
IFRS 16 requires lessees to change the way operating leases are recognised on the balance sheet. As a result, instead of incurring a rental expense through the profit and loss each period, businesses will incur an interest expense and a depreciation charge against the right-of-use asset. This mirrors the treatment of finance leases.
These accounting changes also bring about significant tax implications: they will result in depreciation and interest expenses being taken through the profit and loss statement instead of historical rental expenses. Interest on leases that qualified as an operating lease under non-IFRS accounting standards will not be restricted for the purposes of the Corporate Interest Restriction so IFRS and non-IFRS data may need to be retained in parallel on these leases. There are also new long-funding lease rules to consider for capital allowances.
Interest Relief on Mortgages
As we move from 2019 to 2020, the relief that landlords will be able to obtain on finance costs on residential properties will be reduced once again, from 50% as it stood in 2019, to 25%.
Since 2017, there has been a gradual introduction of this new legislation, which prevents landlords being able to deduct all their finance costs from property income. The rate at which this is allowed has reduced more and more each year and will eventually hit zero percent in 2021, when all financing costs incurred by a landlord will be given as a basic tax rate reduction.
Structures and Buildings Allowance (SBA)
The SBA is a new tax relief that extends the capital allowances regime to the construction and conversion costs of non-residential buildings and structures.
The SBA is a new capital allowance for the costs of constructing or acquiring new non-residential structures and buildings incurred on or after 29 October 2018. Relief is available at a flat rate of 2% for 50 years and can be claimed on both UK and foreign properties, where the business is within the charge to UK tax. Costs of conversion and renovation can also qualify for the SBA.
SBA is a welcome opportunity for tax relief but there are complex rules governing how it interacts with other capital allowances provisions and chargeable gains. Businesses need to ensure they carefully analyse and segregate costs and adhere to strict administrative requirements to be eligible for relief.
UK Corporation Tax Rate
The rate of corporation tax is currently 19% - the same rate it has stood at since April 2017. It was proposed to reduce this to 17% from April 2020. However, it appears that this may no longer happen. The Conservative Party manifesto states that it would not go ahead with the cut but instead maintain the rate at 19%. We expect this to be confirmed shortly in this government’s first Budget.
Given the current economic climate in the UK, we are also likely to see other tax changes in a post-Brexit Budget to help boost the UK economy. We will look more closely at these in due course.
Permanent establishment regulation
With effect from 1 January 2019, the definition of 'permanent establishment' (PE) has been tightened where the non-resident has artificially fragmented their business operations to avoid coming within the charge to corporation tax.
As a result, an increased number of establishments are now classed as a permanent establishment and, because of this, more companies may be liable to pay UK corporation tax.
This change could impact overseas companies with business operations in the UK. It is most likely to affect non-resident manufacturing and distribution businesses that structure their UK operations to minimize their UK tax footprint. There may be instances where commercial landlords also fall into the scope of the new legislation and, as such, a review of all offshore structures trading in the UK should be undertaken as soon as possible.
The new legislation denies exemption from permanent establishment to a non-UK resident company for these activities if they are part of a fragmented business operation.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.