Company’s House: To de-envelope or not to de-envelope?

The need to know on corporate structures ahead of yet more upheaval next year...

The period since 2012 has been marked by an unprecedented wave of reforms to the taxation of UK residential property. The primary, but not sole, target of these reforms has been non-UK investors using corporate structures to purchase and hold high-value residential property. In this essential briefing, Claire Weeks and Edward Burton consider the implications of the new regime…

Prior to the extensive changes introduced since 2012, it was common for non-UK resident and domiciled investors to invest in UK residential property via a corporate holding structure. The main advantage of this structure was that the corporate “envelope” would shield the property from UK inheritance tax (IHT). In the future, a willing purchaser would also have the opportunity to purchase the company, rather than the property, and thereby escape the stamp duty land tax (SDLT) that would be payable on a direct acquisition of the property.

The 2012 to 2016 reforms

Budget 2012 announced that the Government wished to “tackle the enveloping of high value properties into companies to avoid paying a fair share of tax”. This involved the introduction of:

  • a 15% rate of SDLT on residential property purchased by ‘non-natural persons’, such as companies;
  • an annual charge on residential properties owned by such non-natural persons – the “annual tax on enveloped dwellings” (ATED) (subject to exemptions, such as for rental properties);
  • the extension of the capital gains tax (CGT) regime to gains on the disposal of UK residential property by non-natural persons.

Originally these measures applied only to properties valued over £2million, but the threshold has gradually been reduced to £500,000.

The quest for equalisation of the UK tax treatment between UK resident and non-resident investors continued in 2015 with the extension of CGT to all non-resident investors, including individuals and trustees.

The 2017 reforms

The government announced in the summer Budget 2015 that it intends to extend IHT charges to UK residential property owned by offshore companies either directly or through excluded property trusts. Following the Brexit vote, there was widespread speculation that the taxation of residential property was no longer top of the government’s agenda and the reforms would be delayed. Unfortunately, the government has since confirmed that it intends to stick to the original timetable and the changes will take effect from April 2017.

Existing property structures – to de-envelope or not to de-envelope?

Following the introduction of ATED, many investors weighed up the cost of the annual charge against the potential IHT charge on death and decided that ATED remained the most cost-effective option (essentially an insurance policy against untimely death).

Now that the IHT advantages of owning residential property in a non-UK a company are being abolished (but ATED retained) many investors will wish to remove the envelope and move into a simpler and cheaper structure, outside the scope of future ATED charges.

However, the advantages of de-enveloping must be weighed against any potential disadvantages on a case by case basis. Crucially, the government has confirmed that it has no plans to introduce transitional reliefs to incentivise de-enveloping. As a result:

  • SDLT may be payable where there is existing debt; and
  • CGT will be payable on any gain accrued between April 2013 and the date of liquidation. Having said that, recent experience indicates that prime central London properties are not showing an increase in value over that period (or are showing a fairly low increase), as prices have gone up and down in this time and are typically similar to 2013 values.

For rental properties, slightly different considerations apply on the basis that a property let to a third party on commercial terms, is not subject to ATED (although there are still annual filing obligations).

Furthermore, it is ironic that one of the main structuring options the government wanted to curtail – the sale of corporate envelopes free of SDLT – is still possible. The potential to sell the company, rather than the property, and share the SDLT saving with the buyer may provide a further incentive to retain the company and accept the cost of ATED.

It is also important not to overlook any non-tax benefits of the structure, such as confidentiality, asset protection and succession planning.

De-enveloping steps

If the cost-benefit comparison of de-enveloping versus retaining the structure suggests de-enveloping, this will often, but not always, involve the company being placed into voluntary liquidation. Once the liquidator is satisfied that the company’s debts have been paid (or there are none), he will transfer the ownership of the property to the shareholder as a distribution in specie. Where the shareholder is a trustee, it may then be appropriate to distribute the property to a beneficiary.

In this case, it is vital to consider the property law implications at the earliest possible stage. For leasehold properties, a licence to assign will often be required and this can take time to secure. References and in some cases rent deposits and guarantees may be required or demanded so it is worthwhile ascertaining whether this is the case early in the process. If the company also owns shares in a company which owns the freehold of the whole building, it is essential to ensure that the shares in the freehold company are transferred to the new owner on completion.

Many properties will benefit from guarantee or warranty cover in respect of works that have been carried out and a full review of these should be conducted to ensure that these are transferred over to the new owner of the property. Post completion it is important to make sure that the insurance policies for the property, utilities and council tax are transferred to the new owner as well.

There can often be quirks – for example commonly freehold properties do not require anything other than a transfer to be completed. However, where the property is subject to an estate management scheme, the scheme can often require that notice of a transfer is given to the landlord under the scheme. It is therefore important to be well advised to ensure that the requirements of any transfer are properly attended to.

We can only hope that the 2017 changes will be the last major upheaval for some time and the market will be given some breathing space to absorb and adapt to the new regime. It is likely that in the start of 2017, landlords, lawyers and many other private wealth professionals will be very busy, so for those affected by these new rules, it will be worth considering as soon as possible what action to take before April 2017.

Edward Burton specialises in prime and super prime residential property at boutique private wealth law firm Maurice Turnor Gardner LLP

Claire Weeks advises trustees, banks and high-net worth individuals on tax and trust planning at Maurice Turnor Gardner LLP