The tax changes include the removal of the Capital Gains Tax (CGT) exemption, restricted access to Private Residence Relief (PRR) and possible removal of personal allowance for income tax.
Instead of directly holding UK residential property, overseas investors may benefit from alternative forms of property investment, which can give a similar level of exposure and investment opportunity, but in a more tax efficient way.
The tax changes impacting overseas investors holding UK residential property:
- Capital Gains Tax exemption removed: In November 2014, Her Majesty’s Treasury confirmed that non-residents will no longer be exempt from CGT on UK residential property gains. This change came into effect from 6 April 2015 and gains from this date will be chargeable at rates up to 28%.
- Private Residence Relief restricted: The Treasury also confirmed that access to PRR would be restricted. For PRR to be claimed on a UK property, a non-resident would need to live in that property for 90 days per tax year of ownership. This change also came into effect from 6 April 2015.
- Personal allowance for income tax may be removed: Currently the first £10,600 per annum of UK income is covered by the personal allowance. However, this allowance is currently under review and may be restricted for non-residents in future. A consultation is expected on this proposal, with changes likely from April 2017.
There is also inheritance tax (IHT) to consider. There is a misconception that only the estates of UK domiciled clients are subject to UK IHT. This is not the case, and most assets held in the UK, including residential property by non-domiciled clients, are chargeable at the standard rate of 40% on assets above the current nil rate band of £325,000.
Other investment options to consider:
- Investment in property funds – If an overseas investor is keen to have exposure to the UK property market, but is concerned about the taxation changes, a potential solution could be to include a property fund as part of their investment portfolio. Property funds can be a great way to diversify an investment portfolio. As the investor will be holding shares in a fund, rather than the physical property, this asset should be easier to sell if needs be since stocks are a more liquid asset. Also, investment funds continue to be CGT efficient if the investor has been non-resident for over five years as investment gains are exempt from CGT.
- Investment in an offshore bond – Building an investment portfolio within an offshore bond wrapper can help to overcome some of the taxation issues highlighted above. For example, all gains and most income from bonds are on a gross roll up basis, and the tax only becomes payable when some, or all, of the bond holding is encashed. There are also IHT advantages if the offshore bond is placed within a trust wrapper, helping to ensure assets are passed on to beneficiaries in a tax efficient way.
Offshore bonds have another key advantage. Since there is no income, there is nothing to declare to Her Majesty’s Revenue and Customs (HMRC), which helps remove the administrative burden of disclosing assets on the investor’s annual tax return.
Direct investment in the UK residential property market from non-UK residents may reduce following the taxation changes. Property can still offer diversification advantages for most portfolios, and investing in a property fund through an offshore bond can help ensure some taxation, liquidity and diversification benefits are maintained. Those already holding UK residential property directly may wish to review their holdings to check how these new taxation changes will impact them.
