UK tax on trading in, and development of, UK land for non-UK residents

Following its announcement in Budget 2016, the Government has introduced a significant change in the taxation of non-UK residents who carry on a ‘property trade’ in respect of UK land. The scope of what constitutes a property trade is wide, and includes the development of UK land. The charge to UK tax applies irrespective of whether the non-UK resident has a taxable presence (permanent establishment) in the UK.

Historically, disposals of UK land held as an investment by non-UK residents were not subject to UK capital gains tax, unless the property was residential.

The UK generally taxes property trading and property investment activity differently. Whether property development is a trade or an investment is a difficult question, involving a detailed assessment of the activities and intention of the taxpayer.

Where a non-UK resident is trading, profits were historically only table where either:

• The company traded through a permanent establishment; in this case, only the profits and gains attributable to the UK permanent establishment were taxed
• The company may have a residual liability to UK income tax in respect of its UK source trading profits, even where it was not UK resident and had no UK permanent establishment (unless this was relieved by a double tax treaty) or
• The diverted profits tax legislation applied.

Accordingly, non-UK resident companies that did not have a UK permanent establishment and which were resident in a country that had a double tax treaty with the UK which prevented the residual income tax charge (by imposing a particular threshold that must be met before there was a UK permanent establishment), did not historically pay UK tax on trading or development profits.

There could be a very real practical issue as to whether, in fact, there was a UK permanent establishment or not. The Government is aware of this, and has stated that HM Revenue & Customs (HMRC) is already challenging structures where they consider there are strong arguments that there is a UK permanent establishment or a liability to diverted profits tax.

The new legislation amends the scope of the UK charge to tax on trading and development profit, so that the profits of a trade carried on by a company are subject to UK corporation tax where the company is:

• dealing in UK land; or
• developing UK land with a view to disposing of the UK land.

This charge applies regardless of the residence of the seller, and whether or not it has a UK permanent establishment. The usual corporation tax principles are applied to determine the amount to be brought into charge.

Similar legislation has also been introduced in relation to income tax.

The new legislation also applies, where it is the company’s main purpose (or one of its main purposes), broadly, to realise a profit or gain from disposing of or developing UK land.

The new legislation seeks to tax non-UK developers of UK land in the same way as their UK counterparts. However, the Government notes that this is an area where tax planning can play a key role, and consequently introduced a targeted anti-avoidance rule (TAAR), which was effective from March 16, 2016 to prevent any re-structuring ahead of the introduction of the legislation in order to mitigate the effects of the new charge.

Accordingly, the TAAR will apply where:

• between March 16, 2016 and the introduction of the legislation, there was a transfer of the UK land to a related party (regardless of whether there was a tax avoidance motive or not) – effectively to re-base the property before the new tax came into effect or
• in any other case where arrangements were entered into, the main or one of the main purposes of which was to secure that the profits were not subject to the new tax.

In addition, the Government perceived that there were two other areas of tax planning which could enable offshore developers to avoid the new charge. These are described as ‘fragmentation’ and ‘enveloping’.

Fragmentation is where entities are inserted into the structure that are not themselves subject to the charge (as they do not own the UK land). An example could be the use of a non-UK development company, which is appointed to manage the development and takes on all of the risk, in return for a fee (equal to a significant part of the profit on sale) from the economic owner of the property. The new legislation ensures that both the owner of the property and the development company will be taxed on the profit realised. The aim is to ensure that connected persons who act together to complete a development (i.e. who together carry on a UK property trade) do no avoid the tax charge.

Land which is held by a non-natural person (e.g. a corporate) is known as ‘enveloped’. Rather than sell the property directly, the non-UK resident owners could choose to sell that property owning company. The Government considers that such a sale may amount to a realisation of value deriving from the land, and accordingly will tax the proceeds of sale in certain circumstances (particularly where the land has been held as trading stock, rather than as a fixed asset).

Some of the UK’s double tax treaties have been amended to ensure that the UK is entitled to tax profits from UK land (notably the UK-Jersey, UK-Guernsey and UK-Isle of Man double tax treaties). Protocols have been agreed with these jurisdictions, and the changes to these double tax treaties took effect from March 16, 2016.

Other of the UK’s double tax treaties may be re-registered to prevent non-UK companies from arguing that the treaty prevents the UK from taxing profits derived from dealing in or developing UK land.

The Government has confirmed that it will monitor the arrangements to collect the UK corporation tax on behalf of non-UK residents, and will consider whether a withholding tax should be applied to the sales proceeds in order to ensure full compliance.

This is a significant change in policy and one which will impact on a number of non-UK resident property holding vehicles where there is a development of or trading in UK land. It could also apply to a non-UK resident person who sells a property holding vehicle, and not just to a direct sale of the land itself.

The concept of ‘trade’ includes development of the land, and there is no longer any need for a non-UK resident to have a UK permanent establishment in order to fall within the scope of UK tax. In addition, the amendment to double tax treaties, which many offshore developers may have relied on in the past, will no longer relieve the UK income tax charge. Whether further treaties will be amended remains to be seen; such intra-governmental negotiations tend to take time.

While it is clear that certain arrangements are potentially subject to diverted profits tax in any event (please see our briefing dated March 6, 2015 ‘Diverted Profits Tax and Real Estate – Development Property), this new legislation goes further because it is not necessary to have any form of taxable presence in the UK to be caught and the scope of what is taxed is different; the application of these rules to ‘profits from development’ is arguably broader than what is taxed under diverted profits tax (which taxes trading profits).

Crucially, the anti-fragmentation and anti-enveloping rules will ensure that using non-UK resident development companies or indeed realising an asset through a share sale as opposed to an asset sale, will not mitigate the new legislation.