Corporation tax for offshore corporate landlords

James Stewart reviews the draft legislation extending corporation tax to the UK property income of offshore corporate landlords, and the potential impact on offshore structures.

What is the territorial scope of UK corporation tax for non-UK tax resident companies?

The answer to this fundamental question can be found in CTA 2009 s 5. Until 2016, the scope could be summarised as succinctly set out in CTM34210 of HMRC's Company Taxation Manual: "…a company not resident in the UK is only chargeable to CT if it carries on a trade in the UK through a permanent establishment/branch or agency".

How times have changed. In 2016, s 5 was extended to include non-UK resident companies carrying on a trade of dealing in or developing UK land (at the time of writing, CTM34210 does not mention the 2016 changes - which are instead covered in BIM60515 onwards of HMRC's Business Income Manual). From 6 April 2019, TCGA 1992 will be amended so that non-resident companies are subject to corporation tax on gains arising from direct and indirect disposals of UK property.

From 6 April 2020, the scope of corporation tax will be further extended to the income of non-UK tax resident companies carrying on a UK property business (broadly, a UK real estate rental business, whether residential or commercial) – the final piece in HMRC's puzzle of bringing offshore companies fully within the scope of corporation tax in relation to UK real estate.

This article reviews the draft legislation and HMRC policy paper (published on 6 July 2018) extending corporation tax to the UK property income of non-resident companies. For the purposes of this article, non-UK resident companies carrying on a UK property business are referred to as "Offshore Propcos", with equivalent UK companies being "UK Propcos".

Extension of scope

The core change is the extension of CTA 2009 s 5.

From 6 April 2020, an Offshore Propco will be chargeable to corporation tax (in accordance with ordinary corporation tax principles) on:

• profits of its UK property business and profits that consist of "other UK property income"; and
• profits arising from loan relationships or derivative contracts that the Offshore Propco is party to for the purpose of that property business or enabling it to generate that other UK property income

(to be inserted as new CTA 2009 ss 5(3A) and 5(3B)).

"Other UK property income" means those categories of income dealt with by CTA 2009 Part 4 Chapters 7 to 9 (inclusive), e.g. rent receivable for UK electric-line wayleaves. Consistent with HMRC's recent policy of retaining taxing rights over UK real estate, the foreign branch exemption (CTA 2009 s 18A) will be amended so that it cannot include the new categories of property income brought within corporation tax.

Transitional periods of account

Many Offshore Propcos will have a period of account which straddles the commencement date (i.e. a period of account beginning before and ending after 6 April 2020). Transitional provisions therefore assume a straddling period of account is split into two separate periods of account:

• the first of which begins at the same time as the actual period of account and ends on 5 April 2020 - the profits of which will remain within income tax and be included with the final income tax return; and
• the second of which commences on 6 April 2020 and ends at the same time as the actual period of account - with profits being charged to corporation tax.

The 2017 consultation stated that property income would be apportioned on a just and reasonable basis between these two periods, although this is not specified in the draft legislation.

For non-UK resident companies which are partners in a firm carrying on a trade and with untaxed income or relievable losses from a UK property business (thereby treated as carrying on a notional business under ITTOIA 2005 s 854), the basis period for income tax purposes of that notional period is also treated as ending on 5 April 2020.

Grandfathering of income tax losses

The draft legislation dealing with preservation of losses incurred under the income tax regime (previously referred to as income tax property losses, or "ITPL") is refreshingly straightforward.

Grandfathering will apply where an Offshore Propco makes or has made a UK property business loss in the income tax year ending 5 April 2020 or any prior tax years, for which income tax relief is not given. The remaining loss is referred to as the "unrelieved amount".

The unrelieved amount is automatically carried forward to reduce the profits of the UK property business (so long as it remains carried on by the Offshore Propco) for accounting periods ending after 6 April 2020 – and before utilisation of any carried forward corporation tax loss. Profits of an accounting period are relieved in priority to any subsequent accounting period.

The unrelieved amount is not a corporation tax loss as such, and so is not subject to the 50% carry forward restriction. There is no other mechanism for utilising the unrelieved amount, so it cannot be used to reduce other sources of income or be surrendered as group relief.

Non-resident landlord scheme ("NRLS")

Offshore Propcos are currently chargeable to UK income tax (capped at 20%) on their UK property business profits, with UK tenants and letting agents required to withhold tax from rent paid to non-resident landlords. In practice, Offshore Propcos will typically register for gross payment status in order to receive rent without deduction of tax, although they still remain liable for income tax under self-assessment.

It is understood that, notwithstanding the switch to corporation tax, HMRC still intends the NRLS to apply to Offshore Propcos. Whilst the current NRLS regulations (which are not being amended) exclude rental income both chargeable to corporation tax and attributable to a UK permanent establishment (SI 1995/2902, reg 8(3)), that will not extend to an Offshore Propco charged to corporation tax under the new scope.

Despite the policy objective of levelling the playing field between UK and Offshore Propcos, it appears this is one area where differences will remain.

Capital allowances

To avoid the switch to corporation tax triggering a disposal for capital allowances purposes (with potential balancing adjustments), the draft legislation removes ITTOIA 2005 s 362, which otherwise treats a company as permanently ceasing to carry on a UK property business if it ceases to be within the charge to income tax.

As the deeming provision in s 362(2) is stated to apply "for the purposes of this Part", HMRC may want to consider amending CAA 2001 itself to make clear the switch to corporation tax is not a capital allowances disposal event.

Derivatives and Disregard Regulations

The Disregard Regulations (SI 2004/3256) will be available to Offshore Propcos once they are brought within corporation tax. However, the draft legislation provides that just and reasonable adjustments are to be made where there is "tax asymmetry", being where fair value amounts in relation to a derivative were previously brought into account under income tax, but not then corporation tax by reason of an Offshore Propco electing into the Disregard Regulations. This is intended to ensure the "correct amounts" are brought into account over the term of the derivative.

On the flip side, where fair value movements have not been brought into account under income tax as a result of being capital in nature, an Offshore Propco will be deemed to have elected into the Disregard Regulations, again to ensure consistency following the switch.

Equalising treatment

Further changes putting Offshore Propcos on "equal footing" with UK Propcos include widening:

• the rules permitting reallocation of intangible fixed asset de-grouping charges (CTA 2009 s 792) to include Offshore Propcos; and
• the group relief surrender rules to include non-UK resident companies to the extent they are within the charge to corporation tax (group relief can already apply to a non-UK company carrying on a trade in the UK through a permanent establishment).

Compliance

The policy paper provides some useful commentary on the practicalities of the switch and expected timeline:

• HMRC intends to write to Offshore Propcos during summer 2019 to inform them of the switch and provide a corporation tax reference number (this will apparently satisfy the requirement to notify chargeability to corporation tax).
• Offshore Propcos will need to file a final paper Form SA700 for the tax year ending 5 April 2020, with HMRC sending the notice to file in April 2020.
• Thereafter, Offshore Propcos will need to file an online CT600 (using iXBRL and with iXBRL tags) in respect of corporation tax accounting periods, together with online filing of their accounts and computations.

HMRC is still considering the compliance obligations for non-UK corporate investors in UK property through widely held transparent funds.

Comment

The switch to corporation tax will have significant implications for Offshore Propcos beyond the change in tax rates from 20% income tax to (with effect from 1 April 2020) 17% corporation tax, such as application of the corporate interest restriction regime and the rules on corporation tax loss relief (albeit the latter will not apply to grandfathered income tax losses).

The draft legislation is silent on these topics – simply switching the charging provision from income tax to corporation tax and then (as described in the policy paper) the "UK property income profits chargeable to Corporation Tax will be calculated in accordance with ordinary Corporation Tax principles". So, whilst the draft legislation deals with a number of technical areas, a key take-away point remains the application of existing corporation tax rules.

There appear to be some gaps at this stage, e.g. in relation to non-UK resident companies investing in non-UK resident property unit trusts. There is nothing on management expense deductions, despite indications these would only be given if directly linked to the UK property business. The draft legislation remains subject to technical consultation and more detail should be available in due course.

As mentioned previously, Offshore Propcos will also be subject to corporation tax on their UK property gains from April 2019. Notwithstanding the extension of corporation tax, there will remain potential advantages in using an Offshore Propco structure, for example:

• A purchase of the shares in a UK Propco (e.g. as part of a corporate wrapper sale) is subject to 0.5% stamp duty, whereas there is no stamp tax on the purchase of an Offshore Propco incorporated in a jurisdiction such as Jersey (assuming the share transfer is executed, and share register held, outside the UK).
• Subject to any applicable double tax treaty, yearly interest paid by a UK Propco to a non-UK lender would be subject to UK withholding tax (ITA 2007 s 874), whilst interest paid by an Offshore Propco may not (depending on the circumstances) be subject to withholding, although this will depend on an "acutely fact-sensitive" multifactorial analysis of the source of the interest payment (Ardmore Construction v HMRC [2018] EWCA 1438). Offshore Propcos may take the view that, where debt is secured on UK real estate and interest is serviced by UK rental income, UK withholding tax still applies.
• There may also be non-tax reasons, such as local company law, why clients would prefer to use an Offshore Propco to hold UK real estate (indeed some structures already operate on the basis of using vehicles incorporated in non-UK jurisdictions but which are centrally managed and controlled from the UK, and so treated as UK tax resident).

Action points

The changes are still (at the time of writing) a year and a half away, so advisers can use this time to:

• Brief clients with Offshore Propcos (or planning to establish them) on the switch to corporation tax from 6 April 2020 and key implications – particularly the tax compliance differences between the regimes and the need to put in place new systems.
• Review with those clients the potential impact of rules such as the corporate interest restriction regime, as clients will likely not have considered these when establishing their structure.
• Advisers that handle income tax filings for Offshore Propcos, but not corporation tax filings generally, will need to familiarise themselves with the different compliance obligations and rules following the switch. Advisers also need to obtain client authority to act on corporation tax matters.

This article first featured in Tax Journal on 11 October 2018 and is reproduced with the kind permission of the editors.