'Clouds on the horizon' for real estate tax, says expert

Real estate tax expert John Christian of Pinsent Masons, the law firm behind Out-Law.com, said that real estate had "not traditionally been a target for tax raising" other than for stamp duty land tax (SDLT). A new government is unlikely to wish to reverse the residential SDLT changes in the Autumn Statement, which abolish the old 'slab system' for home purchases, he said. Many saw this system as unfair,  as if the consideration was over a threshold for higher rates, even if only by a very small amount, SDLT was payable on the whole consideration at the higher rate.     

He said that, although Labour has pledged to introduce a 'mansion tax', this will not directly affect property investors, other than specialist investors in prime residential letting. However, he said that "some have predicted it will slow the London residential market".

Christian said that one area of concern for the real estate sector is possible restrictions to the availability of tax relief for interest payments.

In December 2014 the Organisation for Economic Co-operation and Development (OECD) issued a discussion draft setting out options for restricting tax deductions for interest, as part of its base erosion and profit shifting (BEPS) project. BEPS refers to the shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid. Following international recognition that the international tax system needs to be reformed to prevent BEPS, the G20 asked the OECD to recommend possible solutions.

Action Point 4 of the OECD's BEPS action plan is limiting base erosion through interest deductions. The OECD is concerned that deductible payments such as interest can give rise to 'double non-taxation'. Excessive intra group interest deductions can also be used by multinational groups to reduce taxable profits in operating companies, even in cases where the group as a whole has little or no external debt.

John Christian said that the next stage of the OECD’s BEPS Action 4 report on interest deductions is likely to emerge in the Autumn. He said: "There has been widespread concern about the potential implications of the current direction of travel towards a ratio based limit on deductions, rather than an arm’s length model. This would have the effect of restricting deductions in relation to property investment structures, and particularly infrastructure investment, and is compounded by the difficulties in applying an EBITDA metric - apparently the current preferred approach - to property investment activities. The BEPS proposals in this area are particularly difficult for a number of countries so this debate has much further to go".

Another area of concern for real estate, according to John Christian, is the government's new 'diverted profits tax' (DPT) which is due to come into effect from 1 April 2015.

DPT was announced in the Chancellor's autumn statement in December last year and draft legislation was published for consultation on 10 December. The government said that DPT is being introduced because it is concerned that multinationals are using "contrived arrangements" to avoid paying their "fair share" of UK tax.

The new 25% tax will apply where a foreign company "exploits the permanent establishment rules" or where a UK company or a foreign company with a UK-taxable presence creates a tax advantage by using transactions or entities that "lack economic substance".

Christian said: "Given the political imperatives and the General Election climate, it is unlikely that there will be material changes in the complex and unclear draft legislation with issues being left in the unsatisfactory position of being addressed by HMRC guidance".

"For the property industry, the application of DPT to offshore structures is uncertain, with structures involving development being most at risk of potentially being caught. There is no grandfathering of DPT transactions so existing structures will need to be reviewed. Legislative change, or at least guidance, that the regime does not apply to property transactions would remove the uncertainty," he said.

Christian said that the capital gains tax (CGT) regime on residential property owned by non-residents will come into effect in April. He said "The consultation process has been helpful in limiting the potential application for institutional property investors and the legislation is largely workable for fund investors, though with some unclear areas at the margins".

John Christian explained that for the purposes of the new CGT regime, residential property excludes purpose built student accommodation – though not conversions - and care homes. He said: "An interesting area will be the private rented sector which is increasingly being seen as an institutional investment class but does not enjoy the same exemption. The fund investor provisions will therefore be important for the private rented sector. "

Christian said that SDLT "will continue to be a challenging area on more complex transactions", and that further cases are likely on historic avoidance structures. "The Project Blue Upper Tribunal decision is being appealed and the outcome in relation to the analysis of section 75A Finance Act 2003 will be keenly awaited. The current position leaves some difficulty in the light of the literal interpretation of section 75A adopted in the case and the absence of meaningful guidance in the case on the principles guiding the application of section 75A," he said.

Section 75A is an anti avoidance provision, which applies where a number of transactions are involved and the SDLT payable is less than if the purchaser had just acquired the property directly from the seller.