Non-resident capital gains: new rule targets pension funds

"The ongoing dialogue with industry has resulted in a widening of the scope of exemption from the tax for investors in property rich property authorised investment funds (PAIFs) and other indirect structures, the reduction in the burden of returns for transparent collective investment vehicles and other technical changes. The overall aim appears to be to minimise impact on the market in collective investment in UK property by preserving the benefit of exemption for indirect investors where reasonably possible," said Richard Croker, a property tax expert at Pinsent Masons, the law firm behind Out-Law.

Since 6 April 2019, gains made on disposals by non-UK residents of UK non-residential property have been subject to UK tax. The charge on gains on disposals of interests in residential property was also extended from this date to include disposals made by widely held companies and investment funds not previously included, and to life assurance companies. The changes also tax non-UK residents' gains on interests in UK 'property rich' entities. These indirect disposal rules apply where a person makes a disposal of an entity that derives 75% or more of its gross asset value from UK land.

The rules contain provisions intended to prevent tax exempt investors such as pension funds from being taxed and to ensure that investors in collective investment vehicles (CIVs) do not suffer multiple tax charges in respect of the same disposal.

Widely held CIVs may make elections, depending upon their circumstances, for either transparency or exemption that have the effect of moving the incidence of tax on gains from the CIV to its investors.

A transparency election treats the CIV as a partnership for capital gains purposes so that investors who are within the charge to tax are taxed on disposals of interests in the underlying assets of the partnership and exempt investors are exempt from tax on such disposals. 

Under the election for exemption, the CIV is exempt from tax on disposals but the CIV’s investors will be chargeable on gains made on disposals of interests in the CIV, unless they are exempt on such gains because of their own tax status, for example because they are pension funds.

However, since the introduction of the rules, professional investors and advisers have called on the government to make changes to the rules regarding CIVs so that they achieve their intended result.

"Representations have made it clear that failing to address these issues would have an immediate impact on exempt investors, reducing their expected returns from investment in UK property, and a lack of certainty as regards operation of aspects of the rules would dampen investment in UK commercial property in particular as it is commonly held within CIV structures," the draft explanatory note to the regulations says.

The existing rules exempt disposals of interests in CIVs which are themselves exempt made by some holding vehicles that are wholly owned by tax exempt investors such as pension funds. However, the rules do not currently include all holding structures used by tax exempt investors, such as PAIFs, and so the exemption has been extended to include these alternative holding structures when held wholly (or almost wholly) by qualifying institutional investors. The exemption is also extended on the same basis to such structures investing in CIVs which elect for transparency.

The draft regulations also make it clear that only principal companies of non-resident property groups will come within the definition of a CIV, meaning indirect subsidiary companies will not  be able to make elections for exemption themselves. The draft regulations also provide that exemption elections by tax transparent offshore CIVs require direct ownership of an underlying investee company, meaning elections in respect of indirect interests are not permissible.

The regulations also clarify the obligations on CIVs that have made transparency elections to report information to HMRC on partnership returns.

Only widely held CIVs can benefit from the elections. Another change in the draft regulations ensures that CIVs that existed at 6 April 2019, or are structured as partnerships, trusts or contractual schemes, are not disadvantaged because they fail, for purely technical reasons, to meet the diversity of ownership conditions, despite being widely held in practice.

"Even after these changes, there will still be some investors who, subject to treaty protection, will incur a potential tax liability and reporting obligations on disposals of minority interests in certain CIVs or other vehicles treated as such," Richard Croker said.

The draft regulations are open for consultation until 25 October 2019. They are expected to come into force on 1 January 2019 but most of the changes will apply from 6 April 2019.