Yesterday George Osborne delivered the 2016 Budget. There were some significant announcements for the real estate industry.
Stamp duty land tax (SDLT)
Commercial property - new 5% rate and move to "slice" system
From midnight on 17 March, SDLT on commercial property will be charged on a "slice" basis (as with residential property). The rates will also change so that:
- a rate of 5% will apply to the part of the purchase price over £250,000. The rates for commercial property will therefore be 0% up to £150,000, 2% between £150,000 and £250,000, and 5% above £250,000; and
- where a new lease is granted, a rate of 2% will apply to the net present value of the rents in excess of £5 million (the current rate is 1%).
Purchasers who have entered into contracts before midnight tonight will have a choice of whether the old or the new regime will apply. It is expected that the new system will result in more SDLT for around 9% of taxpayers (which will of course include the majority of our major real estate clients).
3% rate on "additional" residential properties
As announced in December, the additional 3% rate will apply to residential purchases made from April this year. Following a consultation process, two new announcements have now been made:
(a) There will be no exemption from the 3% rate for "significant investors". If that remains unchanged, this will significantly increase the cost for investors on bulk purchases of newly built residential flats. The draft legislation also amends multiple dwellings relief so that it will include the additional 3% rate. No reason was given for not introducing a relieving measure for bulk purchases.
(b) The period in which buyers of second properties can claim a refund of the additional SDLT paid (eg where they do not sell their previous property at the same time as buying their new home) will be extended from 18 to 36 months (ie they can buy the new property up to 3 years after the sale of their existing property)
Restrictions to interest deductions
Following the conclusion of the OECD's "BEPS" project, there will be a restriction on deductibility of interest costs for UK taxpayers. Interest deductions will effectively be capped at the higher of (A) 30% of UK EBITDA, or (B) the level of the worldwide group's net ratio of interest to earnings.
However, this will only apply to larger groups with more than £2m of net interest costs and there will be an exemption for "public benefit infrastructure" (although the expectation is that this will be restricted to public sector projects rather than the wide real estate sector). Property groups would be well advised not to reduce their worldwide borrowings as it could result in the new UK restrictions applying.
As the real estate industry is, in general, quite highly leveraged, the change is likely to have an adverse impact on larger property groups. It is being introduced despite strong lobbying from real estate industry bodies like the BPF. It will also need to be taken into consideration by real estate lenders as the tax disallowances will impact on the amount of leverage a borrower can comfortably service.
Offshore property developers
Some property developers have been using offshore companies to avoid UK tax on their profits from developing UK property. The government intends to introduce new legislation to ensure these structures cannot be used any longer to avoid UK tax. This will be combined with a new HMRC "taskforce" aimed at improving taxpayer compliance in this area.
The new rules will work by taxing all trading profits from dealing in/developing UK land regardless of the location of the company carrying on the trade (and regardless of whether or not the company has a UK permanent establishment). Anti-avoidance rules will also be introduced to stop offshore developers from circumventing the new rules (including by "enveloping" real estate in corporate wrappers, splitting the transactions into a lower risk planning company and then a higher risk developer company or by selling the corporate wrappers). A new anti-avoidance rule to supplement the existing "transactions in land" provision, which was barely used by HMRC, (commonly referred to as "776", after the section number it was originally located at) is to be introduced and will catch a far wider range of circumstances.
The new rules will apply to both corporation tax (for companies) and income tax (for individuals/partnerships/trusts). None of this will affect UK-based property developers (who already pay UK corporation tax on their profits). However, the new rules are not restricted to residential land and will affect commercial property developers when there is a risk that their activities could be viewed as trading e.g. purchases with a view to sale, after any necessary works, as opposed to an intention to receive rental income and capital growth. The old "776" rule was rarely used in practice but the replacement provisions are far wider and more carefully targeted and we would expect them to cause more problems for commercial property developers e.g. catching corporate wrapper sales.
There is good and bad news for corporation taxpayers. The good: more flexibility is to be introduced on the use of "carry forward" losses from April 2017 (e.g. they can now be surrendered out to other group companies where they could not be before, so there is less chance of "stranded" losses).
The bad: from April 2017 only 50% of future taxable profits over £5 million will be able to be offset by "carry forward" losses. This is only expected to affect around 1% of taxpayers, however.
Other changes that will affect the real estate industry more generally are as follows:
(a) More announcements on infrastructure projects:
i. Improvements to northern transport connectivity, including the green light for High Speed 3 between Leeds and Manchester (only 30 minutes!). ii. Approval of Crossrail 2 with £80m to help fund development and a request for TfL to match the commitment.
(b) The corporation tax rate will fall an additional percentage point to 17% from April 2020.
(c) Changes to the capital gains tax (CGT) regime:
i. The general CGT rates will come down from 28% to 20% (for higher rate taxpayers) and 18% to 10% (for basic rate taxpayers). The 28% and 18% rates will still apply to investors in residential property and those with carried interest arrangements (e.g. managers in private equity funds investing in real estate).
ii. A lifetime limit of £100,000 on gains made by individuals who are "employee shareholders" (aka ESS). This will not apply to arrangements existing before 17 March 2016.
iii. Extension of entrepreneurs' relief (a 10% CGT rate) to investors who are not employees/directors and who invest in trading groups for at least 3 years. This would include investors in private real estate companies that are treated as trading for tax purposes. However, it only applies to purchases of newly issued shares on or after 17 March 2016.
A further reduction in business rates for smaller businesses from April 2017.