Commercial property makes a good target for taxation. Its location is static, its ownership documented, and the commercial property tax liability can be calculated with more certainty.
Commercial property tax receipts have risen rapidly in past decade and a half, from £21bn to £29bn, beating both The Retail Price Index and gross domestic product.
As the UK tax policy seeks to moderate investment in order to cap the rising prices lately, commercial property tax implications have become prominent.
An ICAEW thought leadership piece Business rates: maintain, demolish, rebuild or refurbish? presents a few observations around commercial business property tax:
- The digital economy is putting increasing strain on the retail sector, one of the biggest contributors.
- The system entails additional, unrecognised, costs for businesses. In the UK, rate payers must themselves take responsibility for initiating the review of valuations. Although the new ‘check, challenge, appeal’ system might reduce incidences of appeals, if it induces businesses to accept a level of inaccuracy in valuations, they might not consider it a cost saving.
- Elements of the system discourage economically productive investment, such as where plant and equipment or other movable property is included.
- Property taxes fail to scale with profitability, which differentiates them from other taxes that track the business cycle. When the next downturn arrives, this will place additional strain on the economy and could lead to the failure of otherwise viable businesses
Here are the factors to be considered when buying, renting and disposing of property:
Buying the commercial property
All purchases of UK commercial property are subject to the following:
- Value Added Tax (VAT): VAT at 20% may be charged on the purchase price of commercial property or mixed-use properties. This is applicable in cases with new buildings and those where the seller has opted to tax. In cases where the sale is subject to VAT, there is little practical alternative other than to ‘opt to tax’. That is the effect of making the sale itself VAT-free and consequently mitigating the SDLT payable. Where there is no immediate need to opt to tax, commercial property owners should consider the best strategy for the property as a whole, taking into account future expenditure plans and the likely tenant-mix profile as some tenants will not be able to recover the VAT paid on rent.
- Stamp Duty Land Tax (SDLT): SDLT is applicable if the commercial property is situated in England, Wales or Northern Ireland. SDLT on commercial property starts at 2% for transactions over £150,000 and increases (on a ‘slice’ basis) to 5% for transactions over £250,000. The same rates of SDLT apply to individual, trustee and corporate purchasers. SDLT applies to the VAT inclusive transaction value, where VAT is payable.
- Land & Buildings Transaction Tax (LBTT) and Land Transaction Tax (LTT): LBTT is applicable if the commercial property is situated in Scotland and in addition, from 1 April 2018, SDLT is replaced in Wales by a devolved LTT. In more general terms, LBTT and LTT are both very similar to SDLT however the administrations are not alike.
- Other considerations on purchase of commercial property: A purchaser must review the capital allowances position and consider making a section 198 election. Also, they must consider the VAT position of the property and whether VAT will be payable on its acquisition or whether the property can be transferred as a VAT exempt ‘transfer of a going concern’ (TOGC). This depends on whether the sellers have opted to tax for VAT purposes; this may, in part, depend on whether their tenants are able to recover any VAT charged on rents. To qualify for TOGC treatment, the purchaser will need to register for VAT.
It is worth nothing that in case of shares in a company owning commercial property are purchased, compared to the property itself, no SDLT is applicable. Rather, a stamp duty of 0.5% is payable on the consideration given for shares in a UK company.
Renting the commercial property
Income from let commercial property is subjected to tax. Deductions are available for revenue expenses, such as interest and letting agents’ fees. The tax rates applicable depends on whether the lessor is an individual, trust or company.
- Commercial property tax through renting for individual: Individuals letting UK commercial property are subjected to income tax at 45% – their marginal tax rates on the net rental income, regardless of their UK residence status.
- Commercial property tax through renting for trustees: Both UK and non-UK resident trustees are subjected to income tax at 45% on their net rental income.
- Commercial property tax through renting for companies: UK resident companies are subjected to corporation tax on the net rental profits (19%, reducing to 17% from 1 April 2020). Deductions are commonly available for revenue expenses, but from 1 April 2017, a restraint is applicable to the amount of interest and other finance costs that companies can deduct in computing their profit. This essentially means that interest cost will be restricted to 30% of EBITDA, subject to a de minimis limit of £2 million.
Commercial property tax for non-UK investors
The UK tax regime applicable to non-UK investors in commercial property has been fairly generous. The transaction tax on a commercial property acquisition is low and so is the effective rate of tax on gains realised on the disposal of the commercial property.
Most UK commercial property ventures exist with a non-UK company acting as a special purpose vehicle. This is a tax efficient way out that offers options in terms of future disposal routes when an investor wants to exit the investment. Investment into a UK commercial property through a non-UK company removes the possibility of any applicability of UK inheritance tax.
Historically, capital gains on commercial property earned by non-UK investors were not taxed in the UK. This tradition changed recently, in April 2019. April 2019 onwards, capital gains on direct or indirect disposals of UK land has been made taxable. There is still an exemption for investors who have a stake of less than 25% in a property-owning company or partnership. The rate of tax is set to be 19%.
From April 2019, any income arising out commercial property owned by a non-UK resident company are subjected to tax at a rate of 19%. A withholding regime is applicable which means that the tenant or other paying entity must deduct the tax due and account for it directly to the tax authority, HM Revenue & Customs (‘HMRC’). Largely, the holding company or other owning entity registers under HMRC’s ‘non-resident landlord scheme’ which allows it to receive income gross, deduct expenses, calculate taxable profits, and submit a UK tax return in the conventional manner.
- Attribution of profits to UK individuals: If shareholders of the non-UK resident company are UK resident, or a settlor-interested trust where the settlor is UK resident, the underlying UK source income may be attributed to the shareholder/settlor so that additional tax at up to 45% is due with a credit for the 20% tax paid by the non-UK resident company. The Annual Tax on Enveloped Dwellings (ATED) and related charges are not applicable to commercial property. This means that companies are commonly an apt acquisition vehicle for commercial property.
- Non-resident landlords: Non-UK resident landlords, including individual, corporate and trustees, are subject to a 20% withholding tax on rents received unless an application is made to HMRC under the non-resident landlord scheme for rents to be paid gross. The 20% withholding does not discharge the non-resident’s tax liability: rather it is used as a credit against that liability.
- Capital allowances: The tax system in the UK does not allow a deduction for depreciation. Instead, capital allowances are available on qualifying assets. Qualifying assets are allocated to a capital allowances group, with allowances of 18% or 8% (reducing to 6% from April 2019) depending on the nature of the assets available on a reducing balance basis.
When the commercial property is bought, it is possible for the vendor and purchaser of the commercial property to together elect to fix the portion of the purchase price to be allocated to the fixtures that qualifying for capital allowances (a section 198 election). The value of any transferred allowances, and whether an election needs to be made, should be considered as part of the sale/purchase negotiations of a commercial property.
Earlier, no capital allowances used to be offered on buildings though the Chancellor had announced in the 2018 Budget the introduction of a new 2% capital allowance – the Structures and Building Allowance – offered on qualifying expenditure on new non-residential structures and buildings incurred on or after 29 October 2018.
Ownership of UK commercial property: inheritance tax
UK inheritance tax (IHT) is applicable to UK assets which are directly owned, regardless of the residence or domicile status of the owner of the commercial property.
IHT is liable to tax on death at 40% in relation to assets held at death. IHT is also applicable to any gifts made within seven years prior to death, though there is a narrowing of the IHT rate.
Transfers of commercial property into trust will attract a 20% IHT charge and the UK assets will roughly be subject to a 6% IHT charge every 10 years, with a pro-rated 6% IHT charge on any distributions from the trust. Where the settlor of the trust retains an interest in the trust, in addition to these charges, the property will remain in their estate for IHT purposes.
Tax relief: An individual who is not domiciled in the UK and is not considered to be domiciled in the UK can shelter the value of the commercial property from IHT by owning the property through a non-UK resident company. For IHT purposes they are treated as owning the non-UK situs shares. This, however, was not the case with UK residential property from 6 April 2017.
Sale of commercial property
Commercial property owners may have to pay Capital Gains Tax if they make a profit (‘gain’) when they sell (or ‘dispose of’) property that’s not your home, for example:
- buy-to-let properties
- business premises
- inherited property
Commercial property owners do not usually need to pay tax on gifts to your husband, wife, civil partner or a charity. They may get tax relief if the commercial property is a business asset.
If the commercial property was occupied by a dependent relative, they may not have to pay.
- Residence: Traditionally, non-residents – individuals, trustees and companies, have not been subject to UK tax on the disposal of commercial property held for investment purposes. Specific rules apply where a property is or becomes a development property. The UK government announced that the position has changed from April 2019. From April 2019, all disposals of UK property by non-residents became subject to capital gains tax (CGT), and the disposals of indirect interests in such commercial property. Gains on commercial property and indirect interests in all types of property has been rebased to April 2019, so that only the element of gain accruing from that date is taxable. Tax is due at the same rate as an equivalent disposal by a UK resident.
- Individuals: UK resident individuals are subject to CGT on gains realised on the disposal of UK commercial property at 10% or 20%, depending on whether the individual has any basic rate band remaining after calculating their income for income tax purposes.
- Trustees: UK resident trustees are subject to CGT at 20% on gains realised on disposal.
- Company: A UK resident company is subject to corporation tax at 19%, reducing to 17% from 1 April 2020, on gains realised on the disposal of commercial property.
- Recording: From 6 April 2019 a return needed to be filed within 30 days in relation to any disposal of UK commercial property by a non-UK tax resident. The payment date for any tax due is also be 30 days following the date of disposal. These obligations and deadlines were scheduled to be extended to UK tax residents for disposals arising on or after 6 April 2020.
The commercial property sector does offer an investor some opportunities to secure income streams. Investors need to pay attention to the tax rules before they test whether it will be successful or suitable.