The practice of enveloping UK properties within corporate structures has been a well-established strategy for managing and optimising tax liabilities for many years. However, recent changes in legislation and increasing scrutiny from tax authorities have led to a growing interest in the process of "de-enveloping" UK properties.
In this comprehensive article, we will delve into a real-world case study discussing the intricacies of de-enveloping UK property.
Understanding De-Enveloping Property
To grasp the concept of de-enveloping, it's essential to first understand property enveloping.
Property enveloping refers to the practice of holding UK real estate within a corporate structure, often utilising offshore companies or special purpose vehicles (SPVs).
Therefore, de-enveloping UK property is the process of moving a property out of this corporate setup and placing it into individual ownership.
The Shift Towards De-Enveloping
Recent changes in tax legislation, particularly the extension of ATED charges to a broader range of properties and the introduction of Registration of Overseas Entities (ROE) have made property enveloping less tax efficient. As a result, many property owners and investors are considering de-enveloping to reduce their tax exposure and streamline their holdings.
Case Study: Real-World Example
To illustrate the de-enveloping process, we present a real-world case study of a property owner who successfully de-enveloped their UK property portfolio.
A British Virgin Islands (BVI) registered company owned a property within the United Kingdom which comprised of a sole shareholder, referred to as 'A’ and three directors. The primary objective behind establishing this company was to generate rental income from the property.
Prior to the de-enveloping process, the property was rented out, yielding a monthly gross rental income of £2,500. The company had efficiently optimised its operations, resulting in a substantial profit.
Nevertheless, despite the company's financial success, A, who served as the ultimate beneficial owner of the property, along with the other directors, chose to pursue the de-enveloping option. Their goal was to simplify the corporate structure and reduce administrative burdens, particularly in light of evolving regulations, such as the Registration of Overseas Entities (ROE) and changing tax legislation.
Considering these factors and increased regulatory scrutiny, the shareholder made a significant decision to proceed with the de-enveloping process, transferring ownership of the UK property into his personal name.
- The property was purchased on 25 May 1992, for the value of £50,000.
- The beneficial owner of the property was ‘A’.
- All three directors including A, was non-UK resident for tax purposes.
- The market value of the property at the time of de-enveloping was £600,000.
- The market value of the property as of 6 April 2015 was £420,000.
- There was no mortgage attached to the property at the time of de-enveloping and the only debt owed by the company was to ‘A’.
- The property was transferred to ‘A’ for nil consideration.
The Method Selected
When opting for the de-enveloping process of a property previously held within an offshore company, two primary methods were available: 'Distribution in Specie' and 'Capital Distribution.' In this case, the company decided to transfer the property via a distribution in specie to the shareholder.
Distribution in specie invoices the distribution of the assets without undergoing conversion into cash. Instead of selling the asset and distributing the proceeds, the property is directly transferred in its physical form.
The process of de-enveloping the property carries with it specific tax considerations. Here, we outline the primary tax implications addressed during this procedure:
Capital Gains Tax
Effective from 6 April 2015, Non-Resident Capital Gains Tax (CGT) became applicable to direct disposals of UK residential property. Consequently, the property fell within the purview of CGT. Since the company was a non-UK resident company previously not subject to UK CGT, the gain was calculated by contrasting the market value at the time of de-enveloping with its value as of April 2015.
The property's market value on 6 April 2015 stood at £420,000, while its value at the time of de-enveloping was £600,000. This resulted in a capital gain of £180,000.
Stamp Duty Land Tax
Stamp Duty Land Tax (SDLT) is a tax imposed on land transactions, which includes property ownership transfers, and it is levied based on the chargeable consideration. Moreover, SDLT becomes applicable on a distribution in specie if the recipient takes on, satisfies, or releases any debt linked to the property or if new debt is created.
In this case, since the property had no associated mortgage, and there was no return of capital, there was no consideration for SDLT. Hence, there were no SDLT implications concerning the proposed transfer.
Income Tax on Distribution to A
A, being a non-UK resident, did not face UK income tax implications when receiving a dividend through the in-specie transfer of the property from the company.
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The successful de-enveloping of the property involved a meticulously executed series of steps, ensuring compliance with legal and tax regulations while optimising the outcome. Below, we detail the key components of this process:
A special meeting was held between the board of directors and shareholders of the company prior to initiating the de-enveloping process. The minutes of a joint meeting of shareholders and directors were documented outlining the transfer of ownership to A through a distribution in specie, which was to be satisfied through the transfer of the property.
Confirmation from a Practicing Lawyer
Legal practitioner confirmed that the transfer adhered to the regulations governing such transactions. Additionally, the company provided a study, based on estate market records and evaluations, confirming that the property's current value represented a gain of £180,000 compared to its April 2015 value.
Transfer Deed and TR1 form
The company then initiated the formal transfer of property ownership from the offshore entity to A, utilising a transfer deed. The 'TR1 Form,' officially known as the Transfer of Whole of Registered Title Form, was completed, and submitted to HM Land Registry, facilitating the property ownership transfer.
A letter from legal practitioner was also submitted to Land Registry, confirming that the transfer was in accordance with BVI regulations.
Disclosure of Property Disposal Information
Once the transfer deed was submitted, the British Virgin Islands (BVI) company initiated the process to remove itself from the Register of Overseas Entities, given that it was no longer a registered owner of property in the UK. Consequently, the property disposal details were submitted to Companies House.
As a result of this removal, the Overseas Entity ID lost its validity. This meant that the entity was no longer permitted to participate in property or land transactions within the UK, including activities like buying, selling, transferring, leasing, or charging.
Professional Advice Report
Prior to the ownership transfer, professional advice was sought from tax advisors and accountants. The company obtained a comprehensive tax report, which advised that the transfer of the Property via a distribution in specie would be subjected to UK CGT on the gain of £180,000, although no SDLT would be payable.
To gain insight into de-enveloping UK property, explore our in-depth article titled 'De-enveloping UK Property : Tax and Regulatory Considerations’.
Post De-enveloping Procedures
After the property de-enveloping process was successfully executed, following steps were undertaken:
One of the main factors to address in this case pertained to reporting the gain realised during the property's disposal. As previously noted, the gain was calculated as the difference between the market value of the property on 6 April 2015 and the market value at the time of de-enveloping.
Adhering to Capital Gains Tax (CGT) regulations, the company fulfilled its capital gains tax obligations and submitted the CGT return within the 60-day timeframe following the disposal.
It's essential to emphasise that, even in instances where there is a loss and no Capital Gains Tax liability arose, it is necessary for the company to file the CGT return within 60 days of the property disposal.
Final Arrangements for the Shareholder
Following the transfer to A, who was a non-resident, several arrangements were made concerning his 'UK accounts affairs,' including:
- Registration with HMRC.
- Obtaining a non-residential landlord tax exempt certificate.
- Making and submitting a self-assessment declaration annually.
The property continued to be rented under personal ownership, with A registered for Non-Resident Landlord (NRL) status. This means that the rental income was paid to A without the deduction of basic rate tax, which is typically 20%.
De-enveloping UK property is a strategic move that requires careful consideration of its implications, both from a tax and administrative perspective. As tax laws continue to evolve, property owners and investors must stay informed about the latest changes and assess whether de-enveloping aligns with their financial goals and compliance requirements.
While de-enveloping may not be suitable for everyone, it represents a proactive response to the shifting tax landscape and an opportunity to optimise property holdings in the UK.
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