De-enveloping UK property refers to the process of removing a property from a corporate envelope/wrapper, often involving offshore company or trust structures, and transferring it into personal ownership. This practice has gained significant attention due to changes in tax legislation and increasing regulatory scrutiny.
If you own property within a corporate structure and are considering de-enveloping, this comprehensive guide will walk you through the regulatory changes giving rise to de-enveloping, highlighting important tax considerations, the available de-enveloping options, and the documents required for de-enveloping.
In the past, owning UK property through offshore corporate structures offered several advantages such as tax planning, confidentiality, and flexibility in property ownership.
However, due to numerous regulatory changes, this structure is no more lucrative. The introduction of the Annual Tax on Enveloped Dwellings (ATED), alterations to Capital Gains Tax (CGT), and changes to Inheritance Tax (IHT) regulations have removed the tax benefits associated with such structures.
Additionally, the introduction of the Registration of Overseas Entities required these structures to provide information about the registrable beneficial owners, eroding the secrecy previously offered by offshore corporate veils.
Therefore, recent changes in tax regulations have made maintaining such structures less advantageous, prompting many property owners to consider de-enveloping their assets.
Regulatory Changes Giving Rise to De-enveloping
De-enveloping, the process of transferring properties out of offshore corporate structures, gained momentum as a response to the following regulatory changes:
Introduction of Annual Tax on Enveloped Dwellings (ATED)
The UK government introduced the ATED regime to discourage the use of offshore corporate structures for holding UK residential properties.
ATED imposed an annual tax on properties owned by companies valued at more than £500,000.
The government introduced changes to the ATED CGT rules, extending the scope of CGT to include gains arising from the disposal of UK residential properties subject to ATED.
This change ensured that gains made by non-resident companies on ATED properties were subject to CGT.
Restriction on Capital Gains Tax (CGT) Exemptions
The government implemented measures to restrict CGT exemptions previously available to non-residents on gains made from UK residential properties.
Non-residents were now subject to CGT on disposals of UK residential properties, reducing the tax advantages of offshore structures.
Inheritance Tax (IHT) Changes for UK Residential Properties
The government introduced changes to the IHT rules, bringing UK residential properties owned by non-domiciled individuals and offshore structures within the scope of IHT.
Non-domiciled individuals were no longer able to escape IHT by holding UK residential properties through offshore structures.
Since 6 April 2019, ATED-related Capital Gains Tax is no longer applicable.
Instead, any gains made by a company from that date are subject to Corporation Tax and must be disclosed in the company's Corporation Tax return.
Changes to Capital Gains Tax (CGT) for Non-Residents
The government implemented further changes to CGT, extending its scope to include indirect disposals of UK property by non-residents.
Non-resident investors became liable for CGT when disposing of shares in companies that derived at least 75% of their value from UK property.
Implementation of the Economic Crime (Transparency and Enforcement) Act 2022
The Economic Crime (Transparency and Enforcement) Act 2022 introduced the ROE, requiring overseas entities to register their beneficial ownership details.
Failure to register can result in property freezing, fines, and potential prison sentences.
Tax Considerations when
De-enveloping UK Property
In recent years, there has been a shift in the UK tax landscape concerning the ownership of residential property through corporate structures.
Here are some key tax considerations that arise when de-enveloping UK property and transitioning from corporate ownership to personal ownership:
1. Annual Tax on Enveloped Dwellings (ATED)
In 2013, the UK government introduced the Annual Tax on Enveloped Dwellings (ATED) as a tax initiative to tackle perceived advantages associated with holding UK residential properties through corporate entities or trusts.
ATED initially applied to residential properties valued at £2,000,000 or more, but the threshold was later reduced to £500,000 from the tax returns of 2016 to 2017 onwards.
De-enveloping allows the property to be removed from the scope of ATED, potentially leading to significant cost savings. By transitioning from corporate or trust ownership to personal ownership, property owners can potentially avoid the ongoing ATED charges associated with their residential properties.
However, it is crucial to carefully consider the ATED charge for the period leading up to the de-enveloping date and strategically plan the de-enveloping process to minimise any ATED liabilities.
Mr. Johnson owns a residential property valued at £1,800,000 through an offshore company.
As of the tax year 2022/2023, the ATED threshold is set at £500,000 or above. The property's value falls within the range of £1,000,001 to £2,000,000, resulting in an ATED charge of £8,450.
However, by de-enveloping the property, it would no longer be subject to ATED, thereby reducing ATED liabilities and achieving long-term cost savings.
2. Stamp Duty Land Tax (SDLT)
SDLT is a tax on land transactions, including the transfer of property ownership. De-enveloping, typically achieved through a capital distribution to shareholders after the company's liquidation, may give rise to SDLT depending on whether consideration is given by the shareholders for the property transfer.
If there is no consideration, as in the case of a debt-free company with only the property as its asset and no liabilities, or where the debt is solely owed to the shareholder, there would be no liability for Stamp Duty Land Tax (SDLT). However, if there is a third-party loan secured on the property at the time of liquidation, SDLT would be applicable where there is an assumption of the liability by the shareholders.
In some cases, if a company repays a third-party debt through shareholder action before liquidation, such as subscribing for more share capital or replacing the debt with shareholder debt, there may be no SDLT charge upon property distribution. However, the application of section 75A FA 2003 may arise if the shareholder provides funds to the company to repay the debt before acquiring the property, depending on the specific circumstances.
Alice is the sole shareholder of Company Y, owning a property valued at £3 million with a third-party debt of £500,000. To remove the property from the company's ownership, Alice subscribes for £500,000 of new shares to repay the debt. With the property now debt-free, Company Y is liquidated, and the property is distributed to Alice without consideration, resulting in no SDLT liability.
However, section 75A may still apply. The transactions include the subscription for new shares and the subsequent liquidation and transfer of the property.
The amount given for the subscription of new shares, which is £500,000, is considered consideration, triggering SDLT on the amount subscribed. Therefore, SDLT on £500,000 would be due under section 75A.
3. ATED-related Capital Gains Tax (CGT)
The Budget 2012 introduced reforms that extended UK capital gains tax to all ATED properties. Companies liable for ATED became subjected to capital gains tax, regardless of their residence within or outside the UK. CGT is imposed at 28% on chargeable gains that are classified as ATED-related gains, which relate to periods after 5 April 2013.
Previously, companies liable for ATED had to pay capital gains tax on ATED-related gains for UK residential properties valued over £500,000, based on property ownership duration and ATED payments. However, since 6 April 2019, ATED-related Capital Gains Tax is no longer applicable. Instead, any gains made by a company from that date are subject to Corporation Tax and must be disclosed in the company's Corporation Tax return.
Bill owned a UK residential property through an offshore company. The property's value increased from £7 million in 2014 to £9 million in 2016. In early 2019, the company decides to sell the property, which is now valued at £11 million. The timing of the sale, whether before or after 6 April 2019, can significantly impact the tax liability.
If the property was sold in February 2019 (assuming it was always chargeable to ATED), the taxable gain would be £4 million, subject to the ATED-related CGT rate of 28%. This would result in a tax liability of £1.12 million. However, if the property was sold on or after 6 April 2019, it would be subject to corporation tax at 19%. The taxable gain would be based on the property's value on 5 April 2016, which is £2 million. This would lead to a tax liability of £380,000, resulting in substantial tax savings compared to the ATED-related CGT regime.
4. Non-resident Capital Gains Tax (CGT)
Starting from 6 April 2015, non-resident Capital Gains Tax (CGT) was applicable to direct disposals of UK residential property.
However, as of 6 April 2019, the scope of this charge was expanded to include all direct disposals of UK property and land, as well as indirect disposals of UK property or land.
An indirect disposal refers to the sale or disposal of an interest in an asset by a non-resident individual or entity where the asset derives 75% or more of its gross value from UK land. To qualify as an indirect disposal, the individual or entity must hold a minimum 25% interest in the asset being sold or disposed of.
The gain for tax purposes will be determined by comparing the current market value of the property with its original cost. However, for non-UK resident companies that were previously not subject to UK CGT, the gain will be calculated based on the difference between the current market value and the value as of April 2015.
If a non-UK resident company sells a UK residential property with a current market value of £2.5 million and a value of £1.8 million as of April 2015, the taxable gain would amount to £700,000.
Assuming the property is sold in May 2023, the company would be subject to the corporation tax rate. Consequently, a tax liability of £133,000 would be incurred.
5. Inheritance Tax (IHT)
Prior to April 2017, individuals and trustees who were not UK domiciled could avoid paying inheritance tax (IHT) by holding UK residential properties through offshore entities.
However, in the Summer Budget 2015, the UK government introduced reforms that came into effect in April 2017, requiring non-domiciles to pay IHT on all UK residential properties they own, regardless of their tax residence status. This change applied to properties held indirectly through offshore structures as well.
Individuals owning enveloped residential property are now subjected to a 40% IHT charge upon their death starting from April 2017, regardless of when the property was acquired.
There are no transitional reliefs provided, but individuals will still be eligible for the same reliefs and exemptions as UK domiciles or residents. Additionally, trusts holding residential property will be subject to ten-year charges at 6% based on the property's value going forward. Transfers of enveloped property into trusts will incur immediate taxation of up to 20%, while transfers out of trusts will be taxed at up to 6%.
Sarah, a non-domiciled individual, and non-UK resident owns 100% of the shares of a company incorporated in Switzerland. The company owns UK residential property worth £3 million. Previously, the shares would have been excluded property for IHT purposes, providing an exemption from IHT if gifted or retained until Sarah's death.
However, under the new rules, the shares are no longer excluded property, and the entire £3 million value is now subject to IHT. Therefore, if Sarah decides to gift the shares during her lifetime or in the event of her death, there may be a lifetime IHT charge or a charge on death, subject to any available reliefs or exemptions.
Other Considerations - Register of Overseas Entity (ROE)
The lack of transparency in the past allowed offshore corporate structures to provide anonymity and confidentiality, enabling individuals to hide their ownership interests in UK properties.
With the significant foreign ownership in the UK property market, it became a prime target for addressing these issues. The introduction of the Register of Overseas Entities (ROE) has brought about a substantial transformation by making it mandatory for overseas entities to disclose information about their registrable beneficial owners. This requirement effectively dismantles the secrecy associated with offshore corporate veils, leading to increased transparency within the real estate market.
Additionally, the ROE requires annual updates to the information provided on the Companies House, even if no changes have occurred. These updates necessitate a verification process similar to the original registration, resulting in additional administrative work for the overseas companies involved.
Non-compliance with the registration requirements can have severe consequences, including property freezing, daily fines of £2,500 from 1 February 2023, and potential prison sentences of up to five years.
The De-enveloping Options
When it comes to de-enveloping a property held within an offshore company, there are two primary options available for transferring ownership. Here are two options available which provide pathways to transfer ownership from the company to individuals:
1. Distribution in Specie/Dividend in Specie
One of the most common methods used for de-enveloping involves distributing the property as an asset, which is known as a "distribution in specie" or "dividend in specie" or "distribution in kind." In this process, assets are distributed without being converted into cash. Rather than selling the asset and distributing the proceeds, the property itself is directly transferred or allocated.
For a distribution in specie to occur, it is essential to confirm that the company's articles of association allow for this type of distribution. In cases where the articles of association do not currently permit such a distribution, the directors have the option to pass a special resolution to amend the articles accordingly.
Additionally, it is crucial to ensure that the wording of the resolution is clear and unambiguous.
Therefore, when approving a dividend in specie, the resolution should explicitly state that the distribution is in the form of a dividend in specie, rather than indicating it as a cash value dividend equivalent to the market value of the property.
If the company does not have any external debt and the transfer occurs without any chargeable consideration, the distributions are exempt from Stamp Duty Land Tax (SDLT). If there is a debt owed to a shareholder, HMRC will not consider it as a liability or consideration when transferring the property to that shareholder.
However, it is crucial to carefully address any outstanding debts and consider whether it is necessary to remove them either before or during the de-enveloping process.
If the plan is to wind up the company following the distribution of assets, the process involves the following:
- Pass a resolution to discontinue the company
- File required declaration with the relevant offshore authorities
Obtaining tax advice is crucial to determine whether the transfer of the property through a distribution in specie will result in UK Capital Gains Tax (CGT) implications.
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It is essential to assess the specific circumstances and seek professional guidance regarding potential tax liabilities.
Even if no CGT is applicable, any losses should still be reported in accordance with tax regulations.
2. Distribution of Property in the Liquidation or Winding Up of the Company
During the liquidation or winding up of the company, shareholders must pass a special resolution to voluntarily wind up the company and authorise the liquidator to distribute the company's surplus assets to the shareholders in specie.
Prior to proceeding with the liquidation process, it is again important to review the articles of association to confirm whether they grant authority for transferring assets in specie. In most cases, the liquidation process does not involve any consideration, thereby qualifying it for exemption from SDLT.
Documents Required for De-enveloping
When de-enveloping a property held within an offshore company, several important documents are required to facilitate the process.
These documents ensure the legal transfer of ownership and compliance with relevant regulations. Here are the key documents typically involved:
1. Transfer Deed
A Transfer Deed is necessary to formally transfer the property's ownership from the offshore company to the individual intended to hold it.
2. TR1 Form
The completion and submission of the Transfer of Whole of Registered Title Form ‘TR1 Form’ is a necessary step when de-enveloping.
This legal document facilitates the transfer of ownership from one party to another and collects essential details about the property, including address, title number, and relevant charges, as well as details about the parties involved, such as their names, addresses, and legal representation if applicable. Accuracy in completing the TR1 form is essential to ensure the successful and legally recognised transfer of property ownership.
3. Confirmation from a Practising Lawyer
A letter from a practising lawyer is essential to verify that the transfer was carried out in accordance with overseas regulations governing such transactions.
4. Property Disposal Information
Providing property disposal information to Companies House is mandatory. This step ensures the necessary disclosure and transparency requirements are met.
5. Minutes of a Shareholders and Directors Meeting
The minutes of a joint meeting of shareholders and directors of the company are required to document the resolution to transfer ownership to the company's sole shareholder through a distribution in specie.
To facilitate a distribution in specie, it is crucial to verify that the company's articles of association permit this type of distribution. If the existing articles do not authorise such a transfer, the directors can choose to amend them through a special resolution.
6. Professional Advice Report
Seeking professional advice and obtaining a detailed professional advice report is highly recommended.
This report provides expert guidance and insights into the tax implication of de-enveloping process, ensuring compliance with tax and legal obligations.
As you navigate the process of de-enveloping your property from an offshore company structure, it's important to understand the subsequent steps that will solidify your personal ownership.
This transition involves not only the legal transfer of property but also the necessary administrative tasks to ensure compliance with tax regulations and other requirements.
Filing Update Statement on the Companies House
Updating the information with the Companies House is crucial to reflect the change in ownership and the removal of the property from the offshore company structure.
This is achieved through the submission of an annual update statement which plays a vital role in maintaining accurate data on the register and upholding the responsibilities of overseas entities, thereby promoting transparency and accountability in the ownership of UK properties. Non-compliance with this requirement constitutes a criminal offense, carrying the risk of prosecution and financial penalties.
The update statement can be submitted online unless trusts are involved in the overseas entity. To ensure proper authorisation, entities must request an authentication code before filing, which ensures that only authorised individuals can submit the statement. Additionally, if there have been changes to the information since the entity's registration, a UK-regulated agent is required to conduct verification checks to confirm the accuracy of the updated details. However, if there have been no changes, no additional verification is necessary.
Transfer into Individual Ownership
After successfully completing the de-enveloping process and transferring the property out of the offshore corporate structure, the next step is to make necessary arrangements with regards to your personal ownership of the property. These arrangements include:
- Register with HMRC
- Obtain a non-residential landlord tax exempt certificate
- Make and submit a self-assessment declaration every year
After completing the de-enveloping process, Sarah became the individual owner of a residential property previously held in an offshore company. To fulfil her tax obligations, she registered with HMRC and obtained a unique taxpayer reference (UTR) number.
Sarah also applied for a non-residential landlord tax exempt certificate since she planned to rent out the property. Each year, she submitted a self-assessment return by the annual deadline of 31 January following the end of the tax year, maintaining accurate records of rental income and expenses. Sarah's proactive approach ensured compliance with tax regulations.
De-enveloping UK property offers property owners an opportunity to simplify ownership structures, adapt to changing tax regulations, and streamline administration.
By carefully evaluating the tax implications, complying with legal requirements, and seeking professional advice, property owners can navigate the de-enveloping process smoothly and enjoy the benefits of personal ownership while optimising their tax strategies.
Whether you need help with tax obligations, HMRC registration, or understanding the financial implications of property ownership, we're here to help.
If you're looking for expert advice, don't hesitate to contact us at UK Property Accountants today. Our team of qualified accountants and tax advisers are always ready to help you move ahead, providing advice tailored to your unique situation.