Non residents using a offshore company to own UK properties
Non residents looking to purchase UK property often look to use an offshore company to hold the property rather than purchase in their own name.
Tax implications of buying personally
If they buy the property in their own name the key UK tax implications will be:
- They will usually be exempt from UK Capital Gains Tax on the purchase providing they are purchasing as a non resident
- They will be subject to UK income tax on the rental income.
- The UK property will be within their UK estate for inheritance tax purposes irrespective of their domicile status.
- The income tax and potential charge to inheritance tax in particular can be a big problem – hence the reason why an offshore company can be tax efficient.
Note that there are also many non-tax reasons for using an offshore company to purchase the company (eg privacy and asset protection, overseas tax planning and to avoid forced heirship rules overseas).
Using an offshore company for UK property
Avoiding inheritance tax
The key advantage of using an offshore company for UK property is that if the shareholder is non UK domiciled (and would not be UK deemed domiciled due to having spent less than 17 years in the UK), the value of the UK property (as reflected in the shares in the offshore company) would be excluded property for inheritance tax purposes. Therefore there would be no UK Inheritance Tax charge on the value of the property. Given that Inheritance Tax could be due at 40% this is a significant benefit.
Income tax planning
Income tax is due on UK rental income at source. The default position is that basic rate income tax is deducted by the tenant or agent and paid over to HM Revenue and Customs. This applies whether the property is owned by an individual or a company.
However in all cases it is possible to apply for clearance to receive the rental income income gross (ie without UK tax deducted at source). The property owner then needs to account for the income tax due via an annual self assessment tax return. Again this applies to companies as well and there is a special tax return for a non resident company subject to income tax due to receiving UK rental income. When calculating the rental profits subject to income tax, expenses of the letting can be deducted.
Therefore maximising expenses will reduce profits and also UK income tax.
The big deduction for many property owners will be interest charged on a loan to purchase or enhance the property. Tax efficiently structuring the financing can significantly reduce the UK income tax charge. Using an offshore company to purchase the property, with the non resident individual funding the company as a loan could be an effective way to reduce UK income tax. The offshore company could then pay a market interest rate to the individual which may be tax deductible for the offshore company when calculating rental profits.
Depending on the personal circumstances of the property owner it is also possible to reduce income tax by extracting funds as a management charge.
Extraction of funds by the shareholder
As a non resident individual, the shareholder can extract funds from the company as either dividends or salary free of UK tax. The salary would be tax deductible for the company if the payment was made for the purpose of the rental business.
Therefore using an offshore company can potentially reduce income tax and avoid both capital gains tax and inheritance tax.
Where to establish the offshore company
From a UK perspective any jurisdiction is effective. Therefore BVI, Panama as well as the Isle of Man are popular.
There will be no real double tax treaty benefits in terms of either capital gains tax or income tax on rental income from establishing the offshore company in a country which has a double tax treaty with the UK.
Practically all tax treaties grant tax rights over “immovable property” (eg UK investment property) to both the country where the property is located as well as the foreign country of residence.
The main occasion when using a treaty country such as Cyprus could be useful would be where the offshore was subject to basic rate tax at source on interest payments (see below).
Issues with using an offshore company for UK property purchases
Central management & control
The initial issue would be the management and control of the company. If this is carried on abroad then the company would be non resident, otherwise it would be UK resident. A UK resident company would be subject to UK tax on its rental income and capital gains.
This may not however have an immediate impact if the company is receiving no income and is just used to hold overseas property. If there was no rental income the main practical impact if the company was UK resident would be that it would be subject to UK corporation tax if a gain is realised on a subsequent disposal of the property. The corporate ownership means that the private residence exemption is not available.
By contrast if the company is non resident it would be exempt from UK corporation tax on a disposal of the property.
If the company was non resident it would be important that the shareholder remained non resident when any property was sold. If the shareholder was UK resident any capital gain realised in the offshore company would be apportioned to him for UK tax purposes based on his shareholding in the offshore company.
Therefore if the shareholder was to become UK resident this could lead to a potential CGT charge on a disposal of the property.
Financing the offshore company
One issue that is often of key importance is in relation to funding the purchase of the UK properties.
If financing is obtained from overseas the risk is that the tax deduction at source rules could apply. These can require tax to be deducted by the payer where the interest is from a UK source but the payment is made overseas.
The key issue is where the ‘source’ of the interest is. Revenue and Customs would look at a number of factors to determine whether the interest has a UK source:
- The residence of the debtor (this is usually taken to be the place where the debt will be enforced),
- The source from which interest is paid,
- Where the interest is paid, and
- The nature and location of any security for the debt.
If the loan was made from overseas and in respect of UK property there is a risk that the interest would have a UK source and as such be subject to the deduction of tax at source rules. Therefore whilst it would be deductible for the company when calculating it’s taxable profits there could be a 20% income tax liability on the interest.
This is principally an issue where you have funding to a UK company from overseas.
Where you have an offshore company the tax deduction of source provisions apply where interest is paid overseas and has a UK source.
Therefore it could still apply to a non resident company paying interest overseas although it would provide you with a much stronger argument that the interest had a non UK source. The main factor for HM Revenue and Customs will be the residence of the debtor – which would be overseas in this case. Therefore there should be a good argument the tax deduction at source rules don’t apply.
Aside from this the main option to reduce withholding tax on interest paid overseas would be to rely on a double tax treaty. These provide for an exemption or reduction in UK tax deducted at source depending on the particular agreement that the UK has with the country in question.
You could therefore structure the funding via an intermediate financing company set up in a suitable jurisdiction (eg Cyprus) to reduce the UK tax deducted at source on interest and ensure that the income tax on the UK rental income was minimised.
Occupation of the property
If the property could be occupied by the shareholder or his family this could lead to additional issues.
The main problem with using a company is that HMRC may seek to assess the occupation of the property as a benefit in kind under the employment income provisions. These provisions apply where “living accommodation is provided for a person…by reason of his employment”. The amount charged is the annual value of the property plus notional rent based on a percentage of the amount by which the cost of the property exceeds £75,000.
UK resident shareholder / director
There is no doubt that occupation of the UK property would incur a benefit in kind tax charge if the shareholder is a director / employee and is UK resident.
This is because any accommodation provided by the company for a director / employee or his family is treated as provided by reason of the employment. As defined in Section 721(4) and (5) ITEPA 2003, family covers the employee’s:
- children and their spouses
- dependants and guests.
Note that even if the shareholder is not a director or employee HM Revenue and Customs may still assess the occupation of the property as a benefit in kind.
This is because the term ” director” is defined as including any member of the company if the affairs of the company are managed by the members themselves and “any person in accordance with those directions or instructions the directors of the company… are accustomed to act”. These are also known as “Shadow directors” and are deemed to be employees for this benefit in kind charge.
Therefore if a shareholder is UK resident and can be said to manage the affairs of the company or give instructions to directors he is within the benefit in kind charge on occupation by himself or his family.
If the family member occupying the property was themselves a shadow director a potential benefit in kind charge could arise on them directly due to their UK residence.
If the Director / shareholder was non resident then it is less straightforward.
Non resident director / shareholder
The residence of the offshore company has no effect on whether benefits and expenses within the rules in the benefits code are chargeable. Rather it is the residence of the actual employees/directors. S27 ITEPA 2003 states that:
UK-based earnings for year when employee not resident in UK
This section applies to general earnings for a tax year in which the employee is not resident in the United Kingdom if they are:-
- general earnings in respect of duties performed in the United Kingdom, or
- general earnings from overseas Crown employment subject to United Kingdom tax.
Therefore general earnings of a non resident are only taxed where the duties are performed in the UK.
This is expanded in S32 ITEPA 2003 to state that general earnings includes benefits (non cash benefits) such as a benefit in kind charge arising from the provision of living accommodation:
Therefore if the shareholder is non resident, whether a benefit in kind charge could arise by virtue of his or his family’s occupation would depend on whether there were any UK duties carried out. Assuming not, then there should be no benefit in kind charge.
It should also be born in mind that even though the directors are non resident if there is a UK resident “shadow director” who is actually controlling or managing the company they could be subject to an income tax charge if they occupied the property.
For instance a UK resident family member occupying the property who actually participates in the running of the company should be carefully considered in light of the above.
Whether or not they are a “shadow director” is something that would depend on the specific facts.
One case has held that an individual’s “frequent non-professional advice, usually acted on, is sufficient” to make that individual a shadow director. Therefore for instance a UK resident individual choosing the furnishings of a residence owned by an offshore company could result in a benefit in kind charge if they are a UK resident occupant of the property.
In order to avoid the shadow director rules the offshore directors must be both capable and competent of carrying out the company’s transactions and they must do so under their own steam and not at the behest of the person who might be termed the “party at interest” (and who lives in the UK for these purposes).