Jul 152014

Following this year’s Budget, the Government published a Consultation Paper on its plan to bring non-residents within the charge to capital gains tax on residential property. This article discusses the proposal, with a particular emphasis on what this means for offshore investment funds.

The proposal to introduce CGT for non-residents is a radical move. For years, it has been a fundamental principle that people outside the UK are exempt from taxation on their investment gains. This rule was recently modified when the annual tax on enveloped dwellings was introduced. The latter is aimed at wealthy individuals seeking to avoid SDLT by buying a home through an offshore vehicle. In addition to a higher SDLT rate and paying an annual charge, the non-resident owner must pay CGT on selling the property. However, there is a specific exemption where the property is held for investment purposes.

This is now going to change. At present, the proposal affects only residential property, so offshore landlords in the commercial sector are safe. But is it a matter of time before they too are drawn into the UK tax net?

A comment about “fairness”

This is one of the Government’s favorite words in the tax lexicon. This is what they say at the beginning of the Consultation Paper1:

“However, the government does not believe that it is right that UK residents pay capital gains tax when they sell a home that is not their primary residence, while non-residents do not. Similarly, we do not believe that it is right that UK companies are subject to tax on gains that they make from disposals of residential property, whereas non-residents are not. It is important for the integrity of our tax system that when gains are made from UK residential property, UK tax is paid.”

A number of points need to be made here.

First of all, how does the Government know that non-residents don’t pay tax on UK property? A foreigner has his own home jurisdiction which may impose a CGT charge on all his worldwide gains. This is the way the UK taxes its own citizens, so a UK resident has to pay UK tax on an overseas property, subject to the rules on double tax relief.

Of course, what the Government means is that it is unfair that non-residents don’t pay UK tax on UK property. But why is it unfair? Will it become fair if a foreigner has to pay tax in two jurisdictions and not one? And what would be the position if, after the new rules come into force, he still pays no UK tax because he is protected by a Double Tax Treaty? These issues aren’t actually addressed in the Consultation Paper.

Furthermore, if it isn’t right that non-residents don’t pay tax on residential property, how can it be any more right that they don’t pay tax on commercial real estate? And yet there are no plans to introduce a CGT charge on office blocks and warehouses.

And what about other types of asset such as equity holdings? If fairness is so important, why not tax share capital as well? Indeed, other jurisdictions such as India impose a tax charge on equity gains2, but the UK Government isn’t keen to go so far at present. No doubt the position of London as a world financial centre is too important to risk scaring off foreign investors.

What are the key points?

Who is affected? – Non-resident individuals, corporates, trusts and funds, but with exemptions for certain types of entity such as offshore pension funds, REITs and other funds where ownership of the investment vehicle is widely spread;

What type of property? – Residential property, including property acquired for investment purposes, as well as property occupied as a home by the owner. There will be a limited exception for communal dwellings which are attached to an appropriate institution such as care homes and university halls of residence;

What will be the tax rate? – This has yet to be decided, but it is envisaged that non-residents will pay a rate comparable to their UK counterparts. For example, individuals will have an annual allowance, and their tax rate will depend on the level of their UK income. This is similar to the way a UK individual is taxed, though in the latter case, it is worldwide income that determines the tax rate. It is also envisaged that similar reliefs will apply;

When does the new charge kick in? – From April 2015. Any property that is held on this date will be subject to CGT, but this is likely to apply only on the gains accruing from the day that the new rules come into force. So for those non-residents already owning a sizable portfolio, there is probably no need to rush to disinvest. Furthermore, capital losses will be available to set against taxable gains;

How till the tax be enforced? The details have yet to be worked out, but it is likely that when the property is sold, the buyer will be required to withhold a certain amount of the purchase price and pay it over to the UK tax authorities. There may also be reporting requirements for the seller, similar to the way in which SDLT is collected.

We shall now explore some of these points in more detail.

Principal Private Residence Exemption

Principal Private Residence Relief – PPR for short – is to be extended to non-residents, ensuring that they have the same benefits as their UK counterparts. Of course it isn’t often that a non-resident will have his main home in the UK, but this situation can arise in certain circumstances. The Consultation Paper mentions the case where a person emigrates from the UK, and has to put his house on the market.

How will this interact with the tax rules in the individual’s home jurisdiction? For example, there is nothing to stop a person from having two main residences – one in the UK and one “back home”. The Consultation Paper recognises that under the current rules, one could simply elect for the UK property to be the main residence for the period that it is on the market, and no CGT will be payable on sale. Which is why the Government is proposing to change the election rules!

Foreign investors will now have to pay tax

As mentioned at the start of this article, the new rules will extend to non-residents who hold the property as an investment and not just as a home for their own personal use.

This represents a radical change in the UK tax regime. The CGT exemption is one of the key attractions for foreign investment into the UK, and it is therefore surprising that the tax is now being introduced, albeit applying to only one particular type of asset. It is particularly hard to understand, given that the Government recently introduced reforms to the REIT regime to encourage overseas investment in the social housing market.

Could foreign investors make use of the communal home exemption? Care homes and student accommodation have proved to be quite popular investments in recent years, but unfortunately, this is not an option. To qualify as a communal home, the property must be associated with an institution – so a university hall of residence will qualify, but privately owned student flats will not.

However, the news isn’t all bad. Where a property is held by a fund, CGT will not apply provided that the ownership structure of the fund is sufficiently diverse. In a nutshell, most funds that one wouldn’t normally expect to be paying the tax, won’t be paying it. These would be the UK equivalent of unit trusts, OEICs and REITs, which are available to the general public. However, closely held private residential funds which have a relatively small group of investors will be subject to the charge. 

Why are funds exempt from CGT in the first place?

Let’s go back to first principles.

A fund is simply a vehicle that acts as a proxy for its investors – the latter pool their money together and the fund invests it on their behalf. There are various reasons for investing in this way – it is an ideal route for those who lack the skill or time to do it themselves. Even for sophisticated investors a fund can provide access to opportunities which wouldn’t otherwise be open to them.

As the fund is a proxy, taxation is normally kept to a minimum, with no CGT payable when the underlying investments are sold. Instead the tax is passed on to the investors who only pay CGT when they sell their units or shares in the fund.

The principle that no CGT should be charged at the fund level means that investment decisions are not distorted by tax considerations. This leads to greater flexibility of choice, which benefits investors. Furthermore – and this is crucial – the tax saved and retained within the fund gives rise to increased returns as it is reinvested.

So how is this position to be preserved under the new rules?

Which funds are to be exempt?

The Government proposes that the exemption will still apply to those funds whose investor base is widely held. These funds would be similar to the UK authorised funds that are marketed to the general public. Indeed, it is proposed to use the same “genuine diversity of ownership” test (“GDO”) that applies to the authorised funds regime3.

Note that the Government has stated that it doesn’t intend to tax the investors of these funds. This is on the basis that it would be just too difficult to collect the tax where there is a wide group of people involved. However, it is worth bearing in mind the following points:

  • For a truly foreign fund – that is where the fund vehicle and the investors are all non-resident – the investors may already be subject to tax in their home jurisdiction;
  • Not all foreign funds have the same degree of “foreignness”. For example, in the UK, it is possible to invest in Luxembourg SICAVs, and exchange traded funds, such as Blackrock’s ishares (formerly Barclays), which are domiciled in Ireland. So the UK investors will be subject to UK tax on their gains in any event;
  • The shares or units in a fund do not constitute real assets – they are holdings in securities. So if the exemption is to apply strictly to direct ownership of property, these investors should be outside the tax net anyway.

There are two other types of fund that are being considered for exemption:

  • Certain funds that don’t pass the GDO test “for particular reasons.” What the Government has in mind is a fund that invests primarily in other types of assets, where only a part of the portfolio is in real estate. This is subject to further consultation;
  • Foreign funds whose UK equivalent is tax exempt, such as pension funds.

But what about corporate funds? Foreign REITs to be exempt

At this stage, it may be helpful to explain the distinction between what it means to be a fund in investment terms, and what it means in legal terms.

As we have noted before, a fund is a vehicle that invests money on behalf of its investors. On this basis, a wide number of vehicles can be considered to be a fund – as well as unit trusts and OEICs, which are open ended vehicles, we have closed ended structures such as investment trusts, VCTs and REITs.

However, for legal and regulatory purposes, a distinction is drawn between:

  • Open ended vehicles on the one hand, governed by the Financial Services and Markets Act 2000 and secondary legislation. These creatures are normally regarded as funds, and the funds that are available to the general public are regulated by the Financial Conduct Authority; and
  • On the other hand we have close ended vehicles – companies – which are governed by the Companies Act 2006. Those companies that are available to the general public are listed on the London Stock Exchange, which is also the relevant regulatory body.

This distinction is apparent from the way in which the Consultation Paper treats the two types of investment vehicle.

When discussing the exemption for funds, it is proposed to apply a “genuine diversity of ownership” test. As we have already mentioned, this is the test used in the UK’s authorised funds legislation for open-ended vehicles. It is implicit that this is the sort of fund that the Consultation Paper has in mind when applying this test.

The test for close ended vehicles is to be different. In place of the GDO test, the Consultation Paper states that the exemption will also apply to the foreign equivalent of UK REITs. This makes sense on two counts:

  • Firstly, as the Consultation Paper notes, a UK REIT has a wide degree of ownership, as is the case with authorised funds. In place of the “genuine diversity of ownership” condition, the REIT must satisfy the close company test – it cannot have more than five “participators”. This condition, together with the fact that it must be listed on a recognised stock exchange ensures that its ownership structure is sufficiently diverse;
  • Secondly, the recent reforms to the REIT regime came about to address the perceived hurdles involved in setting up residential REITs, and also to encourage foreign investment. So it isn’t surprising that foreign REITs are to be exempt from the new CGT charge.

So unlike their open-ended counterparts, it is not sufficient for a corporate fund to have a wide degree of ownership. The company must also satisfy the test for being a REIT in its home jurisdiction under guidelines to be produced by HMRC4. Is it possible for a corporate fund to satisfy the ownership test but still fail to be a REIT under the new guidelines?

For example, what would be the position of close-ended property funds such as F&C UK Real Investments or Invesco Property Income Trust? These funds are companies incorporated in the Channel Islands and are exempt from CGT by virtue of being offshore. They were set up at the height of the last property boom, just before the introduction of REITs to the UK market. The shares of these companies are freely available to retail investors as they are listed on the London Stock Exchange.

Will these offshore property funds qualify as foreign REITs and so retain the tax exemption should they choose to invest in residential property? If not, will they adjust their activities accordingly, or will they even come onshore and convert to UK REIT status? The answers to these questions will of course depend on the outcome of the Consultation and the HMRC guidelines on foreign REITs.

How will the tax be enforced?

It is proposed that the buyer of the property will be required to deduct a certain amount of withholding tax. Alternatively the seller will have the option to “self-report” the transaction and pay the tax (how likely will the latter be? Why pay the amount immediately, if UK residents pay only when the tax return is due?)

The proposed withholding obligation cannot be easily bypassed, even if the buyer is also non-resident. For legal title to the property can only pass on registering the land interest, and it is likely that registration will be refused until the correct amount of withholding is paid. This is similar to the situation with the SDLT regime.

The extra burden of identifying whether the seller is non-resident doesn’t sound an attractive proposition – the Consultation Paper even envisages that this task should fall on accountants and solicitors5.

As a foretaste of how a withholding tax might operate, the following is a summary of how it works in South Africa (I am grateful to Mansoor Parker, a South African tax lawyer for this information).

  • The buyer is required to withhold between 5 to 10% of the purchase price – the minimum of 5% applies where the seller is a natural person and the maximum of 10% applies where the seller is a trust;
  • Where the seller’s actual tax liability is less than the amount of withholding calculated by the buyer, the seller may apply to the South African Revenue Service (SARS”) for a directive that either no withholding should apply or a reduced amount should be withheld;
  • The buyer becomes personally liable if he fails to withhold the tax and knows, or should reasonably have known that the seller is non-resident;
  • Although a non-resident buyer is outside the jurisdiction, this is not an issue for the tax authorities. Because the property itself is within the jurisdiction, the SARS may attach and sell the property to settle the buyer’s withholding liability;
  • These rules are subject to a few exceptions and limiting provisions. For example, properties below R2 million are exempt from the withholding tax.

But will the new tax on non-residents make any difference?

This question has two sides to it.

From the Government’s point of view, the key issue will be whether the new tax will raise sufficient revenue, which will exceed the costs of collection.

It is quite surprising that while the Government has stressed that it is only fair that non-residents pay CGT on property located in the UK, there is no mention of the fact that these people may actually be paying in their own jurisdiction. Furthermore, it won’t be every non-resident who pays up because he may be protected by a Double Tax Treaty – again, no discussion of this issue appears in the Consultation Paper.

From the point of view of investors, this is obviously not good news. Not only will non-residents be affected, but UK residents buying property may be faced with additional compliance costs in ascertaining whether they have a withholding obligation.

The Government has been careful to exempt certain types of fund that would have been exempt if they were UK based. However, what about those investors who aren’t exempt? Will this deter them from residential property and so focus more on the commercial sector? And who is to say that the latter won’t be the next to be drawn into the tax net?

Only time will tell. The consultation has now closed, and no doubt we shall be hearing more later on in the financial year.


The  Government has just published the Minutes of the working group meetings held to discuss the Consultation Paper. The good news is that corporate funds won’t have to jump the additional hurdle of being a foreign REIT. Instead the close company test will suffice. This is what it says in the summary on the GOV.UK website:

 “The consultation document explained that pension funds and other diversely owned collective investment funds were not intended to be brought in scope of the extension of CGT to non-residents. We are clear that widely held non-resident collective investment schemes should not be affected by the CGT charge. However, we have received several representations arguing that in many ways widely held companies are analogous to diversely held investment funds and therefore should be treated in a similar way (emphasis added).

 The government wants to continue to encourage large-scale institutional investment into much needed development and supply of housing in the UK. In this context…we intend to introduce a form of “close company” test to limit the scope of the extension of CGT to non-residents. This should ensure that the extension of CGT will not apply where a disposal of UK property is made by diversely held institutional investor that holds UK residential property directly, or by one which invests indirectly through an arrangement that is not controlled by a few private investors. The government will draw on existing legislation to achieve this.

In short, corporate funds will be treated in the same way as their open ended counterparts.

 This is welcome news, as it recognises the fact that it is artificial to make a distinction between the two types of fund vehicle. They both serve the same common purpose, which is to invest money on behalf of their investors.

A shorter version of this article can be found at WhichInvestmentTrust.com.


  1. Consultation Paper, Foreword page 3.
  2. For example, see Sagar Wagh’s article “India Strikes Back” which concerns Vodafone’s recent troubles with the Indian tax authorities over the acquisition of Hutchinson Essar. In India, the sale of share capital is subject to capital gains tax and the buyer has an obligation to pay a withholding tax.
  3. Authorised Investment Funds (Tax) Regulations 2006 (SI 2006/964) Part 1A Reg 9A. Further guidance can be found at CTM48150.
  4. Consultation Paper, paragraph 2.22.
  5. Consultation Paper Question 13, page 18.
Print Friendly
The following two tabs change content below.
Satwaki Chanda

Satwaki Chanda

Satwaki Chanda is a tax lawyer with a First Class degree in Mathematics. Called to the Bar in 1992, he is the Editor of Tax Notes.
Satwaki Chanda

Latest posts by Satwaki Chanda (see all)

Related Posts

  One Response to “New Capital Gains Tax for Offshore Investors – what does the Consultation Paper say?”

  1. Excellent article. Looking forward to hearing what happens next.

Sorry, the comment form is closed at this time.