Changes to the tax system usually take time to make an impact on behaviour and one such change is the approach to capital allowances claims by Non-Resident Landlords (NRL’s) companies arising from changes in April 2019 and 2020 which brought chargeable gains and then profits into the UK corporation tax rules.
The changes are designed to level the playing field between UK and offshore investors and HMRC's latest guidance for non-resident companies can be found here.
Often seen as a ‘nice to have but not essential’, capital allowances which can be present in most commercial property transactions are now coming under enhanced scrutiny in deals to reduce the tax charge on both gains and profits.
Chargeable gains
Previously outside the charge to tax, Finance Act 2019 (Schedule 1) brought gains arising on indirect or direct disposals by non-resident investors within the UK tax net on 6 April 2019 (unless a specific election has been made or the trading exemption applies). The move to corporation tax from 6 April 2020 means net gains on disposals are included in the company’s profits chargeable to corporation tax and subject to corporation tax at 19% (25% from April 2023).
Deductibility of finance costs and loss restrictions
Instead of being deductible as a property expense, finance costs are now assessed under the corporation tax loan relationship rules from 6 April 2020 which means the Corporate Interest Restrictions and hybrid mismatch rules may apply. An election can be made to use the group ratio (based on a group’s external borrowing), which may be beneficial for more highly geared companies. A public infrastructure exemption is also available, recognising that such property assets are usually highly geared.
NRL companies will be subject to the restrictions on the carry forward of corporation tax losses that have applied to UK companies since 1 April 2017. The amount of carried-forward losses that may be deducted in an accounting period is limited to 50% of profits over an annual allowance of £5 million. This restriction may delay tax relief for losses for some companies and accelerate tax payments.
The combination of interest deductibility and loss restrictions have the potential to significantly alter the post-tax return of an investment. It may alter the effectiveness of the traditional non-resident PropCo (property company) landlord with UK Resident (OpCo) trading company tenant.
Capital Allowances
From 6 April 2020, any existing capital allowances pools should transfer from the income tax regime to the corporate tax regime at tax written down value (no balancing charge or allowance). However, any business that has taken a ‘light touch’ approach to maximising past capital allowance claim opportunities (in acquisition or development) may still be entitled to make fresh claims.
The rules for second-hand property assets are complex. Essentially, if you have a bought a property from a pension fund, charity or other non-tax paying entity you may have inherited a significant claim. If you have bought a property from another taxpayer (including mixed funds) there is a high chance any claim will be restricted.
In either case, due diligence is needed to confirm contractual agreements, capital allowances election status, ownership and development history.
If you would like a health check on your business’ historical capital allowance position, please get in touch.