Inward Investment into UK commercial property

This article reviews commercial property in the UK - including UK capital gains, and UK rental income.

Commercial property in the UK

Outside observers of the UK economy will be well aware of the “perfect storm” which is affecting UK commercial property prices. Commercial property activity relies on fully functioning financial markets to provide debt funding and a healthy economy to support occupier demand. Both have been strikingly absent from the UK with the result that capital values have fallen by around 40% from their peak in mid 2007. With the change in the rate of the £ against the Euro it would be perfectly plausible for a buyer from the Euro zone to acquire UK commercial property at half the cost of an acquisition at the peak. The commercial question of course is whether investors from outside the UK regard all this as a buy opportunity or whether they still feel the risks of holding commercial UK property are too great. The purpose of this note is to draw attention to the tax frameworks for inward investment into UK property which mean that the return on investment – both in income and capital terms – can be free of UK tax if the investment is correctly structured. This is irrespective of whether the property is acquired as a passive investment or as part of a UK trade.

UK capital gains

Firstly, it will normally be possible to ensure that no tax is payable in the UK on any gain made on the sale of the property. This is because as a very general principle non UK residents – corporate or personal - are only taxed on gains from UK property if the properties have an additional connection with the UK as a result of permanent establishment or branch or agency. It would normally be possible to structure arrangements, whether they are passive investments or properties from which a trade is carried on by the investor group, without creating such a UK connection. This would be the case for example where a UK hotel is acquired or built where a group member is also carrying on the business of hotelier.

UK rental income

Secondly whilst the rental income stream is subject to UK tax, it would usually be possible to create sufficient deductions from this rental to reduce it to, or close to nil. This would be by a mixture of financing costs and tax depreciation allowances for the part of the building which qualifies for fixtures allowances. So far as financing cost is concerned, where the funds are borrowed from a connected party the interest deduction is subject to UK transfer pricing provisions, the need to comply with rules on UK tax withholdings and, potentially from 1 July 2009, the worldwide debt cap restriction. The deductions generated from borrowing for new investment in this way are less likely to cover rental than in the past due to the current rise in commercial property yields relative to interest rates. This however can be compensated by tax depreciation allowances on a portion of the property cost. The proportion of total cost which can qualify for tax depreciation varies depending on the property investment. For a hotel refurbishment it is quite usual for this to be in excess of 50%. For modern but basic offices without air conditioning it is likely to be around 10%. The value of these reliefs was increased in the UK Budget on 22 April 2009 which will help in closing the gap between interest rates and property yields.

Tax is attractive, is the commercial opportunity also?

Essentially therefore structures can be created for an inbound investor which can be free of UK direct taxes which creates an attractive tax framework for such investment. For inbound investors the current conjunction of UK property prices and exchange rate may also create a unique commercial opportunity for investment.