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Are Buy-To-Let Investors ‘Caught’ For Income Tax On Property Gains?

Lee Sharpe looks at whether or not landlords should be concerned following the late introduction of some wide-ranging legislation on transactions in UK land in Finance Act 2016.

The passage of the Finance Bill 2016 saw some rather late anti-avoidance legislation to tackle the development of, and/or trade in, UK land or property via offshore entities. While this would not generally worry most buy-to-let (BTL) landlords, the legislation was deliberately wide in scope – so much so that the Law Society saw fit to step in and challenge the government on its intentions in relation to UK property investors. Were they right to be alarmed?

It seems to me that Finance Bills are getting longer, and the time that Parliament spends scrutinising the legislation before rubber-stamping it, gets shorter, with every passing year. This year saw another (roughly) 600 pages of legislation – although we had only the one Finance Act this year, so that is some good news. The lack of scrutiny, however, does trouble many tax practitioners and their professional bodies.

Finance Act 2016, ss 76-82 introduced anti-avoidance legislation that basically aims to bring offshore activity in relation to UK land comfortably within the charge to UK income tax or corporation tax. The focus of the new legislation is no longer on where the entity that conducts the activity is situated but, more simply, the fact that the land or property in question is in the UK. While aimed at capturing offshore entities for UK tax purposes, onshore entities are also caught – as they would have been in the past, broadly speaking. Many BTL investors might well argue: so far, so what?

The problem is with the scope of the new legislation, and the fact that it charges to income tax (or corporation tax). The new ITA 2007, s 517B(4) says that the transaction will be caught for UK income tax if:

‘…the main purpose, or one of the main purposes, of acquiring the land was to realise a profit or gain from disposing of the land.’

The legislation (ITA 2007, s 517E(7)) confirms that this income tax treatment will apply to transactions that would otherwise be considered capital gains. In other words, this new legislation can potentially convert something that would normally be considered a capital gain, into trading income – with a corresponding rise in the effective tax charge. There are similar provisions for corporation tax in relation to properties held in a corporate wrapper.

This wording was so broad in scope that the Corporation Tax Sub-Committee of the Tax Committee of The Law Society of England and Wales felt moved to write to the government, on behalf of UK property investors. 

The Law Society’s concerns
Apart from being less than impressed with the late introduction of the legislation, the Law Society raised the following points:

‘The Society notes that the draft legislation is closely based on the existing ‘transactions in land’ rules. These are clearly stated as being to prevent tax avoidance. There is no such indication with these draft rules.

‘In particular, we consider that this formulation of the test could apply to many buy-to-let investors, despite the fact that they are clearly engaged in a property investment business on general principles. Any buy-to-let investor will assess the overall yield before making an investment decision. ‘In areas of the country with low rental yields, an essential part of the investment proposition is the prospect for capital growth, even if the investor’s intention is to hold the property for the medium to long term. Indeed, in the current market, and given the low returns on other asset classes, there are few areas where the prospect of capital growth is an immaterial consideration for investors.’

In other words, applied literally – and without the protective condition for taxpayers that this new legislation is supposed to be triggered only in circumstances where someone is trying to avoid tax – the mere fact that, when buying a property, an ordinary BTL investor might rationally expect to make a capital gain on the ultimate disposal of the land/property (and that might broadly influence his or her buying decision) could convert the capital gain then arising into an income tax profit, chargeable at much higher rates.

Just because you’re not paranoid…
The Law Society then went on to say:

‘We do not consider that it would be sufficient to deal with this issue in guidance, when the legislation is not clear on its face. Nor do we think that it would be a sensible precedent for the government to set in the context of other instances where a ‘main purpose’ test is used.’

This is not the first time that HMRC has been endowed with legislation that appears to significantly overstep its ostensible purpose; when challenged in similar cases in the past, HMRC has basically said, ‘don’t worry, we’ll apply these new rules only in the following, reassuringly narrow circumstances’. 

As many readers will be well aware, the problem is that HMRC’s guidance can change over the years – as can their interpretation of the legislation. The fear that HMRC might wake up one day in (say) 2020 and decide that they have been interpreting this legislation too narrowly and that it should in fact be applied to UK BTL landlords, is not completely unreasonable – particularly if, by 2020, the political mood has darkened even further towards landlords (although it is difficult to imagine how it could get that much worse).

The National Landlords’ Association (NLA) responded by issuing a press release that outlined the guidance it had received from HMRC in reply to the NLA’s concerns on behalf of its members:

‘We have now confirmed the following with the HMRC official responsible that these measures are still not designed to alter the existing tax arrangements between landlords and HMRC.’ 

‘HMRC considers that generally property investors that buy properties to let out to generate property income and some years later sell the properties will be subject to capital gains on their disposals rather than being charged to income on the disposal.

The exception, that is the reason why it says ‘generally’ above, is that:
  1. If the investor decides to undertake development prior to sale the profit on the developed part, from the date the decision to develop for sale, will be trading income. But that would be trading income without the new legislation. Or
  2. If the investor sells the land in a contract with a ‘slice of the action’ clause (allowing them to benefit from changes in the future development of the property) the slice of the action profit will be taxed under the new legislation - but it was previously taxed under the transactions in land legislation.
We will be sharing draft guidance with stakeholders shortly…’
Mark Carnduff
Senior Transfer Pricing and International Advisor

Funnily enough, I do seem to recall receiving a similar reassurance from HMRC (albeit only verbal) in relation to whether or not the statutory renewals basis would cover furnishings in BTL lettings that were unable to access ‘wear and tear’ allowance because they were insufficiently furnished. And yet, roughly two years later, HMRC had quietly reversed its position. So, while a written assurance is welcome, I am afraid it does not completely dispel my concerns as to how the legislation may play out in the fullness of time.

Practical Tip:
BTL investors and their advisers should continue to treat their normal disposals of let property as subject to capital gains tax (albeit generally at what is now the ‘higher’ rate for residential properties, etc.) but should be aware that a strict interpretation of this new legislation could perhaps be applied at some point in the future. There is a specific saving that the new legislation cannot be applied to gains eligible for ‘main residence relief’ under TCGA 1992, ss 222–226 (see the new ITA 2007, s 517M), although this does not of course apply to corporate property ownership. Note also that similar broad provisions have already been toned down in relation to main residence relief – see HMRC’s guidance in the Capital Gains manual at CG65210.

This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.