There are already a host of tax changes which are expected to affect the real estate sector in the new year – read ahead for a preview of what awaits.
1. Landlord-to-tenant payments to be removed from scope of the Construction Industry Scheme
In April 2023, HMRC commenced a consultation into the Construction Industry Scheme ("CIS"), which requires those paying for construction services to withhold tax at up to 30% from payments to subcontractors in certain situations, unless those subcontractors are registered for "gross payment status". Many firms, including Travers Smith, responded to this consultation. HMRC have announced that they will make two key changes to the CIS, which are expected in 2024:
1.1 The first change is to remove the majority of landlord-to-tenant payments from the scope of the CIS. It is commonplace for landlords to seek to pay tenants to perform works. Where that payment is for the tenant's ordinary fit out, the CIS does not apply. However, if that payment is for improvements which benefit the landlord's reversionary interest, is for "Cat A" work to the structure or fabric of the building, or, like remedying dilapidations or removing the previous tenant's fit out, would otherwise be the landlord's responsibility, the CIS could apply. This gives rise to cashflow issues for the tenant in funding the works as well as administrative issues for both parties. HMRC's announcement is therefore welcomed, and we look forward to seeing draft legislation to ensure this is fit for purpose.
1.2 The second change is to add VAT to the list of taxes HMRC can consider when determining whether a subcontractor can obtain "gross payment status". Since gross payment status removes a subcontractor from the CIS scheme and enables it to pay tax under the normal self-assessment regime, it is important that HMRC is allowed to consider the entirety of a taxpayer's tax compliance history, including VAT, when assessing gross payment status. Following our representations in the consultation HMRC has ensured that minor noncompliance (for example, late returns) will not impinge on gross payment status.
2. UK–Luxembourg Double Tax Treaty expected to come into force
In 2022, the UK and Luxembourg signed a new double tax treaty (DTT). This new treaty will be effective in the UK from various points in 2024, including (i) from 6 April for capital gains tax payers and (ii) for financial years beginning on or after 1 April for corporation tax payers.
The most significant change from the previous DTT for real estate investors is the introduction of a rule which allows the UK to tax Luxembourg residents on gains arising on indirect disposals of UK real estate (and vice versa for indirect disposals by UK residents of Luxembourg real estate). Until now, the absence of this rule had made Luxembourg a popular choice for holding structures to invest into UK land. This means that disposals of interests in Luxembourg companies will be subject to the UK's non-resident CGT rules where that company derives 75% or more of its value from UK land.
Real estate investors should therefore (if they have not already done so) start considering the impact on their current and future structures. In doing so, they should bear in mind that there is no grandfathering, meaning that the entire gain from the disposal of an interest in a UK property-rich vehicle by a Luxembourg resident would be subject to UK tax, including any part that has accrued before the changes to the treaty came into effect. However, a base cost uplift is available to 5 April 2019.
3. REIT rules changes to be enacted
Following on from changes to the REIT regime in 2022 and 2023, the government intends that the Finance Act 2024 will contain a further batch of reforms. Like the previous measures, these reforms are generally aimed at making the regime more attractive, particularly for "institutional investors". The expected changes include:
3.1 making it possible, when applying the exemption from the close company condition, for institutional investors, to trace through intermediate holding companies; and
3.2 relaxing, in certain situations, the rule that can impose a tax charge on REITs that make distributions to a corporate shareholder with a holding of at least 10%.
However, it is expected that the ability of certain funds to benefit from the use of REITs will be restricted unless those funds either (i) meet the "genuine diversity of ownership test" or (ii) are not closely held. Helpfully, there should be grandfathering provisions to protect existing structures where funds currently hold REITs but those funds will not meet the new requirements.
4. Full expensing to become permanent
In his Spring Budget, the Chancellor announced "full expensing" of qualifying capital expenditure incurred in the next three years, with the intention of making this permanent afterwards. This means that 100% of the amount of any "main rate" capital allowance expenditure will be immediately deductible, with 50% of any "special rate" capital allowance expenditure being deductible in the first year with a deduction at 6% thereafter. The Chancellor has now confirmed in his Autumn Statement that "full expensing" is to become a permanent measure. The government is also expected to launch a consultation in relation to wider changes to simplify the UK's capital allowances legislation.
The United Kingdom has historically been seen as much less generous than its peers in giving tax relief for capital expenditure, so this change will be welcomed by the industry. Full expensing will mean that capital investment in the UK can be made out of pre-tax profits and therefore will encourage businesses to invest in plant and machinery in the UK.
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