Osborne pushes the envelope – too far?

By Dermot Callinan, Head of Private Client at KPMG in the UK

One Budget announcement aimed at turning the lights back on in empty homes in London strikes outside investors who use a corporate to make the purchase on any flat or house purchase for £500k or more – but then don’t let it. The policy objective is to encourage buy to let investment instead of property being left empty by investors who hold it just for a gain.

The changes were trailed in the press towards the end of February. Coalition government Chief Secretary to the Treasury Danny Alexander said: “From a social policy point of view we are worried about all of these people buying houses and leaving them empty when thousands of families don’t have anywhere to live.”

The practice of purchasing residential property via a company, perceived by Treasury to be stamp duty land tax avoidance (SDLT), has been dubbed ’enveloping‘ by the Treasury (sticking the property in the corporate envelope). If you buy the company in which the property is enveloped, then you avoid stamp duty land tax which does not apply to a share purchase – so the assumed abuse goes. The solution announced in 2012 and introduced last year in the Finance Act 2013 was the imposition of a new rate of 15 percent SDLT when a company (and other defined ’non-natural‘ persons) make the purchase or are sold on in future. In other words, the envelope triggers the charge. However, the charge only applied to high value residential property valued over £2m. The Chancellor announced the intention to drop that threshold to £500k and thus vastly extending the numbers caught from tomorrow.

On top of SDLT at 15 percent, if a property is in a corporate envelope, a new tax already applies. The Annual Tax on Enveloped Dwellings (ATED) is a progressive annual tax linked to the value of a residence which also came in last year. It starts at £15k per annum for a residence over £2m (but less than £5m) and progresses to £140k per annum if more than £20m. This now extends to include a starting rate of £3.5k if over £500k from 1 April 2016 and £7k if over £1m (less than £2m) from 1 April 2015. The ATED is designed to encourage investors to ’de-envelope‘ and abandon the perceived SDLT benefits of the structure.

If that isn’t sufficient, and if last year’s extension of Capital Gains Tax (CGT) to foreign owners doesn’t apply, there is CGT on the sale of all ’envelopes‘ the new ATED affected by the new ATED. So, the deterrence is three fold: high SDLT on the way in, ATED whilst in and CGT on the way out.

There is however a very important relief which in theory does help the policy objective. The SDLT and ATED taxes don’t apply if the property is used commercially, in particular if it is let for occupation. So, if the lights are on in a buy to let then those taxes are not applied.

Will this fiscal strategy help the policy objective or adversely affect the residential property market by deterring investors?

It just isn’t clear how many investors use companies to purchase residential accommodation in the UK. The Treasury originally seemed to have underestimated the ATED tax take when they estimated it would raise £35m per annum whereas  it raised £92m last year and SDLT of £70m.

Nevertheless, I do think there is a fundamental problem in meeting the policy objective. Investors could simply purchase the residential property in their own name and avoid a corporate envelope altogether. The policy objective is only met if you assume a vast number of investors benefit from the enveloping structure and will let the property to avoid those taxes.

I am not convinced investors ever used envelopes simply to avoid SDLT which at most cost seven percent before higher SDLT rate was aimed at enveloped dwellings. Perhaps in contradiction to the perception at the Treasury at the time, my observation was and remains that Inheritance Tax (IHT) was the main driver in enveloping high value residences. The advantage being that an offshore holding company was outside the IHT net for the investor, mitigating an otherwise expensive potential 40% charge on death. This IHT exposure will be perceived as much less of a threat at values below £2m. Consequently, switching to personal ownership rather than enveloping will probably be the response for those who still wish to invest here.

The response so far with higher value (over £2m) property has been to decide to pay the ATED (hence the higher than expected take up), not to let the property. ATED is often ultimately accepted as a cost of the IHT protection. If that is right then the penalty for not letting property will fail to bite. So, the properties may remain unoccupied by investors or tenants who are not in need of the rents and prefer to take the capital gain.

The need to comply with new taxes, and make returns to the authorities, could however deter overseas investors completely. Without whom large residential developments, with generous social housing allocations may not get funded and may therefore not happen. It would be counter to the policy objective if the tax penalty deterred the investor capital that builds social housing. In the short term the rising values in London may continue to attract investors who may just avoid enveloping through personal ownership. However, that will fade if the market cools and the inconvenience and cost of investing in the UK becomes a drag.

Instead of pushing the tax envelope, a better approach would be to incentivise letting through the relaxation of capital gains tax on let property, but that would be to move in the opposite direction.

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