A&M Tax Advisor Update
The UK remains a hotspot for global investment in real estate. In 2021 there was over £67 billion transacted in UK commercial real estate with a focus on the London market, up 20% compared to the previous ten-year average. Broadly half of this investment has come from UK capital and the remaining half from international capital, which has largely come from American private equity funds and Asian in particular, Singaporean funds.
This article explores the market outlook for Hong Kong and Asian investment and outline the key tax considerations that investors should be aware of based on the recent panel discussion organised by the Hong Kong Association. Chris Harvey from Mayer Brown, Melissa Ng from Alvarez & Marsal, Fraser Bowen from JLL and Jerome Goh from Shanghai Commercial Bank were speakers at the panel discussion.
UK commercial real estate investment from Hong Kong and Chinese buyers has slowed down over the past two years. This cool down is primarily attributable to the impacts of the Covid pandemic. Travel restrictions have understandably made potential investors reluctant to buy without being able to see a property in person.
Interestingly, there has been an increase in sales of commercial real estate in London by certain group of Asian investors recently. These are primarily accounted for by those who bought well in the immediate aftermath of the Brexit vote in 2016 and who have now decided to strategically sell some of their assets to further reinvest. It is estimated that £2 billion worth of London commercial real estate sale by Asian investors will have taken place by the end of 2022.
As Covid-imposed travel restrictions loosens, transactions by Hong Kong and Asian investors are expected to resume. This is largely driven by the favourable foreign exchange rate for USD pegged currencies and the generally resilient London commercial real estate market.
That said, the near term macro economic outlook for the UK remains unstable and has therefore caused volatility in the markets. Some investors are exercising caution in regards to their existing holding in the meantime. Most commentators are predicting the wider macro economic impact to be mild; coupled with the stability this jurisdiction provides, the UK remains an attractive destination for Hong Kong and Asian investors.
Since 6 April 2019, non-UK investors are subject to UK tax a direct disposal of UK commercial real estate. This also applies to indirect disposal on a share sale of certain ‘property-rich’ companies (i.e. broadly where at least 75% of the companies’ gross asset value are derived from UK real estate). This has an impact on investors who are looking to exit.
On exit, the base costs of the UK commercial properties (on an asset sale) or the shares (on a share sale) are uplifted to their 6 April 2019 market value for UK tax purposes, and therefore the gains on disposal that are subject to UK tax should in principle be limited to their value increase from 6 April 2019.
However, it is important to note that on a share sale, there is usually a latent gain on the property which would only crystallise and be subject to UK tax upon a future direct disposal of the property by the new owner of the target company. The latent gain is based on the property’s value increase since 6 April 2019 to the date of the share sale.
The general market practice is that a buyer would usually ask for a discount to the sale price based on the deferred tax liability on the latent gain. The level of discount is dependent on commercial negotiation.
Where the target company has other tax attributes such as deferred tax asset on tax losses or capital allowances, this may be used to offset against the deferred tax liability on the latent gain which may help with the commercial negotiation.
To maximise tax attributes, investors should consider making claims on super deduction of up to 130% on qualifying plant and machinery and 50% first year allowance on qualifying special rate assets. These are available on capital expenditure incurred between 1 April 2021 and 31 March 2023.
In addition to the latent gain and other tax attributes of the target company, the SDLT saving by the buyer on a share purchase would usually impact the pricing of the transaction. The position of a share sale versus an asset sale should be modelled on a deal-by-deal basis with legal and tax input.
Certain structures which qualify as Collective Investment Vehicles (“CIVs”) may make certain tax elections that either exempt the gains or defer the tax on the gains where the relevant qualifying conditions are met (see A&M article on this topic here).
Broadly, a ‘transparency election’ may be made to preserve the tax-exempt treatment of the gains on disposal where the ultimate investor is a tax-exempt investor (e.g. certain sovereign wealth funds and pension scheme).
Alternatively, a ‘exemption election’ may be made broadly to defer the tax on the gains until the investors in the CIVs realise their investment or receive distributions out of gains from the CIVs.
Certain time limits apply, and tax analysis should be performed to assess whether investors qualify to make these elections prior to exit.
On 7 June 2022, the UK and Luxembourg has signed a new DTT (see A&M article on this topic here). Under the old DTT, the taxing rights on gains realised on the sale of shares in companies holding UK real estate where they are owned by Luxembourg tax residents are given to Luxembourg. This is followed by a potential full exemption of the gains in under the participation exemption regime. However, in line with expectation, the new DTT has now given such taxing rights to the UK. Investors with Luxembourg structure should carefully review their structure.