Inland Revenue Penalises Foreign Property Owners

Investors Offshore, London

22 October 2002

Gary Rogerson, Director of Tax Planning at UK wealth management advisors Cripps Portfolio (www.crippsportfolio.com) reports on recent judgements which substantially worse the tax position of UK residents who buy foreign properties through companies.

The House of Lords decisions in the cases of “Dimsey” and “Allen” went in favour of the Inland Revenue and subject UK residents who control companies which own overseas properties to income tax on the presumed benefit they gain from occupation of the properties. This is calculated at 6.5% of the value of the property concerned.

Writes Mr Rogerson:

'Very often properties in favourite destinations such as Portugal, Spain and France are purchased through companies rather than directly owned. There are a number of good reasons for this which include:

• Avoidance of forced heirship rules, which apply in civil law jurisdictions, such as those referred to. These rules mean that you cannot gift your assets, or leave them on your death, to whoever you choose. Typically, children have entrenched rights which can be enforced if you tried to cut them out. Normally these rules will apply to land and property directly owned in your chosen holiday destination but will not apply to the shares in a company through which property is owned provided that you have not made your permanent home there.
• Property Transfer taxes can be avoided because when you buy or sell your holiday home it is the shares in the company which change hands not the title to the property itself. Transfer taxes can be very high. In Portugal for example the SISA is approximately 10% of the property value.
• Property registration and Notary fees can also significantly add to the cost of buying your home. In Portugal these amount to about 2% of the property value and again can be greatly reduced through company ownership.
• Capital Gains taxes on an eventual disposal will typically apply to the direct sale of property but not to the sale of shares in a foreign company which owns the property.
• Similarly, Inheritance Taxes in your destination country can often be avoided by company ownership.

'Some of these benefits are already being eroded by changes in rules in your destination country. Portugal for example has recently introduced more stringent rules relating to property owning companies registered in “tax havens”. An annual property tax of 2% of the rateable value of the property will now apply. In addition, all properties owned by such companies are now assumed to generate rental income. This will be treated as being a minimum of 1/15th of the rateable value of the property, tax is then payable (in Portugal) at the rate of 25% on the assumed income.

'Rather more worrying, and this applies to property owning companies wherever they are situated and wherever the property itself is situated, are the implications of two cases, Dimsey and Allen which were heard together in October last year and decided by the House of Lords in favour of the Inland Revenue. They were in fact criminal cases involving “cheating the public revenue” but their implications are much wider than the facts of the specific cases.

'If you own your holiday home through a company you will no doubt want to exercise as much control over the company (and more particularly the property owned by it) as possible. In practical terms things would usually be set up to give you complete control. However, the Inland Revenue say that this makes you a “shadow director” of the company and the House of Lords agree with this. If you are a “shadow director” of the company then registration treats you as being an employee of the company and further legislation provides that where “living accommodation” is provided to you because of this, you are treated as receiving a taxable “benefit in kind” and you must declare this in your tax return each year!

'If the fact that you may have to pay tax for the use of your own property does not seem outrageous enough, the way in which that benefit is calculated adds further insult to injury! You may think that if you use the holiday home two or three weeks a year then you will pay tax on the benefit of that limited use. In fact however, if the property is only used by you (or you and friends) and is therefore available for your use throughout the year, you will be taxable on the whole “annual value” of the property. This is the “appropriate percentage” of the value of the property and the “appropriate percentage” is currently 6.25%. If therefore you own a holiday home worth £250,000, you could have an annual benefit in kind of up to £15,625 and a tax bill of £6,250!

'You may well think that this tax liability is entirely unjustifiable and that even if the Inland Revenue could in theory collect it they would be unlikely to do in practice. In fact, this is not the case. They are co-ordinating their approach through a senior officer at their Technical division and have no present intention of applying a formal or informal concession.

'It may seem tempting to ignore this potential tax liability on the basis that the Inland Revenue are unlikely to find out about it. This is never an approach to be recommended and particularly so now that the Inland Revenue are much more sophisticated in their information gathering techniques. You should bear in mind that under Self Assessment you are responsible for declaring everything which is relevant for tax purposes and could face both civil and criminal penalties if you do not!

'How then should you go about purchasing your dream holiday/retirement home if this article has not put you off altogether?! For those of you who have not done so already, the answer may well be to buy the property in your own name and accept the additional costs involved in your destination country as a price worth paying. If no company is involved, there can be no question of a UK Income Tax liability being imposed on you. Alternatively, you could buy the property through a company but try to have the best of both worlds by arranging for the company to execute a Deed saying that it holds the property as Nominee for you. This should probably avoid the UK Income Tax problem if the Deed is accepted as valid, but there could be some doubts about this and also about how it will affect the problems which you are trying to get around in your destination country.

'For people who already own properties through companies, the problem is even more tricky. If you try to extract the property from the company or to arrange for the company to declare that it holds the property as nominee for you, this could crystallise a substantial “one off” UK tax liability, particularly if the property has gone up a lot in value since the company bought it.

'Unfortunately this is one of those cases where the only clear answer is that there is no clear answer! It is very important to take advice both from a lawyer who is familiar with the property and tax rules in your destination country and also a tax adviser in the UK if you are considering buying through a company. Ultimately, the only answer for everyone caught by this trap may be for you to petition your MP on the basis that parliament could never have intended this clearly unfair treatment and that new legislation should be introduced to put things right!'

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