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SHELLING OUT? - July / August 2005

CARL BAYLEY advises on the tax implications of investing in property overseas

As the UK property market shows signs of levelling out, more and more investors are being attracted to the idea of buying property abroad.

Different territories take their turns at being flavour of the month: a couple of years ago it was Spain, now many are turning their eyes to Eastern Europe.

Wherever the nest may be in which you hope to place your eggs, one thing will remain constant: tax!

UK taxes

If you remain UK resident, you will continue to pay UK income tax on rental profits from properties abroad, as well as capital gains tax when you sell your investments.

Hence, for those who have always lived in the UK and intend to stay here for the rest of their life, investing abroad is not a tax-saving measure.

Exceptions

But there are exceptions to this general rule, which can make investing abroad very attractive for some.

The exceptions boil down to two areas: people who have come from somewhere else and people who intend to move somewhere else.

Many UK residents were born elsewhere or come from immigrant families. A large proportion of these people are what we call ‘nondomiciled’.

‘Domicile’ is a very important concept in international taxation. It has a far greater degree of permanence than ‘residence’ (which may vary from year to year). It is close to, but not quite the same as, nationality, and, unlike residence, is very difficult to change.

Example

Tony was born in New Zealand but moved to the UK when he was 21. Although he has lived here for more than 20 years, he still considers New Zealand to be his home and intends to return there when he retires.

Tony is New Zealand domiciled. For UK tax purposes, he is therefore nondomiciled.

"So what?" you ask. Well, here’s what.

Despite being a UK resident for tax purposes, Tony can invest in property abroad practically free from UK tax, as long as he never brings any money back to the UK.

A non-domiciled taxpayer is only taxable on any profits or capital gains from foreign investments if and when they bring the money back to the UK.

All that someone like Tony has to do, therefore, is to set up an offshore bank account to collect his profits and gains free of UK tax.

Tony can happily spend his money whenever he is abroad, even on a family holiday. He can also bring his original capital back to the UK if he is very careful to keep it separate from any profits or gains.

This kind of strategy also works very well for couples where one member of the couple is non-domiciled. The couple should just ensure that all foreign investments are made in the name of the non-domiciled partner and avoid bringing any profits or gains back to the UK.

Emigrating

But we’re not all as lucky as Tony, are we?

The other class of investors who will ultimately benefit from foreign investments are those who intend to emigrate.

Whilst such people remain UK residents, they remain liable to UK tax on profits and gains from foreign property.

However, after emigrating they will be completely exempt from UK tax on any foreign property. This is because the UK does not continue to tax expatriots on their overseas income.

Hence, if you wish to invest in property for the long-term and intend to emigrate at some point in the future, you may well be better off by investing abroad. In that way, after emigrating you can enjoy your rental profits free from UK income tax. By contrast, if you still held UK properties after emigrating, you would continue to face UK tax charges on your profits.

I say ‘long-term’ here, because you are, in any case, exempt from UK capital gains tax once you have emigrated (although the UK can usually claw back any CGT savings if you do not emigrate for at least five whole UK tax years). Companies When we look at companies as a possible vehicle for investing in properties overseas, there are two types to consider: a UK company or an offshore company.

A company will be regarded as a UK company if it is either:

a) Registered in the UK, or

b) Centrally managed and controlled in the UK.

It is very easy to avoid the first of these two tests: you simply register your company somewhere else! Ensuring that the company’s ‘place of central management and control’ is not in the UK is slightly more difficult, but it is achievable, although far from cheap!

Your next problem, however, is that, regardless of where the company is resident, if you pay the company’s profits out to yourself, you will be taxed anyway; hence any tax advantage which you may have gained in the first instance will be lost.

Furthermore, a UK resident individual who controls an offshore company will be taxed on all of the company’s profits as if they had received the monies directly.

So, where does this leave us?

Firstly, as with UK investments, a company is only worthwhile for foreign property if you intend to use it as a long-term investment vehicle.

If you are UK domiciled and have no plans to leave the UK in the foreseeable future, then in many cases a UK company will provide a good vehicle, even for your foreign investments. In most cases, the tax paid by the company will be no more than 19 per cent.

On the other hand, for those who are non-domiciled, or who intend to emigrate in the near future, a UK company is usually the last thing that you want for your foreign property investments. By using a UK company, you would be bringing the properties into the UK tax net.

For non-domiciled taxpayers, this means losing the chance to keep their profits offshore tax free. For those intending to emigrate it means losing the prospect of tax-free income and gains in the future.

Such people may find an offshore company useful in the long run, but remember that:

a) It has to be set up and run properly, and this is far from cheap to do.

b) Income and gains arising while the controlling shareholder is still UK resident will be taxable in the UK.

Foreign taxes

When investing abroad, it is absolutely vital to ensure that you also consider the local tax regime.

It is not humanly possible to be an expert in the tax systems of every country in the world, but this much I do know: there are many countries in the world with higher rates of tax than ours.

Many of these countries will tax foreign property owners on their income. Unlike the UK, many countries will also tax foreign property owners on their capital gains (such as Spain and the USA, to name but two).

Double tax relief

Fortunately, whilst this means that you may sometimes be taxed abroad on your property income or gains, the UK does allow a measure of relief for this, known as ‘double tax relief’.

Double tax relief is available against any UK tax liability arising where you have also been unavoidably taxed abroad on that same income or gain.

However, the maximum double tax relief is limited to the amount of your UK tax bill. The UK Treasury does not make repayments to those unfortunate enough to suffer excessive tax on foreign investments.

The overall effect of double tax relief is thus to ensure that you are not taxed twice, but are taxed at the higher of the two countries’ rates of tax. A word of caution There are many countries which, at first, do not appear to tax you at all. In the UK, we have income tax and capital gains tax. It is tempting, therefore, to think that a country which does not impose these taxes is a ‘tax haven’.

Always consider what other ways you may be taxed abroad. What about stamp duty? Or rates? Or some other bizarre tax which we would never think of!

Where you are taxed in some other way abroad, you will effectively be taxed twice, since the UK does not allow double tax relief for other forms of taxation.

The best that I can say, therefore, is always take local expert advice before you invest abroad.

In other words, look before you leap.

Carl Bayley is the author of several tax planning guides available from www. taxcafe.co.uk including ‘How To Avoid Property Tax’, ‘Using A Property Company To Save Tax’ and ‘How To Avoid Inheritance Tax’.

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