UK Tax Changes Affecting Real Estate and Construction

This article highlights changes to United Kingdom taxation that affect Real Estate and Construction.

CORPORATION TAX REDUCED

From 1 April 2011, corporation tax will be reduced to 27%; then, by 1% each year until 2014, leaving it at 24%. As a result, money left in a company as working capital, rather than paid as dividends to individual shareholders paying higher rate tax, becomes more tax efficient.

CAPITAL ALLOWANCES REDUCED

From 1 April 2012, allowances on plant and machinery will be reduced to 18%; and, for long life assets and integral features, to 8%.

As a result, it will now take longer to reclaim the cost of these items.

From 1 April 2012, the annual investment allowance will be reduced to £25,000 per year. This may encourage purchases sooner rather than later.

CAPITAL GAINS TAX INCREASED

These changes will, from 23 June 2010, affect individuals, partnerships and trusts in two ways:

• tax rate increased to 28% for higher rate taxpayers; and

• the entrepreneurs' relief increased from £2m to £5m.

Entrepreneurs' relief is an important way to reduce the tax paid on capital sales. Its impact is, however, more limited in relation to property ownership. Where it does apply, it provides an effective tax rate of 10% on gains from sales of:

• assets of a trading business if sold within three years of the business ending - in limited circumstances, the disposal of a property let to a company for its business, will qualify for relief where the individual in question also disposes of shares or securities in the company; or

• shares or securities (such as loan notes) in a trading company or group, provided certain conditions are satisfied.

There is generally a requirement that assets must have been owned for at least 12 months before the disposal.

A "trade" will not include a property letting business but, could apply to a property dealing business and the business of property development with a view to sale. The relief does not apply to the sale of property held as trading stock, as this is subject to income tax, not capital gains tax.

As there is still an appreciable difference between the rate of capital gains tax and income tax, efforts are expected to be made to treat sales as capital wherever possible.

VAT RATE INCREASED

From 4 January 2011, the standard rate of VAT will rise from 17.5 % to 20%. Rules have been created to stop tax loss by businesses issuing invoices and/or making prepayments before 4 January 2011, when the services or goods are actually supplied later. These loss prevention rules apply if the customer cannot recover all its VAT on what you supply to it and, one of the following applies:

• the pre-payment/pre-invoicing exceeds £100,000, unless in accordance with "normal commercial practice";

• the transaction is between connected parties;

• the invoice is issued six months or more before payment is due; or

• the supplier is involved in financing the payment for the supply.

These rules do not apply to the letting of property if the pre-invoicing/pre-payment accords with "normal commercial practice" and is for less than 12 months. Normal commercial practice is defined as the normal commercial practice of that supplier or, if none, the normal commercial practice of similar businesses.

Here are some examples on how to treat transactions that span the date VAT is increased:

Sales

VAT will be chargeable at 20% where completion takes place on or after 4 January 2011. Where exchange takes place before 4 January 2011 and completion after, this will still be the case. Provided the contract stipulates the price "plus VAT", the seller will be able to charge the additional VAT to the Buyer whether or not the rate of 20% is specifically mentioned in the contract.

Leases

In relation to rents and service charges, the general rule is that the VAT rate applicable is determined by the date when the payment is received or the VAT invoice is issued if earlier. When there is a change of rate, this rule is modified, and the landlord can if he so chooses, issue split invoices so that VAT is charged at the old rate to the extent it relates to a period of occupation before the change, and at the new rate to the extent it relates to a period of occupation afterwards. The landlord does not have to make use of this optional treatment for all tenants, but can pick and choose. In practice, this means that landlords who wish to ensure that the rent payable for the quarter ended March 2011 carries VAT at only 17.5%, should ensure either that the tenant pays before 4th January 2011, or that their rent demands sent out in December 2010 constitute valid VAT invoices and trigger the time of supply for VAT purposes. This will mean that the entire quarter's rent can be treated as subject to VAT at 17.5 %. However, if the tenant delays in paying, there would be a cashflow cost for the landlord as it would be forced to pay H M Revenue & Customs the VAT before receiving it from the tenants.

Works

If you are providing regular services, (eg, staged payments for works), and you issue an invoice after 4 January 2011 for work carried out before and after that date, it is possible not to charge VAT at 20%, but to make an apportionment between the payments due for the works carried out before 4 January 2011 which are chargeable to VAT at 17.5% and those which are carried out on or after 4 January 2011, which are chargeable to VAT at 20%. The same principle applies to single payment contracts, where payment is made on or after 4 January 2011. That payment can be apportioned between works done before and after 4 January 2011 at the different rates.

HM Revenue & Customs have given a number of examples dealing with works contracts.

Rent Deposits

Where landlords already hold rent deposits from tenants which include an element of VAT, landlords should now ask tenants for additional contributions to cover the proposed 20% standard rate of VAT. Where leases are being negotiated, or between now and 4 January 2011, landlords should collect prospective VAT at the 20% rate on any rent deposit, as if the tenant defaults, the rent deposit will be drawn down at a time when the VAT rate is 20%.

Errors and Refunds

If you have to make a refund or issue a credit note for any reason, the VAT refunded is always at the same rate as it was charged, even if there has been a change in rate.

VAT and SDLT

The increase in the standard rate of VAT will need to be taken into account when calculating the SDLT payable on a property transaction, as SDLT is also chargeable on the VAT element of any consideration. In particular, when calculating the SDLT due on a new lease that spans 4 January 2011, VAT at 20% should be inserted into the lease duty calculator in respect of rents due after 4th January 2011.

LANDFILL TAX

Landfill Tax Rules are to be introduced to require HMRC to detail which materials are subject to the lower rate of landfill tax. This will replace the current criteria of the materials being described as inactive or inert. This is expected to have effect from 1 April 2011.

REITS MADE MORE FLEXIABLE

In response to industry lobbying due to market conditions, UK REITS are permitted to issue stock dividends instead of cash as a way to comply with their obligations to distribute 90% of profits from property rental.