Scottish Residential Property – Main Tax Issues to Consider for Overseas Buyers

Scotland remains an attractive place for the overseas buyer to purchase a residential property. For many, they will be looking for a property as an investment. However, other overseas buyers could be looking for a second home or a base to do business.

The demand for residential properties to rent in Scotland remains strong with most landlords continuing to enjoy good occupancy rates and capital appreciation in recent years. At the same time, an increasing number of tourists are staying in properties made available for short term letting by local residents. Edinburgh has a strong Airbnb sector and is now second only to London in terms of average revenue per room let.

However, there are tax traps waiting for the overseas buyer due to a number of recent changes to property taxes. Tax will need to be considered at the time of a purchase or sale of residential property in Scotland, and when income is received from the letting of the property.

An overseas buyer should consider:

  • Land and Buildings Transaction Tax (LBTT) on the purchase of a property.
  • Income Tax when they receive income from the letting of a property.
  • Capital Gains Tax (CGT) on the sale of a property.

The rates of LBTT and CGT have increased in recent years. In addition, the method of assessing the profits liable to income tax has also changed.

Purchasing a Residential Property in Scotland

An overseas buyer purchasing a Scottish property will need to pay LBTT. Those purchasing property in the rest of the UK pay either Stamp Duty Land Tax (in England and Northern Ireland) or Land Transaction Tax (in Wales). No LBTT is payable on purchases of up to £145,000. The rates of LBTT are then as follows:

  • Above £145,000 to £250,000 – rate of 2%
  • Above £250,000 to £325,000 – rate of 5%
  • Above £325,000 to £750,000 – rate of 10%
  • Over £750,000 – rate of 12%

LBTT is charged with reference to the chargeable consideration that falls within the relevant band. So, for a property with a purchase price of say £300,000, the first £145,000 is charged at 0%, the next £105,000 at 2% and the remaining £50,000 at 5%. The total LBTT payable would be £4,600. There was a temporary reduction in the rates of LBTT for purchases between 15 July 2020 and 31 March 2021.

In cases where a residential property is already owned (either in the UK or overseas) there is an additional LBTT charge. The ‘Additional Dwelling Supplement’ (ADS) is payable at a rate of 4% on the total consideration; so, the ADS payable on a purchase price of £300,000 would be £12,000. Therefore, the total amount of LBTT payable on the purchase of a second home in Scotland worth £300,000 would be £16,600.

An overseas buyer who is considering purchasing a number of properties in Scotland would be strongly advised to obtain tax advice before proceeding. One of the issues to consider would be whether to make the purchase in the individual’s own name, or if this should be made through a company or a partnership.

If the purchase is made through a company or partnership, there will be a different method of calculating LBTT. In the case of high value properties (over £500,000), there may also be ATED (‘Annual Tax on Enveloped Dwellings’) charges to consider. Income received from the letting of a property held within a company will be liable to UK corporation tax at a flat rate of 19%. Any gain realised on the disposal of a residential property would also be liable to corporation tax (rather than CGT).

Letting a Residential Property in Scotland

An overseas buyer who receives income from the letting of a Scottish residential property may have income tax to pay on the rents received. The assessable income will simply be the difference between gross rents and allowable expenditure. Allowable expenditure will include letting agent fees, property repairs, property insurance, etc.

The assessable income is then taxed at the UK rates of income tax. Nationals of European Economic Area countries (including UK nationals living overseas) are entitled to the UK personal allowance. This means that for the 2020/21 tax year they will have no income tax to pay provided their assessable income is less than £12,500. For 2020/21, the first £37,500 of assessable income in excess of the personal allowance is then taxed at a rate of 20%, with the balance at 40% / 45%.

Individuals who are Scottish taxpayers pay the ‘Scottish Rate of Income Tax’ (SRIT) on assessable rental income. In general, the SRIT is one percentage point higher than in the rest of the UK. A Scottish taxpayer is an individual who is UK resident and who belongs to Scotland, i.e. they spend most of the UK tax year in Scotland.

It could be that income tax is payable on the same source of rental income in both the UK and overseas. Where this is the case, it is likely that credit will be received for income tax paid in the UK against tax due on the same source of income overseas. However, the terms of the relevant double tax treaty would need to be consulted.

An overseas buyer may decide to make their property available for either long term lets or short term lets. There are differences in the tax rules that apply to long term lets and to short term lets that qualify as a ‘Furnished Holiday Letting’ (FHL). A FHL is a property that is made available as a holiday let for at least 210 days during the tax year and is actually let for 105 of those days.

The one major difference between the calculation of profits when a property is let on a long-term basis and when a property is a FHL concerns interest payments made on loans taken out to purchase the residential property. Until 5 April 2017, interest payments made on all loans taken out to purchase a residential property were allowed in full as a revenue expense. However, since 6 April 2017 relief is no longer available in full on long term residential lets and from 2020 / 21 is restricted to the basic rate of tax.

The restriction in the tax relief due on interest payments may have a significant impact on the profits after tax of some landlords. For many landlords, the most straightforward option may be to transfer property ownership to a lower earning spouse. Other landlords may decide to sell one or more properties and reduce borrowings or, for certain properties, transferring to a FHL may be appropriate. Transferring a residential property business into a company may be advantageous from an income tax point of view but it may be difficult to avoid a charge to CGT and / or LBTT.

Overseas landlords will need to register with HM Revenue & Customs and submit self-assessment tax returns covering the period from 6 April to 5 April each year, with a submission deadline of 31 January following the tax year. Tax is also due on 31 January following the end of the tax year.

Non-resident landlords (NRL) are also subject to the provisions of the Non-Resident Landlords Scheme (NRLS). The NRLS requires tax to be withheld on the rent received by either the tenant or the letting agent, as appropriate. However, it is possible to receive rent without a deduction of tax, if tax matters are fully kept up to date. Where the NRLS does not apply, either the tenant or the letting agent must make quarterly returns to HMRC within 30 days of the end of the quarter. The tax must also be paid over to HMRC by the same deadline.

If the property is not going to be let and the intention is for it to be owner occupied, the overseas buyer will need to pay council tax. The rate of council tax due is set locally and is an annual charge that is usually paid on a monthly basis. The rate of council tax due is determined by the value of the property.

Selling a Residential Property in Scotland

When an overseas individual sells a residential property in Scotland, they may have CGT to pay if the property has been sold for a gain. CGT is only payable where the gains in a particular tax year are more than the annual exemption (£12,300 for 2018/19). CGT is then payable at a rate of 18% on the first £37,500 of gains. Any additional gains will be taxed at a rate of 28%.

The gain is calculated as the difference between gross sales proceeds (less costs of sale such as legal and marketing costs) and the amount paid for the property (including costs of purchase such as legal fees and SDLT/LBTT). Any costs incurred on capital improvements to the property (such as building an extension) will also be allowable.

Relief from CGT may be available where a property has been an individual’s main residence at some point during the period of ownership.

Until 6 April 2015, a gain realised on the disposal of a UK residential property by an overseas individual who was not resident in the UK was not chargeable to UK CGT. However, special rules were introduced from 6 April 2015 and these apply to all non-resident individuals who dispose of a UK residential property. If a disposal is within the ‘Non-Resident Capital Gains Tax’ (NRCGT) rules, a NRCGT Return must be filed within 30 days of conveyance.

Under the NRCGT rules, it is only the gain attributable to the period from 6 April 2015 to the date of sale that is liable to NRCGT. The gain may be calculated using the ‘default method’ which requires a property valuation at 5 April 2015. This value then becomes the base cost that is used in the CGT calculation. Alternatively, the gain on sale is calculated as normal and a day count used to determine the gain attributable to the period from 6 April 2015 to the date of sale.

Position on Death

Should the overseas buyer die while holding a Scottish residential property, Inheritance Tax (IHT) may be due. A Scottish residential property would be considered a UK situs asset for IHT purposes. IHT is charged at a rate of 40% on the total UK assets of a deceased individual when these exceed the IHT nil rate band, which is currently £325,000.  IHT is also due on gifts made in the seven years before death. The overseas buyer would be advised to have a Scottish Will in place.

There are various ways in which the exposure to IHT could be mitigated. Ownership in joint names with a spouse would avoid a charge to IHT on the first death, with any charge being deferred until the second death. Alternatively, ownership in joint names with adult children would provide multiple IHT nil rate bands.

The overseas buyer may not be intending to hold the property for the long term. Should the property be sold, and the sales proceeds returned overseas, no charge to IHT would arise.  However, taking out life assurance to cover the risk of an IHT charge arising on an unexpected death may be prudent.

Overseas individuals who had previously been advised to purchase a UK residential property through a corporate structure in order to avoid UK IHT should be aware that the rules recently changed. With effect from 6 April 2017 they will have an exposure to IHT with reference to the value of the residential property.

If you are an overseas investor and have a query about the UK tax implications of purchasing or selling a residential property, please contact Richard Clarke at property@chiene.co.uk or call 0131 558 5800.

 

Non-Resident CGT regime continues to cause a headache for taxpayers (and HMRC!)

Stephen Baker in our Personal Tax team outlines that the lack of publicity for the Non-Resident Capital Gains Tax return has seen a huge rise in individuals falling foul of the filing requirement.

Since 6 April 2015, non-resident individuals are liable to UK Capital Gains Tax on the disposal of UK residential property. Such disposals must be reported to HM Revenue & Customs (HMRC) within 30 days by way of a Non-Resident Capital Gains Tax (NRCGT) return. Penalties arise if the return is submitted late.

Despite rules being in existence for over 3 years, there continues to be a large number of individuals falling foul of this filing requirement. Recent published tribunal cases on the issue suggest that the reason for late filing is largely due to the short 30-day timescale for reporting and a general lack of awareness of this deadline.

In most cases where penalties have been levied, by the time the taxpayer realises that a return is required, it is likely that multiple late filing penalties are already accrued (even in cases where the CGT due is zero). For example, if a return is filed 12 months late on a disposal on which no tax is due, a total potential penalty of £700 may arise, comprising of a £100 late filing penalty and two £300 tax geared penalties.

A number of taxpayers have appealed against these penalties by bringing a case to the tax tribunal. From these appeals, a number of interesting outcomes have emerged. As would be expected, ignorance of the rules is not a reasonable excuse and the tribunal has stated this in several cases, although initial tribunal rulings were somewhat critical of HMRC’s lack of sufficient promotion of the new regime and found in favour of taxpayers in a couple of appeals on this basis. More recent tribunal decisions however, have found in favour of HMRC and concluded that lack of awareness of the change in law was not a reasonable excuse.

Despite the trend of cases in favour of HMRC, there were several smaller wins for taxpayers:

  • In cases where there were multiple disposals and subsequent multiple penalties, the tribunal has reduced or eliminated some of these penalties. It was found that there had been no chance for the taxpayer to learn from their first mistake (i.e. filing the return for the first disposal late) and therefore charging penalties for additional disposals would be unfair.
  • The tribunal analysed the penalty legislation in great detail and held that any tax-geared penalties should not exceed 100% of the actual tax due. Therefore, if no NRCGT is actually payable, penalties should be restricted to the initial £100 late filing penalty. It will be interesting to see how this point develops as the legislation applies to other taxes also.

Going forward it appears that there will need to be an increased awareness of the requirement to file a NRCGT return within 30 days. Although this is a requirement that tax advisers should be aware of, clients tend to notify advisers of transactions after the tax yearend (when a NRCGT return is likely to be already long overdue). This problem has the potential to become more prominent; currently there is a proposal to extend the 30-day reporting limit to both Non-resident commercial property disposals and to residential property disposals by UK residents.

It will be interesting to see how HMRC deal with any further appeals on this matter, but in the meantime, if you have any queries regarding NRCGT, please do not hesitate to contact me or one of the Personal Tax Team at Chiene + Tait on 0131 558 5800 or email mail@chiene.co.uk.