What is ‘acceptable’ tax planning for property rich company disposals?

Before 6 April 2019 non-UK resident individuals and companies could generally sell UK companies without having to worry about UK tax issues. From 6 April 2019 the rules on indirect property disposals (which have become more widely known as ‘the property rich company rules’) were introduced. These treat companies whose assets are comprised at least 75% of UK property as chargeable assets for UK capital gains tax and corporation tax purposes. The impact of these rules has been something of a slow-burn because such companies were rebased in value at 6 April 2019. However, as time goes on the value of such companies tend to grow and when they are sold significant gains can be triggered.

It is important to remember that gains are calculated as the difference between the value of such a company between 6 April 2019 and disposal, rather than the value of the properties.

Example

IOM Holdco Ltd has held IOM Propco Ltd since 2004. Both companies are registered and centrally managed and controlled in the Isle of Man. IOM Propco Ltd, which derives over 75% of its value from UK property, was valued at £20m on 6 April 2019 and is currently valued at £35m, some of this increase relating to the receipt of planning permission. There is a plan for IOM Holdco Ltd to sell IOM Propco Ltd for £35m. This would give rise to corporation tax of £3.75m (25% of £15m) in the hands of IOM Holdco Ltd. Looking at the balance sheet of IOM Propco Ltd, it includes £7m of reserves. Therefore, before the sale, IOM Propco Ltd borrows £7m from a bank and distributes this up to IOM Holdco Ltd. The deal is then amended so that the buyer pays £28m for the company and uses £7m to refinance IOM Propco Ltd, which will then repay the loan to the bank. The corporation tax liability would then reduce to £2m (25% of £8m), thus ‘saving’ £1.75m.

Although there are-value shifting rules that can counteract the effect of some pre-sale planning, it is generally accepted that ‘dividend-stripping’ is not offensive and HMRC even say as much in their guidance. This is because there is an exemption for any arrangement which wholly involves the payment of an ‘exempt dividend’.

Taking things further…..

There is however an interesting twist on this theme where jurisdictions have more flexible distribution rules than the UK. For example, some Isle of Man companies can make distributions to shareholders as long as the company meets a solvency test. Consider in the above example if the bank were to lend £15m to IOM Propco Ltd followed by a £15m distribution. Prima facie, this would reduce the tax liability to nothing. Although this is probably against the spirit of the legislation, it is difficult to see why such a distribution would not fall within the definition of an ‘exempt dividend’.

Forbes Dawson view

It seems clear that existing anti-avoidance rules apply to disposals of ‘property rich companies’ without any tweaks. It seems tolerably clear that ‘dividend stripping’ is acceptable tax planning here, but there may be shades of what is ‘acceptable’ to HMRC. I think that going from uncontroversial to verging on aggressive the planning could be categorised as follows:

1. Distributing profit and loss reserves which have built up since 6 April 2019. This should fall squarely into the category of HMRC’s ‘approved planning’.
2. Distributing profit and loss reserves which were in existence on 6 April 2019. I think that if the Government had thought about this properly, they would have put in a rule about restricting the deductible base cost to the extent that non-taxable distributions have since been made from it. However, no such rules exist.
3. Distributing what is effectively unrealised profit as mentioned in the ‘£15m example’ above. The normal anti-avoidance rules probably did not envisage a scenario whereby distributions could be made from anything other than realised profits.

In summary, it seems that the normal capital gains tax anti-avoidance rules are somewhat deficient when it comes to ‘property rich companies’. Because of this it is difficult to know where the boundary between acceptable and unacceptable tax planning lies here. However, what is clear is that any owners facing a ‘property rich company gain’ should consider their tax planning options carefully.

 

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