UK government proposals to remove the capital-gains-tax (CGT) exemption for foreign investors could slow the country’s real estate market and have unintended consequences for domestic institutional investors, according to industry experts.
During Wednesday’s budget announcement, the government said it would extend rules that already apply to residential property to commercial property, while providing an exemption for institutional investors such as pension funds.
Alex Thomas, partner and head of tax at law firm Dentons, said: “This announcement has come as a shock and is contrary to government reassurances only made last year that this was not on the cards. What a difference an election makes.”
He said not taxing non-residents’ capital gains on UK property investments had been a key driver to the “investment boom we have seen in UK commercial real estate and was something that made the UK unusual in the world real estate marketplace”.
Thomas added: “It is fair to say that the UK industry will lobby hard to get government to change its mind; however, with the current political climate – and the fact that [the Labour Party] has recently picked this up as a major bugbear – it is extremely unlikely that legislation will not be enacted.
“The timing of this proposal is not ideal. As we are hitting the top of a cycle and already expecting a bit of a cooling, having a rule which comes into force moments after Brexit cannot be good at a time when the UK should be doing as much as possible to attract inward investment.”
Russell Gardner, head of real estate at EY, said the announcement signalled “a seismic change to the UK property landscape”.
He said: “At a moment in time [when] the UK wants to attract more international capital for real estate and infrastructure investment, this will send a chill through the investor community.”
Ion Fletcher, director of finance policy at the British Property Federation, said: “The UK is particularly good at attracting overseas investment capital, much of which goes towards regenerating our towns and cities.
“Not only does this result in better places to live and work, it supports thousands of jobs in industries as varied as construction and leisure.”
Fletcher said the move could “jeopardise this much needed investment”, adding that the inclusion of an exemption for institutional investors “will need to be carefully considered to ensure investment keeps flowing to the UK”.
This year, a series of large property transactions in central London — mainly by Asian investors — has restored the UK as the largest commercial real estate market in Europe.
According Real Capital Analytics (RCA), commercial property deals in the UK during the second quarter of the year rose 12% to €15.5bn from the same period a year earlier, making the UK the top investment market in Europe.
The £1.15bn purchase of the Leadenhall Building, known commonly as The Cheesegrater, lifted the average deal size in central London to the highest level on record, RCA said.
Tom Leahy, senior director of EMEA analytics at RCA, said: “The past quarter was the strongest ever for investment from Asia into Europe, and London benefitted as the continent’s deepest and most liquid market.”
Also in July, Land Securities and the Canary Wharf Group sold 20 Fenchurch Street, the London skyscraper nicknamed the ‘Walkie Talkie’, for almost £1.3bn (€1.4bn) to Infinitus Property Investment, a subsidiary of Hong Kong-based LKK Health Products Group.
Independent consultant John Forbes said the move could have unexpected consequences for UK institutional investors using offshore structures, such as Jersey Property Unit Trusts.
“Institutional investors will in some circumstances be less adversely affected than some other non-resident investors, but this will depend on a complex set of permutations, not all of which will be in the control of the investor.
“There is a consultation period on the proposals, so hopefully some of the presumably unintended booby traps can be defused before the provisions come into effect.”
The consultation runs for 12 weeks from 22 November 2017 to 16 February 2018. The government will publish its response, along with draft clauses, in the summer.
According to the published document, legislation will be introduced in the 2018 to 2019 Finance Bill and will take effect from April 2019.
Brenda Coleman, tax partner at Ropes & Gray, said: “The timing of this fundamental change in the taxation of UK commercial property is surprising given the fragility of the commercial property market as the UK leaves the EU and the increased tax burden on this sector as a result of restrictions on the deductibility of interest.
“It is hoped that the consultation process will take account of the need to attract foreign investment into this sector and the UK’s participation exemption will provide some protection for institutional investors.”