It is becoming increasingly common for UK resident individuals to purchase property abroad, but not all countries will allow foreigners to hold an interest in their soil. This article looks at the tax treatment of foreign homes purchased using a foreign company.
a) Rental basics: UK fully resident and domiciled
When an individual is ordinarily resident and domiciled in the UK and buys an overseas property personally it is fairly straightforward to work out the tax liability on any profits derived from foreign rental income. This will be a matter of taking the actual income less a proportion of the relevant expenses in maintaining the property, which includes mortgage interest. If there is private use, expenses are restricted on a reasonable basis to reflect this. Sometimes there are some local taxes which are income tax deductible, these are generally uncomplicated. Tax will generally be paid or withheld in the country concerned and back in the UK the individual will receive a tax credit for foreign taxes, and so will not suffer a double tax charge.
b) Rental basics: Non UK Domiciled and UK residents owning property abroad
If you are not domiciled in the UK then you are only taxed in the UK on income from a property abroad if it is remitted to the UK.
It is not always possible to purchase real estate abroad if you are not a citizen of that country, and this creates an extra layer of complexity in the purchasing process as well as in the tax treatment. Take the problem of buying a property in Bulgaria, for instance, - this country came up in a query in the Any Answers forum last month. “Sofia” wanted to know the ins and outs of buying a holiday home in Bulgaria via a foreign company. As it attracted no responses, and it is quite common for UK nationals to do so, I thought it warranted a closer look.
Bulgaria is very liberal in its attitude to foreign investment and allows both foreign individuals and companies to invest in its real estate, but with one proviso; foreigners can acquire only buildings, which limits foreign purchase to the actual bricks and mortar and not the land on which they sit. Only Bulgarian citizens and legal persons, such as Bulgarian resident companies can hold the land and so the easy way that foreigners can hold any land is by setting up a Bulgarian company.
There are no problems in setting up a Bulgarian company – even estate agents will do this for you, but it is probably sensible to appoint a solicitor to handle this together with the purchase. Domestic corporation tax on any rental income is at 15% which is the same rate of tax that applies if you are an individual in receipt of rental income. Profits are calculated on the conventional basis of income less relevant expenses but you also receive a deduction for depreciation, providing that the property is not held as an investment. In the main, it appears that you receive a depreciation allowance if you are using the property as a fixed asset, and holiday rental income will indicate that this is so. Losses can be carried forward and not back, and there is no VAT on residential land and buildings.
Benefits in kind
As a shareholder in a Bulgarian company, you will not be taxed in Bulgaria on any deemed benefit in kind if you stay in your property. The position is less clear as far as UK taxes go. Following two criminal cases R. v. Dimpsey and R. v. Allen, the general view seems to be that if you set up a company, such as one registered in Bulgaria to hold the title deeds to the garden of your Bulgarian holiday home, then you will either be a director (because you appointed yourself as one) or you will be a 'shadow director' because the company will be run under your direction. The widely held view goes that as a shadow director, you will then succumb to a benefit in kind charge for the benefit of having a holiday home available to you.
HM Revenue and Custom view as per the Employment Income Manual at paragraph EIM20507 – “The benefits code: expenses and benefits from non- resident employers” is as follows:
“The residence of the employer has no effect on whether benefits and expenses within the rules in the benefits code are chargeable. The residence of any other person providing benefits or expenses payments within those rules similarly has no effect.”
It is clear that HMRC might expect to see a benefit in kind declaration in respect of a foreign holiday home, when it is held by a foreign company. To this end, one needs to be aware that a 'personal' holiday home will by its very nature be available to the owners throughout the year. This means that if purchased via a company a benefits charge could arise under s.102 ITEPA 2003 on the cash equivalent of the benefit for the entire year to the director.
Alternatively, if private use is not the primary objective and the accommodation will be let out on a commercial basis for the rest of the year, then a benefits charge will only apply for the period that it is available to the director and his family. It is essential to fully document this, because the Revenue take the view that if the property is not available for commercial letting then it must be available to the director.
Opposing views
Dimpsey and Allen were criminal cases dating back to 2001 and so their findings are not fully relevant to the benefits code and ITEPA 2003. As far as the writer is aware, HMRC have not yet tested the application of s.102 in respect of holiday homes owned abroad in the courts.
Benefits in kind can be expensive, and so it may make more sense if you are looking at Bulgarian property to purchase the building privately and the land through a limited company. This way the benefit will only arise on the land, and that may be minor.
If you are not a director of your foreign company, and the position is held by a solicitor or professional overseas, who files the company accountants and does the annual legalities year, the company may be dormant for the entire period of its existence until its asset is sold. It may be difficult on the facts to make the description of 'shadow director' fit. EIM11413 of HMRC's Employment Income Manual deals with shadow directors, but only in the context of accommodation available in the UK. EIM11440 describes how you calculate annual value on a property situated outside the UK.
Capital taxes
A foreign company will pay some form of capital tax on disposal of its land and property in the county where it is resident, what the shareholder chooses to do with the company from then on in will decide whether or not there is a tax charge for the individual back in the UK. At present CGT in Bulgaria is also 15%. In many countries there is also an annual property tax charge which is levied on the property’s value, there is not one in Bulgaria, but there is an annual municipal tax, which is not dissimilar to Council Tax. For inheritance tax purposes, the shares in an overseas company will form part of the deceased’s estate if he is UK domiciled or deemed domiciled paying heed to the 20 year / 3 year rule. There is no IHT in Bulgaria.
Conclusion
The query raised some interesting points in relation to the benefits code. I have found differing opinions as to what might apply as a benefits charge, if any, and these would vary depending upon the ownership structure. I can see that it will be very hard for HMRC to spot these cases in practice, but if you happen to use the foreign branch of a UK bank, HMRC is now entitled to your details following success in a string of s.20 TMA 1970 cases against high street banks.
There have been some reports of 'unreported" accommodation benefit in kind cases before the Commissioners, it would be good to hear from any members of AccountingWEB to find out if the facts of these lend anything material to the debate on shadow directors or whether these problems are settled quietly on a case by case basis.
