The authors of this article put the world of enveloped UK real estate, and the complexities around its tax treatment, under the spotlight.

The term is familiar in the investment property world but the sector known as “enveloped” real estate has its complexities. In this guest article by Andrew Sneddon, head of tax, and Denielle Rickman, real estate associate, in the London office of law firm Trowers & Hamlins, the authors delve into the UK enveloped market. Their views aren’t necessarily shared by this publication but the editors are pleased to share these insights and invite readers to respond. They can email tom.burroughes@wealthbriefing.com

Non-UK high net worth investors in UK residential real estate have traditionally used offshore companies as the purchase vehicle. The use of a company to buy a property is referred to as enveloping.

It was reported in 2012 that 50 of the 56 units sold at the One Hyde Park development were purchased by offshore corporate structures. The £100 million of revenue raised by the annual tax on enveloped dwellings (ATED) during the 2013/14 financial year is further testament to the popularity of the corporate vehicle.

This enveloping can be for a number of reasons, for example, to protect confidentiality and to improve the UK inheritance tax position.  

The taxation position of prime and ultra-prime enveloped assets is undoubtedly not as favourable as it once was owing to the implementation of tax policies by the UK government designed to reduce the number of empty properties in central London and prevent what was perceived as stamp duty land tax abuse.

In addition to IHT and SDLT, there are a number of other relevant UK taxes (and reliefs from those taxes) to consider when buying residential property, the main ones being:
- SDLT – acquisition of residential property valued at over £500,000 by a company is taxed at 15 per cent;
- ATED – currently applied to enveloped residential properties valued in excess of £1 million;
- ATED-related capital gains tax – this took effect from 6 April 2013 on the disposal of enveloped dwellings which are subject to ATED;
- Non-resident capital gains tax (NRCGT) – this took effect from 6 April 2015 where residential property is disposed of whether it is enveloped or not; and
- Diverted profits tax (DPT) – takes effect in respect of "diverted" profits arising on or after 1 April 2015

Proceed with care
When it comes to the sale of enveloped properties, the buyer is faced with the decision as to whether to buy the property from the company or buy the shares in the company.

The tax position can become very complicated, but if the buyer wants to buy the company, presumably to benefit from the SDLT saving, care must be taken to ensure the buyer is not left in a worse position than if the property had been bought directly.  

Due diligence
It is vital to carry out an early and comprehensive due diligence on the target company so as to reveal any risks covering, for example:

- The company's accounts and constitution, and the identity of its beneficial owners. Care should be taken to ensure that all the beneficial owners of the company consent to the sale. If the target company is offshore foreign lawyers may need to opine on the standing of the company and annual running and administration costs should be explored;
- Contracts entered into by the target company containing obligations which will continue after completion. For example, occupational tenancies and agreements with letting agents or property managers;
- Any staff employed by the company and the application of TUPE;
- The company's financial and tax position. For example, there are creditors, debtors, borrowings and cash reserves. Watch out for capital contributions made to the company and the proposals for their repayment on the completion of the share sale and existing tax liabilities of the company and its potential liability on a future disposal of the property;
- Title, planning and environmental issues. The main asset of the target company is usually the residential property. The same searches and enquiries should be made as for an ordinary property purchase. If the property is let, compliance with the deposit protection rules and non-resident landlord scheme must also be looked into.

Buyer protection
If necessary, the share purchase agreement should include appropriate financial protections for the buyer in relation to known and potential risks. In this regard, if enforcement against the selling shareholders might be difficult, a retention from the purchase price for a period of time may be sensible.

Failure to carry out a comprehensive due diligence exercise could be extremely costly.