Service France

The following is a conversation between David Anderson and Graeme Perry both of Sykes Anderson LLP Solicitors and Chartered Tax Adviser and the UK resident owner of a UK business who is about to sell it. They discuss the discriminatory provisions connected to certain UK tax reliefs in relation to investments abroad.

Please note that tax law is a complex subject and you should not rely on this article without professional advice on the facts of your case. Nothing herein constitutes financial advice and if you are in any doubt as to your financial position you should consult an IFA.

Q I currently run a UK business and am looking to invest in French property. I understand that leaseback properties in France are popular for investors. Could you please explain how this system operates?

A An investor can purchase units from a developer and then enter into a commercial lease with a hotel operating company which agrees to pay a guaranteed income per annum. This will normally be based on a percentage of the purchase price which is index linked. This means that the income received by an investor generally does not depend on how well the hotel business performs. The property is fully managed and maintained by the management company and the developer also provides furniture for the property. The management company does not occupy the flat but rents it to tourists for the purposes of its business so that it is considered a commercial lease.

Q. This sounds like an attractive investment especially with inflation going up. It is a good way to balance my investment portfolio with direct exposure to property. I was planning to take advantage of some of the tax incentives offered by the Government for re-investing part of the sale proceeds of my business in these French properties. Is there anything I should be particularly aware of?

A. Generally the UK tax system is designed to encourage international investment by UK residents abroad and foreign investors in the UK. However there are a few glaring anomalies in the legislation which discriminate against UK residents wishing to invest in foreign property. These can restrict investors from using some of the reliefs usually available when seeking to invest abroad.

Q. I understand that it is possible to use some of my business profits to re-invest without having to pay tax. Could you please explain how this works?

A. Yes, this is known as “Rollover” relief and is a useful way for UK residents selling their business or business assets to avoid paying UK capital gains tax straight away. For example if you sell a UK trading business and decide to buy another trading business, then in most cases you do not have to pay capital gains tax on the sale but can “roll the gain over” into the new business. When you sell the new business the capital gain you “rolled over” becomes taxable as part of the sale of the new business. If this relief was not available then there would be a powerful disincentive to buy and sell businesses because the tax costs would make it impossible to buy a business of similar value.

It is available in relation to the replacement of business assets used in a trade, and is intended to allow the seller to reinvest all of the proceeds of a disposal in a replacement asset. It operates by reducing the cost of any new asset by the gain realised on the disposal of the old asset. This has the effect of allowing the point at which a gain is chargeable to be deferred.

In order to qualify for the relief, the assets must fit into the categories in section 156 Taxation of Chargeable Gains Act (TCGA) which includes land and buildings occupied and used for the purposes of a trade. It is not necessary for the asset disposed of and that acquired to be in the same category or to be for the same trade. The location of the assets also does not matter. The acquisition of the replacement asset must take place within the 12 months before the disposal of the original asset or within the 3 years following the disposal.

Q. I see. Do the French Leasebacks which you spoke about previously qualify for such relief?

A. Unfortunately it seems not. In order for the French leaseback property investment to qualify for the relief, it must be used for trading purposes. The general rule is that land and buildings which are let out giving the tenant the right to exclusive possession do not qualify for the purpose of the owner’s trade. Any income received from such lettings is considered property income rather than trade income. However as an exception to the rule under section 214(3A) TCGA ‘furnished holiday lettings in the UK’ qualify as a trade for the purposes of roll-over relief.

Furnished holiday lettings are defined in UK legislation as “let on a commercial basis with a view to the realisation of profits” with “the tenant entitled to use of the furniture”. It must be available for commercial letting to the public as holiday accommodation for not less than 140 days per year and the period it is so let aggregate to at least 70 days. On the face of it, so long as the governing contract was correctly drafted, any leaseback arrangement in France would satisfy these UK tax criteria.

However, the exception as stated in section 241 applies only to the commercial letting of furnished holiday accommodation in the UK. Despite therefore representing an investment essentially akin to a seaside flat available for holiday rental in the UK, a leaseback in France would fall outside the roll-over relief requirements. This applies to any holiday rental business outside the UK not just leasebacks.

Q. It seems very unfair that an activity should be viewed as trading if carried out in the UK but not when in France. Is there any rule against such discrimination?

A. Although the Double Tax Treaty between the UK and France contains protective provisions, they are largely aimed at preventing residents of one state being taxed less favourably in the other state than residents of that other state. The Treaty does not make provision for a situation such as the rollover relief legislation to preclude a company from being taxed differently due to investing in France rather than the UK so is unlikely to help here.

The law could be considered to be a restriction on free movement of capital in the EU which is contrary to EU Law. The legislation discourages investors from partaking in the investment in real estate which is one of the operations considered as a capital movement under EU Law. It seems therefore that the law could be challenged on this basis although no challenge has been made as of yet. Should the UK Revenue reconsider how this law is applied it could prove a huge boost to investors and the leaseback industry.

Q. Is it just Rollover relief which operates like this?

A. No it is not. In fact the newly introduced entrepreneurs’ relief which seeks to encourage investors by allowing for a lower rate of CGT on the disposal of certain business assets has a similarly discriminatory effect. As with roll-over relief it is crucial that the business is trading in order to qualify. Identical provisions to roll-over relief mean that a furnished holiday letting in the UK will count as a trade for these purposes. This will only be subject to 10% tax on the gain (subject to the lifetime limit of L1million) whereas similar investments in France will be taxed at the full 18% rate in the UK. Again this serves as a restriction on investors and could be seen as contrary to EU Law. In short if you sell furnished holiday lets in the UK you pay 10% UK capital gains tax whilst you pay 18% UK capital gains tax on the same property in France which is blatantly unfair and distorts where people will invest.

Q. And are there any taxes other than CGT which face this discrimination?

A. Yes inheritance tax (IHT) is also affected in this way. Agricultural Property Relief (APR) operates to reduce the value of transfers for IHT purposes on certain agricultural properties to either zero or 50%. In most cases the relief operates to exempt any transfer from UK Inheritance tax. The relief extends to “life style farmers” who do not undertake any farming activity themselves but rent out the farmland and in the process their main residence farm house is exempted either wholly or partially from UK Inheritance Tax. This is a powerful incentive at the top end of the market to buy a farm house rather than an “ordinary” house because there will be little or no UK Inheritance Tax for your children to pay on your death because with a bit of planning it should be exempt as agricultural property even though you have never driven a tractor in your life. This explains the continued buoyancy of country house prices even in down turns because the wealthy will always buy for the tax breaks.

The discriminatory nature of this relief is in section 115 Inheritance Tax Act 1984 which states that only property located in the UK, and bizarrely the Channel Islands or the Isle of Man may qualify for the relief. Why tax havens should get this special treatment whilst countries with double tax treaties with the UK do not is a mystery. This is despite the fact that inheritance tax will be charged on the worldwide assets of UK domiciled individuals. The result is that a non UK resident but UK domiciled person running a working farm abroad is taxed to UK Inheritance tax on foreign agricultural property but any one who buys what qualifies as UK agricultural property is exempt.

This exemption also distorts the UK country house market and acts to inflate prices of such properties as a buyer faced with Inheritance Tax at 40% on the purchase of a “non agricultural” house and exemption from tax on an “agricultural” house will pay more for the latter. In similar vein the French Chateau with a working vineyard which parents wish to buy with their children will not be exempt from UK Inheritance Tax for a UK resident investor, which is a disincentive to purchase.

Q. Do you see this position changing at all in the future?

A. As I mentioned before no challenge has yet been made against these laws but one may arise especially now the highly publicised entrepreneurs’ relief has been introduced and contains discriminatory provision. It is likely that many people will want to take advantage of investment opportunities outside the UK and will not want to be prohibited from doing so by this discriminatory legislation. The answer would appear to be to extend the reliefs to investment in land in any EU country. The leaseback industry may care to make representations to the UK Revenue on this subject to open up further possibilities for investing in their schemes.