Real estate: a rich blend

Written by: Alexander Garrett Posted: 14/10/2020

BLCITY_Real EstateMajor changes to the UK’s property tax regime and the Crown Dependencies’ Double Tax Agreements have caused some overseas property investors to sit up and take notice. But the attractiveness of UK property to international investors and the use of the Channel Islands as a pathway to it means the City and the islands continue to offer the ultimate blend of flexibility and benefits

When Philip Hammond, then UK Chancellor, announced in his 2017 Autumn Budget that from 6 April 2019, non-resident investors would have to pay Capital Gains Tax on disposals of all types of UK real estate, it sent a ripple of concern around the world of offshore investment. 

For fund managers, administrators and other professionals in the Channel Islands, these changes threatened to erode some of the tax advantages that investments made via Jersey and Guernsey had traditionally enjoyed.

They come at a time when the UK, in light of Brexit, is seeking to redefine its place in the financial services competitive landscape. This is also a time when the outlook for UK property in general has been clouded by the coronavirus pandemic. 

It’s not just how people invest that’s having to be revalued, but also the basic argument around what type of property is worthy of investment.

Investment in real estate, especially UK property, is big business in Jersey and Guernsey. The Monterey Insight Jersey Fund Report 2018 estimated that, even back then, there were already more than 100 Jersey-based funds focusing on UK real estate, with a combined net asset value of more than $42bn. 

And, according to Guernsey Finance, in excess of £20bn of property is held in Guernsey-domiciled real estate funds.

Until now, the tax benefits offered to overseas investors have been something of an anomaly, says Richard Daggett, Partner at Ogier.

“The UK was, for a long time, an outlier in how it sought to tax property within its borders,” he says. “Seeking to charge overseas investors CGT and Corporation Tax is merely bringing the UK in line with other countries that vie for foreign investment in their real estate sectors.”

The UK government’s tax reforms were aimed squarely at levelling the playing field for non-resident and resident investors. 

The process began in 2015 with the imposition of non-resident Capital Gains Tax on disposals of UK residential property. 

The latest measures extended that to commercial property – potentially drawing into the net pension funds and institutional investors from around the world who invest in all kinds of UK real estate, from student housing to shops, restaurants, hotels, offices and warehouses. 

And CGT was also applied to gains on ‘property-rich’ vehicles in which 75% of the value is in UK real estate. 

Islands impact

For a variety of reasons, these changes have had less of an impact on those in the Channel Islands than might have been expected. 

First, HMRC has allowed funds and other collective investment vehicles to elect for ‘transparent’ or ‘exempt’ status, which means that the vehicle itself is not taxed, although the investors are taxed at their usual level. 

As Philip Hendy, Director, Real Estate, at Intertrust, explains: “The political point was: ‘Let’s try and equalise the standing of an investor into UK real estate, irrespective of where they have invested from, so whether your investment was made from Jersey, Guernsey or within the UK, you are on a similar tax footing’. 

“But what wasn’t initially considered properly was that most investors into UK real estate are probably tax-exempt investors because they are your and my pension funds, or sovereign funds, or exempt for another reason. The HMRC concessions have dealt with that issue.

“For the transparency election, you need to have a vehicle that could be considered transparent prior to the election – not a company, which is opaque – but it would include Jersey and Guernsey Property Unit Trusts, as these are ‘Baker Trusts’ (JPUTs and GPUTs), and traditional limited liability partnerships. 

“You can elect for that vehicle to be transparent for CGT, and that means each investor into that entity, whether a limited partner, a partner or a unit holder, is taxed as if they had invested individually into that UK real estate.”

Transparency for vehicles such as JPUTs and GPUTs is a key element, explains Simon Burgess, Head of Alternative Investments at Ocorian, because it avoids “tax leakage”. 

“These types of unit trusts are very attractive because they have the flexibility to accommodate different types of owners,” he explains. “These different investors each have their own taxpayer status, and the benefit is that it’s the unit holder who pays the tax, not the vehicle itself. If you’re a UK taxpayer, you’ll pay tax on it; if you’re not, you won’t.”

Malcolm Macleod, Head of Funds and Institutional, Jersey, at IQ-EQ, reinforces this point. “It’s worth noting that, for many, structuring through offshore jurisdictions like Jersey has never just been about CGT,” he says.

“It’s more about ensuring that the vehicle being used to pool funds is transparent for tax purposes, so that investors do not suffer multiple levels of taxation.”

Sharpening the focus

One of the key effects of the UK government’s tax changes, says James Mulholland, Partner at Carey Olsen, has been that “it has sharpened the focus as to those who would ordinarily be onshore and those who would look at offshore”.

Structures such as JPUTs “have been a very good investment platform for lots of joint ventures where you have a primary investor with a developer, or institutional investors that are non-UK investing in London trophy assets”, he explains. “And we have definitely seen an uptick in that.” 

However, where this type of vehicle is not deemed appropriate, and particularly where the investment is made through a company structure, a UK-based vehicle may now be the preferred option.

Philip Hendy gives an example. “Say you are a commercial enterprise that has a footing in the UK and wants to own your own building – it isn’t necessarily of benefit to hold that offshore if you’re running as an operational property and are not going to sell in the foreseeable future. 

“In that case, there may be some benefit in taking the company onshore or, more correctly, changing the tax domicile to the UK and fully embracing paying UK tax as a UK entity.”

Donna Shorto, Guernsey-born but now the London-based Managing Director of PraxisIFM Corporate Services (UK), offers another perspective. “As a result of the new regime, we’ve certainly seen a shift in mindset when clients are setting up structures or looking to invest in UK real estate generally,” she says. 

“Whereas offshore vehicles would have previously taken preference, onshore vehicles are now being considered more readily.”

Beyond taxation

However, what all agree on is that tax is only one part of the reason investors use the Channel Islands to hold UK real estate investments. 

Burgess explains: “Jersey and Guernsey each offer a stable jurisdiction; they each have a recognised rule of law, as well as elected parliaments and judicial systems that bring freedom and independence. 

“There’s a very high standard of regulation, which is important for investors having confidence in any jurisdiction, and the strong level of compliance here means that investors can be sure the money that flows through the Channel Islands is legitimate.”

Having said that, neither Jersey nor Guernsey has an open share register, unlike the UK – which could be a further factor in determining where individual investors choose to locate their investments going forward.

Shorto adds: “Some clients are worried about an investigation, even if they’ve done everything properly, and they do want to have UK structures now because it’s easier. It’s transparent, you can see the ownership, and there’s nothing they could be hiding. 

“On the other hand, you do still have investors who are very conscious about privacy and, while they understand that there have been tax changes, the offshore jurisdictions still appeal to them because of privacy.”

The concentration of professional expertise and the diverse range of financial structures available – as well as the relative ease in setting these up – are also cited as reasons why people choose to establish investment structures in the Channel Islands.

Richard Daggett continues: “The ability to transfer shares in a Jersey company (or units in a Jersey Property Unit Trust) without incurring UK stamp duty remains a highly sought-after benefit to structuring through Jersey.”

The recent revision of Double Taxation Agreements (DTAs) between the UK and all the Crown Dependencies has also played in favour of the Channel Islands and the Isle of Man. 

Philip Hendy gives one example. “In the past, if you wanted to lend money from Jersey into the UK, under certain circumstances when the borrower was paying you back, they would have to withhold 20% tax because of the antiquated nature of the Double Taxation treaty,” he says. “If that lender was in Luxembourg, for example, there was no withholding tax. You could remit the money in full. 

“The revision of the DTAs has put Jersey and Guernsey on a par with other jurisdictions – so there is now no withholding tax.”

Hendy continues: “In the past, because of withholding tax credit funds, lending money to the UK would be based in another EU jurisdiction – Ireland, Cyprus, Malta and Luxembourg were all used.

"Now, that fund doesn’t have to be in the EU to take advantage of that, and it’s a great opportunity for Jersey and Guernsey to work with the UK and the City on something that’s not worked particularly well in past. 

“Credit funds are a different opportunity to invest in real estate, through investing in lending rather than in physical properties.”

Prospect of PIFs

One further potential change coming in the UK is the creation of Professional Investment Funds (PIFs), on which the Chancellor of the Exchequer announced a consultation in March – and which could be seen as a rival to Jersey Private Funds and Guernsey Qualifying Investor Funds.

Malcolm Macleod says: “To date, the UK has not had a suitable fund structure that optimises tax efficiencies and was suitably commercial to make it a viable choice for managers. 

“The regulatory environment was complicated and did not lend itself to closed-ended alternative funds such as real estate. Brexit has sharpened the focus on this issue for HMRC, the government and UK-based fund managers.”

If they do get the go-ahead, PIFs could make the UK a more attractive environment for raising funds, deter fund managers from moving elsewhere, such as France, and spur post-Brexit financial growth, says Macleod. 

In terms of competition, he argues that the existing strength of the Channel Islands in marketing their funds internationally to key investment centres such as the US, Asia and the Middle East is unlikely to diminish.

In spite of everything that’s happened in the past few years – Brexit, Covid-19 and the UK tax changes – the overall attractiveness of UK property to international investors, and the use of the Channel Islands as a pathway to that investment, hasn’t really changed.

Mulholland says: “Since the Brexit vote, we’ve definitely seen an uptick in Asian investors looking at the weakened pound and the strength of assets on sale, particularly in London and the South East, and they are taking the opportunity to invest in that. 

“We’ve seen the pound devalued over four years. Then there’s the backdrop of Hong Kong investors – we may start to see a flight of capital out of HK and into safer assets, and that could well be back to London again.”

Burgess concludes: “The property investment market works in cycles, and different types of investors are interested in different things. 

“For example, pension funds typically need an income stream to match their liabilities. The UK economy is one of the strongest in the world, and even with Brexit and the uncertainty of coronavirus, it is still seen as a strong economic force that pension funds will continue to target. 

“Others are interested in using their skillset to spot or enhance the value of a property, so they are selecting property that will rebound well after Covid-19 and Brexit. There are lots of people with that strategy and they could do very well.” 

BLCITY_Real Estate_ESGESG – the new dimension in real estate?

If there’s one trend that’s changing the face of property investment, it’s the growing emphasis on environment, social and governance (ESG) considerations. 

“Whereas previously, investors in real estate funds were concerned solely about returns, no self-respecting real estate investor will now be without an ESG policy and will expect any fund into which they put funds to be equally focused on such issues,” says Richard Daggett at Ogier.

“We’ve gone from a world where people talked a good ESG game to now having investors demanding it as more than lip service – and not being afraid to deploy their capital elsewhere to make that happen.”

That’s especially the case where succession planning takes place and a new generation of investors is stepping up, says Donna Shorto at Praxis. “Covid-19 has been a major turning point for ESG investment,” she says. “When you have a portfolio and it’s invested in ESG, you have done very well in this time and have made good returns. 

“Covid-19 has given everyone the chance to step back, and people are now placing greater emphasis on corporate governance and fairness within the workplace.” 

ESG considerations in real estate include strong BREEAM and energy ratings, the construction materials used, and working practices. ESG could also impinge on the office environment after Covid-19.

Philip Hendy adds: “Companies will provide a different environment in work, and no longer cram so many in. The more enlightened employers will look at this quite differently. Their workplaces will be more varied and interesting, with the ability for people to get up and walk around, different kinds of seating and so on. 

“If you want to attract talent, to become an employer of choice you will have to adapt your ways of working.”

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