How to protect your overseas property from tax

Wednesday, August 05, 2009

How to protect your overseas property from tax

To the untrained eye, making a profit from overseas property can seem pretty simple. Property prices are continuing to rise by 20 per cent per annum in several markets. Even in Spain, where theres been a slowdown in the last two years, annualised capital growth for 2006 is running at 12 per cent, according to official Spanish Ministry of Housing statistics. However, as encouraging as these figures are for the investor, looking at capital growth alone does not reveal the whole picture. There are a number of costs, fees and taxes to be taken into consideration. Firstly, you will need to factor in purchase costs, including, in most countries, a local equivalent of stamp duty. Secondly, in all likelihood, there will be a local property tax (similar to UK council tax) for services and amenities. Next, should you let out the property, there is a percentage to be paid to the local tax authorities (25 per cent in Spain). Fourthly, in Spain and France, an annual wealth tax is levied against the value of your assets (primarily property). Succession tax is applicable in some countries. Lastly, on the sale of a property, Capital Gains Tax (CGT) is levied on the gain. Jonty Crossick, director for Ready2invest, a specialist investment company, describes the taxes thus: There are four categories of taxes that may come into play in property.

They are transaction taxes, profit taxes, operating taxes and VAT. Most transaction taxes come into play when you buy property rather than when you sell it. Profit taxes are levied on the profit you make when you sell property. Operating taxes are the various taxes the local authority levies on a particular house or apartment. In some countries, VAT is charged only when the developer sells the property to a buyer. Others charge real VAT on property, which acts like a massive transfer tax. Crossick notes that in Belgium, for example, there is a real VAT, set at a flat rate of 21 per cent for buildings less than two years old. Its important, therefore, to understand the VAT regime of the country youre buying in. But it is not only VAT considerations which you need to bear in mind. No two countries are identical in their interpretation and levying of property taxes be they transaction, profit or operating taxes. International and offshore tax specialist Daniel Feingold who offers taxation advice through highlights a few areas of concern that, if ignored, could end up costing you a large sum of money off your bottom line. Some countries operate a withholding tax, that is typically triggered when an asset (ie, property) is sold, he says. When you sell the property, the purchaser is obliged to withhold, lets say, five or ten per cent of the purchase price.

This is handed directly over to the tax authorities in the country where the property is situated. Examples include Spain, where the purchaser must withhold five per cent, and the US where the purchaser must withhold ten per cent of the purchase price and hand it over to the US tax authorities. In both places, the only way to get money back is to file a local tax return. In doing so, notes Feingold, you must remember that you will then be dealing with two tax authorities one overseas and in the UK and paying tax in both countries. This means that you will need two sets of tax returns, one tax return in the country where the income is generated and the second tax return in the UK for that same income. This will cost you more in professional fees, as you will need two advisers. The good news is that, generally speaking, you will get a credit in the UK for tax that you have paid overseas. So, if you paid the equivalent of 1,000 then this would be deducted from any UK tax liability. The issue of where a tax liability falls (ie, in which countries jurisdiction) on the sale of a property abroad, is a common cause of confusion. Feingold clears things up: A common misconception that people have is that if they have paid taxes (eg, CGT) overseas, and do not bring the money back into the UK then there is no further tax to pay. This is totally wrong, he says. It is important to understand that UK residents are usually taxed on their worldwide income and gains, whether or not the money is actually brought back into the country. In general, the tax rates do not exceed 40 per cent on the gain.

As an example, Nick Dare, Managing Director of investment specialists Dare Property, outlines how CGT applies in Poland, where he does business: Assuming that the investor is a UK resident, he is liable to pay CGT on the disposal of properties held overseas to the UK Inland Revenue. Where a country has signed a double taxation treaty with the UK (as Poland has) the investor receives a credit for the amount of tax paid abroad. What many investors dont appreciate is that this means that if no Polish CGT has been paid and the profits are brought back into the UK, they pay CGT at the UK rate. There are ways of reducing this burden and one of the most effective ones is to make use of what is known as taper relief. If I hold a Polish property for five years and then sell, I do not pay CGT in Poland and I receive 15 per cent taper relief in the UK so if the profit is 50,000, Id be taxed on 42,500 (before taking into account annual allowances). The longer the property is held, the greater the taper relief. As things currently operate in the UK, individuals have an annual allowance before CGT becomes payable and, by coordinating the disposal of any other assets, the tax liability can be reduced by taking full advantage of each years allowances. The difficulty of comprehending which allowances are permissible highlights the need to seek specialist tax advice. Its recommended by advisors that you do so before purchasing, rather than afterwards, as it gives them the opportunity to suggest which strategy will suit your circumstances best, thus saving you money in the process.

For example, says Bill Blevins of tax specialists Blevins Franks, taking a mortgage can be a way of reducing both succession taxes and wealth taxes in an overseas country because they are normally deductible against the value of the asset for the purposes of taxation. Bear in mind that you would have to pay the mortgage interest although, on the other hand, you would have invested less in the property. Another tax-saving alternative often mooted is to go offshore, the idea being that far less tax is paid in such domains than in the UK. Not so, states Feingold. The claimed benefits of purchasing through an offshore company include no local CGT, no local income tax, no local inheritance tax and no wealth tax. Sadly, this simply isnt the case. The only tax that can be avoided by using an offshore company is wealth tax, but a number of countries have enacted special rules that attack the holding of local property in offshore companies. So, it actually ends up being a big disadvantage holding property through an offshore company. The only time you should consider holding assets through an offshore company is when you have had specific UK and overseas tax advice clearly demonstrating that this will be to your advantage. Dare notes that the Inland Revenue is clamping down on funds being held offshore, and the advantages of trusts and other tax avoiding vehicles are not as great now as in the past.

In reality, the cost of establishing and maintaining such vehicles means they may not be worthwhile for investors owning a single property abroad, he says. Offshore vehicles such as wrappers restrict the amount of equity that can be brought back into the UK each year, and investors must decide what their investment strategy and cash-flow requirements are likely to be over a ten-year period before proceeding. A long-term plan is a prerequisite to reducing your tax burden, allied to paying attention to your personal annual allowances in the UK, and being aware of the operating and transaction taxes in the country where the property is located Getting tax right is a crucial element in making progress towards your property investment goals, Crossick says. But remember that it is the constant buying and selling of properties that triggers tax bills, both transaction and profit taxes. The most successful investors in the stock market are usually people who understand the gains to be made by making good longterm decisions and sticking to them. This is even more the case in property, where the costs of entering and exiting the market are that much higher.


A Place In The Sun