Currently, a non-UK resident company carrying on a property investment business in the UK is chargeable to income tax on the rental income. From 6 April 2020 the UK property business will come within the charge to corporation tax. In this article, we provide an overview of the key changes in the tax treatment of such businesses, focussing on borrowing incurred by a non-UK resident company to fund the purchase and development of investment property in the UK.

Importantly, such funding will come within the scope of the various corporation tax provisions which determine whether and how interest payable and associated hedging contracts are to be taxed.

The effect of coming within the scope of the corporation tax rules can be summarised as follows.

• Taxable profits will be calculated applying the existing corporation tax rules for a UK property business, which overlap with the rules for calculating trading profits. The corporation tax rate will be 17 percent (or 19 percent if the government reverses the reduction due to take effect) as compared to the income tax rate of 20 percent.
• Property businesses are typically debt funded. From 6 April 2020, profits and losses from loans and associated hedging contracts which the company is a party to for the purpose of its UK property business will be brought into account as non-trading profits and losses under the prescriptive rules for loan relationships and derivative contracts. This may lead to differences from the historical income tax treatment. 
• Companies which have entered into a derivative contract to, say, hedge the interest cost of borrowing to fund the purchase and/or development of an investment property are potentially subject to tax on fair value movements recognised in the income statement. Under the income tax rules, capital profits and losses must be identified and excluded. From 6 April 2020, the tax treatment will be more certain as a result of applying the corporation tax derivative contracts rules. Consideration can be given to managing volatility in taxable profits and cash tax payments by adopting a hedge accounting treatment in the accounts, or electing to apply the Disregard regulations. Both options may help to match the timing of when taxable profits and losses on an interest rate contract are recognised with the recognition of taxable profits and losses on the hedged borrowing. Depending on how the income tax rules have previously been applied, there could be changes to the tax treatment going forward. 
• Going forward, the finance charge will be subject to the Corporate Interest Restriction rules (CIR) and the hybrid and other mismatch rules. The CIR rules restrict the deduction for interest to the lower of a percentage of tax-EBITDA (taken from the tax computations) and a measure of the group interest expense (taken from the consolidated financial statements). The hybrid and other mismatch rules can deny relief for the cost of borrowing if there is a mismatch in the tax treatment of the UK tax deduction and the corresponding interest income (or a deduction is available for the cost of borrowing in more than one territory). Such rules could disallow part or all of the cost of the funding and so the potential implications will need to be assessed and modelled.
• The timing of relief for interest incurred to develop a property should be reassessed. From 6 April 2020, interest capitalised into the carrying value of an investment property development should be deductible under the loan relationship rules when incurred. Any differences in the timing of tax relief should be reflected in the modelling of tax cash flows and the compliance treatment when preparing the tax returns.

The corporation tax treatment will apply from the commencement date of 6 April 2020.

• Where a period of account straddles 6 April 2020, the straddling period is treated as two periods, with separate accounts deemed to be drawn up in accordance with Generally Accepted Accounting Principles (GAAP). Profits or losses arising in the first period (ending on 5 April 2020) will remain chargeable to income tax and the profits or losses arising in the second period (commencing on 6 April 2020) will be within the charge to corporation tax.
• Unrelieved income tax losses of the UK property business at 5 April 2020 are carried forward and reduce taxable profits of the UK property business and from associated loan relationships and derivative contracts. This transitional treatment does not deem such losses to be corporation tax losses generally so that, for example, the losses are not subject to the restrictions which limit the utilisation of carried forward tax losses to the £5m annual deduction allowance and 50 percent of the excess taxable profits.
• There are rules to smooth the treatment of loan relationships and derivatives which transition from the income tax to corporation tax treatment. A loss (but not a profit) from a loan relationship or derivative contract that arises after the 6 April 2020 commencement date is disallowed where it is wholly or partly referable to a period before that date and the loss would not have been allowable under the income tax rules. For example, this rule could apply to disallow amounts to be brought into account in respect of an interest rate contract coming to an end before its stated date of maturity where, had the contact been closed out before commencement, the termination payment would not have been deductible under the income tax rules because the payment is capital in nature.
• The disallowance described above may be reduced or eliminated where a matching profit on a derivative contract or loan relationship arises which is hedging the loan or derivative on which the loss arises.
• There are two transitional adjustments in the context of the CIR rules which were considered in an earlier article.
• The rules for UK property businesses coming within the charge to corporation tax have a targeted anti-avoidance rule which applies to an arrangement entered into on or after 29 October 2018 where the main purpose, or one of the main purposes, is to secure a tax advantage related to the coming into force of these rules.

It is likely that further changes will be announced for inclusion in the next Finance Act to ensure that the rules work as intended.

Existing non-UK companies with UK property businesses will, at the very least, need to assess the implications of transitioning to being within the corporation tax rules to identify any practical issues.

As part of this, it will be important to assess the impact on tax payments from the application of the corporate interest restriction rules, hybrid and other mismatch rules and the treatment of any hedging contracts.