UK losing tax competitiveness edge, but property market remains attractive to investors - for now

The United Kingdom lags many of its international rivals when it comes to corporation tax competitiveness. And it has fallen rather rapidly down the list of corporation tax-friendly countries in the past two years.

Despite this, however, the UK property market remains buoyant, and is widely recognised as one of the most attractive for investment anywhere in the world, thanks in large part to the fact that it is mature, well-regulated, transparent and relatively stable. And there are significant opportunities for investment, notably in the residential sector, Grade A office space, data centres and life sciences.

The UK cannot rest on its laurels, though, and to ensure it remains competitive in future the incoming government - of whatever political stripe - must take action to ensure investment continues to flow and the property market retains its attractiveness to investors over the long term.

The UK was one of six OECD countries to increase its main corporation tax rate for the fiscal year beginning April 1, 2023, to 25% from 19%. Research by the OECD has shown that high corporate taxation has the most significant negative impact on economic growth, while property taxes have the smallest impact.

Last year, the Washington DC-based non-partisan, not-for-profit tax advisory group Tax Foundation published its index of International Tax Competitiveness. The index ranks the tax systems of 38 countries in the OECD for competitiveness and neutrality. The 2023 index examined the changes that many countries made to recoup shortfalls incurred during the worst of the COVID-19 pandemic.

The UK ranked 28th most competitive for corporate taxes, down from 10th just a year previously, and 35th for property taxes.

Typically, the tax benefit of capital investment is spread over several years, and the International Tax Competitiveness Index compares the capital allowance regimes of countries for three major asset types: machinery, buildings and intangibles.

A major factor that is likely to have contributed to the UK’s steep fall down the tax competitiveness ladder is the phasing out of the so-called Super-deduction, introduced in 2021 and aimed at rebooting investment in assets.

The Super-deduction, in place from April 1, 2021 until March 31, 2023, enabled companies investing in certain qualifying new plant and machinery assets to claim a 130% capital allowance giving them a tax cut of up to 25% on every £1 invested. Qualifying assets included things like solar panels, offices desks and chairs, electric vehicle charging points and foundry equipment.

Full Expensing, whereby companies can claim a 100% tax deduction on capital expenditure in the year it was incurred, which replaced the Super-deduction was announced as a temporary measure. Therefore, if it was made a permanent relief the UK would see its tax competitiveness improve.

Real estate-related taxes on overseas investment

Since 2017, a series of new rules have meant that even when overseas investors use corporate structures, they may find themselves liable for significant tax costs on property investments in the UK.

Among other measures, non-resident companies are now subject to UK corporation tax on profits from the sale of UK real estate. They also are subject to UK corporation tax for annual profits earned from property businesses. Additionally, investors that hold shares in companies that derive value from UK real estate can be subject to UK Capital Gains Tax on the sale of those shares.

The rules changes also mean that an individual’s estates is exposed to inheritance tax on the value of shares in companies that derive value from UK property.

Property taxes affect investment decisions too

Although corporation taxes are considered to be the biggest tax disincentive for investors in property, the impact of property taxes on investment decisions cannot be ignored.

Among OECD countries, seven have property tax collections in excess of 1% of private capital stock. The UK heads this list with property tax collections of 1.8% of private capital stock.

In the UK, Stamp Duty Land Tax, as well as various other annual levies like business taxes, may place a brake on investment in some cases. Stamp Duty Land Tax on residential properties held in a non-UK corporate structure of up to 17% is a potential issue when looking at investment returns.

The UK has established “investment zones “with the intention of making inward investment attractive including support for infrastructure, enhanced CA’s and general rate incentives. This opportunity needs to be promoted more robustly.

Opportunity and election ahead

Despite its comparative lack of tax competitiveness, the UK property market remains attractive to investors looking to exploit the many opportunities ahead.

The recent student housing crisis has laid bare the urgent need for more student accommodation, with research from Savills showing that 234,000 extra beds are needed to reach a ratio of 1.5 full-time students per bed.

A steady return of workers to offices is also an encouraging sign, with clear opportunities for investment in Grade A office buildings. An uptick in interest in mixed-use projects and the need for green and sustainable building projects also represent opportunities for investors.

As we look ahead to the election, the main political parties have made various pledges. about The Conservatives have said they will permanently adopt Full Expensing, if elected, for example.

Labour has said, if elected, it will cap corporation tax at its current rate of 25% - the lowest of the G7 countries - for the duration of the next Parliament.

And at the Labour Party’s annual conference in October, party leader Sir Keir Starmer said that if Labour is elected it will build 1.5 million new homes and begin a project of New Towns that will include at least 40% affordable houses. The Conservatives also have put building housing front and centre of their manifesto pledges primarily recognizing the need to reform the planning system.

Whoever is elected should ensure there is clarity on the tax implications and opportunities for investment in property in the UK. And as with any new government, the first 100 days after the election should shine a light on the extent to which the investment landscape, including tax changes, might be brought in to boost the attractiveness of investment in UK property once again.

This insight was first published on Estates Gazette on 18/06/24.