Tax

Keith Gordon tells you what you really need to know when buying homes abroad.

A number of people own a second property - sometimes the second property is somewhere else in the United Kingdom. But occasionally, the second property is abroad. Are the tax rules for a second home any different if the second home is overseas?

For the vast majority of us, the tax rules are the same at home and abroad

If you rent out the other home you will have to pay income tax on any rental profits (broadly the rental income less the expenses incurred in renting out the property). And if you subsequently sell the property, you will have to pay capital gains tax on any profit you make. (There are sometimes ways of reducing the capital gains tax exposure, but these are beyond the scope of this article.)

Tax rules differ if you are from outside the UK

The only situation where the tax rules are different for overseas property is if you are from overseas (not necessarily the same country as the one where your property is situated). If you are from overseas, referred to as being 'domiciled abroad', it might be possible to keep any rental income you receive, and any profits you make when you sell the property, completely tax free.

To do this, you should keep the income and sale proceeds in an offshore account and not bring them in directly to the UK. In other words, the income and proceeds must be spent abroad or invested abroad. You cannot even buy something overseas (for example a car or item of jewellery) and sell it once you are back in the UK.

I would advise anyone in this position to seek professional advice both here and abroad as there may still be some local taxes to pay - depending on where your property is situated. And the rules to determine whether you are domiciled abroad or not are particularly complex.

Different rules can apply to how the property is inherited

However, assuming that you are domiciled in the UK, the fact that the tax rules for overseas property are broadly the same as UK property does not mean that you should ignore tax when it comes to buying a home overseas.

The problem, for once, is not because of this country's tax laws. The problem is instead because some countries (for example, France) have special rules about what happens to real property (i.e. land and buildings) that you own when you die. In this country, if you want to pass a property to a particular individual when you die, you simply have to ensure that your will provides for this.

In other countries, however, the local laws dictate who inherits the property irrespective of what your will says. These 'forced heirship' rules apply even if you have executed a second will overseas just to cover the property.

Consider using or a creating a company to buy the property

The normal response to this problem is to use a wholly-owned company to buy the overseas property. The forced heirship rules do not necessarily apply to shares in limited companies and you can ensure that in your will you leave the shares in the company to whomsoever you would wish to leave the property. However, this is where the tax problem arises.

Under this arrangement, you will be holding shares in a company which owns a property. And you will almost certainly have the use of the property without paying a market rent.

The problem is that there are rules which impose a tax charge if you have the use of accommodation owned by your employer. You might not be an employee of your property-owning company, but you will probably be a director. And for tax purposes, company directors are treated as employees of the company.

So, for tax purposes, you will be an employee of the company getting the benefit of company-owned accommodation. That means you will probably be subject to an income tax charge. You cannot avoid this by nominating someone else to be a director if, ultimately, you can dictate what happens to the company's property.

Seek professional advice before proceeding

There is a way around this and that is to make it clear that the company is merely holding the property as your nominee (or "bare trustee"). In other words, you retain the beneficial control over the property and the company is merely the 'legal owner'.

Because the countries with forced heirship laws do not generally recognise trusts, a bare trust should often be sufficient to avoid the forced heirship rules without giving rise to a UK tax problem. However, you should always seek professional advice, both here and abroad, before proceeding.

The downside of this approach is that it is often tempting to treat the company as the beneficial owner of the property (as well as the legal owner). The reason this is so tempting is that using a bare trust you will be liable for any income tax on any rental profits received by the company - and for most of us, personal tax rates are higher than would be paid by a company. But the risk of an income tax charge on the use of the property will usually outweigh any disadvantages.