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Our panel of experts discuss mortgage and tax issues for borrowers to consider when buying a property abroad

The Panel:
Mike Warburton
Senior tax partner, Grant Thornton

Philippe Piedon-Lavaux</b
Head of French private assets and tax team, Blake Lapthorn Linnell

Mike Boles
Director and Head of International Department, Savills Private Finance

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When buying a second home abroad, should investors take out a mortgage from a UK lender, offshore lender or in the country where they are buying the second home? What factors should they consider when deciding where to take out the mortgage and the type of mortgage to take out? Is it worth considering remortgaging their first home in the UK?

Warburton: If an individual buys a property and rents it out, then from a tax perspective, it does not matter if they have bought the property using a loan in the country where the property is located or if the loan is from their country of origin. The UK tax rules allow a deduction for the interest payments against the rental income when calculating the tax liability. For tax purposes, it does not matter which property the loan is secured on. However, you need to be able to show that the loan was taken out as part of your property rental business. It is a commercial decision as to what sort of loan is taken out.

Piedon-Lavaux: There is no legal obstacle for raising the funds through a UK lender, an offshore lender or in the country where they are buying the second home. From a tax and estate planning point of view, finance raised abroad should be disclosed and it might be recommended to mention it in the title.

Boles: Most people buying property abroad will take out a new mortgage to do so, often with a local lender in the local currency. This can be cheaper than borrowing in sterling as the rate of interest on euro and Swiss franc mortgages is currently lower. But the global trend for interest rates over the next year or so appears to be upwards. Lenders which are happy to lend abroad tend not to do so on a cross-border basis but have local subsidiaries in different countries. The exception is for bigger mortgages in excess of euro1m where lenders will lend from one jurisdiction into another for financially sophisticated clients. It may be possible to remortgage your UK home to raise the cash to purchase overseas but this will depend on the equity in the property.

What should borrowers do about the currency risk of the mortgage? Is it always possible to take out a sterling mortgage on foreign property?

Warburton: Currency risk applies to all assets and liabilities. It is often wise to match the currency of your income with your expenses so that any changes in exchange rates do not affect your finances adversely. For example, if the property is to be let, you could take out borrowings in the overseas currency. If it is for personal use and funded from your UK income, it could be funded in sterling.

Piedon-Lavaux: Some lenders will not agree to lend for buying a property abroad as they are usually not confident of taking a guarantee against a foreign property and would prefer to secure the loan against assets in the UK or stocks and shares. The currency risk of the mortgage is one which will lie when investing in the euro area although some currency dealers or financial institutions will secure a rate during a certain period of time.

Boles: If you earn in one currency and buy property in another, there is always a degree of currency risk. We usually recommend that you borrow in the same currency as the asset you are buying. For example, if you are buying in France, you should take out a euro-denominated mortgage. That way, you do not have to worry about the equity value in your property falling due to exchange rate fluctuations. Obviously, in this scenario, you will still have a degree of currency risk associated with the mortgage payments as you will have to transfer an amount of money every month to pay the mortgage at an unpredictable rate of exchange. In some countries, lenders will allow you to take a sterling mortgage but this tends not to be a popular option nor universally available.

What taxes could borrowers be subject to in the country where they are buying the second property? What potential planning is available to mitigate these taxes?

Warburton: An individual’s tax liability will depend on their residence and domicile status and, where the asset concerned is property, the location of that asset. This will affect their tax bill in the UK and abroad. On the purchase of property, stamp duty may be payable. A lifetime wealth tax exists in countries such as France and Spain, which is calculated annually on an individual’s entire estate. Similarly, a wealth tax on death, often known as inheritance tax, might apply. Individuals should seek professional advice locally. A capital gain on a property may be taxable in the local country. Rental income is likely to be liable to local income tax. Individuals should draft a will for the country in which they own property as a UK will typically will not be recognised.

Piedon-Lavaux: When buying a property in France, one would normally fall under the same taxes as the French nationals. It is more a question of domicile which will need to be taken into account, as for those who are buying a second home, only they are unlikely to have a worldwide tax liability in France. Potential planning is available in the light of both the double-tax treaty in relation to Income Tax 1968 and in relation to the Inheritance Tax 1963. There is no double-tax treaty that deals with gifts between the UK and France. Planning needs to be considered especially carefully as France taxes wealth more so than in the UK. The use of corporate structures even for buying a second home might be useful although one should remember that France does not recognise trusts and also tends to discourage the use of tax haven structures.

Boles: Apart from purchase taxes, which in many countries can add up to a considerable 10 per cent or so of the purchase price, there are often further taxes associated with the ongoing ownership of a property abroad. Many countries have wealth taxes, which will be affected by the value of equity you have in your property. One way of reducing this equity and any wealth tax liability is to take out a mortgage. For this reason, borrowers tend to opt for the maximum gearing they reasonably can.

What taxes could borrowers be subject to in the UK on their property abroad? What potential planning is available to mitigate these taxes?

Warburton: Again, this depends on residence and domicile status. A capital gain on a property abroad will be taxable in the UK if the owners are resident or ordinarily resident in the UK unless the property is their main residence. If a person is not UK-domiciled, they will normally only be taxed on any gains remitted to the UK.

Rental income from a foreign property will also be taxable for UK residents or, if the person is not UK-domiciled, when income is remitted to the UK. A UK-domiciled individual will pay inheritance tax on their worldwide assets and not just those in the UK. There are planning opportunities available.

The most straightforward is to give assets away. If you survive seven years from the date of the gift, it will no longer be in your estate. Care has to be taken with property to ensure you can no longer benefit from the property. If you were to continue to use a second home, it would remain in your estate for inheritance tax purposes.

Piedon-Lavaux: Generally, UK domiciles will be subject to income tax from a French source as well as capital gains tax on their second property. Inheritance tax would also need to be taken into account due to the fact that there is not a spouse’s tax exemption in France, for example. One could use a holding property company which might mitigate those taxes in some circumstances.

Boles: If you rent out your overseas property, you may have a potential liability on any profit you make on the rent, depending on whether you are resident in the UK for tax purposes in a particular tax year. If you are resident, the amount of your overseas income that is taxed in the UK may also depend on whether you are ordinarily resident or domiciled in the UK. You should check with HM Revenue & Customs and will have to declare this income on your tax return. As in the UK, interest payments on mortgages are often deductible against possible income tax, which is another reason why investors will almost always seek to take out a mortgage against the property being bought.

Could borrowers be subject to taxes in the country of their second property and the UK? How can they avoid paying taxes twice? What tax planning should people do before buying the second home?

Warburton: Theoretically, this can be the case. Much will depend on an individual’s residence and domicile. However, countries often have agreements with each other to avoid double taxation. Even without an agreement, you may be able to get tax relief in the UK for foreign tax.

Piedon-Lavaux: There are two double-tax treaties between the UK and France in relation to estate duties and income tax for the avoidance of double taxation. These would allow a tax credit for UK domiciles.

Boles: The country in which your overseas rental property is based may tax you on that income, depending on its own laws. You will have to ask the local tax authority for advice. If you find you are paying tax on your overseas income both in the UK and in the country where the income arises, you will normally be able to get relief for any double taxation.

This will mean the income is taxed in only one country or, if both countries tax it, for your combined tax bill to be no more than the amount you would have to pay in the country with the higher tax charge. Before buying an overseas property that you plan to rent out, contact a tax enquiry centre, your UK tax office or the overseas tax authority.

What are the forced heirship rules and what should people do if they buy a second property in a country with these rules?

Warburton: The forced heirship rules are derived from the Napoleonic code. They are in place in a few European countries, including France and Spain, and can require that the deceased’s estate is divided equally among his or her children, irrespective of the provisions of any will. Owning a property through a company can circumvent these rules. However, as a result of the cases of Dimsey and Allen, there is a risk to a UK resident owning a property through a company, of which they then have use, in that HM Revenue & Customs may attempt to charge for a benefit in kind. Professional advice should always be sought.

Piedon-Lavaux: Some beneficiaries in France, such as children and more recently the surviving spouse, are entitled to statutory inheritance rights for the assets whereas, in the UK, one can usually bequeath you assets to whoever you want. Those with children will have to leave a bulk of their estate to their children, even with a will saying otherwise. The latest French Inheritance Act of June 2006 has softened these rules and introduced possible waivers from the beneficiaries. Until now, one could circumvent these rules by buying a property with the benefit of a survivorship scheme or through a holding property company which will put the second property under UK inheritance law as long as they remain UK-domiciled. Some tax issues may arise, such as benefit in kind.

Boles: Forced heirship rules apply in certain countries, such as France, so you must be wary if you are buying property there. Local laws in these countries dictate who inherits your property once you die, irrespective of what your will says. This is the case even if you have executed a second will overseas dealing just with that property. One way of getting round this is to use a wholly-owned company to buy your overseas property as forced heirship rules do not necessarily apply to shares in limited companies, so you can leave them to whoever you wish. However, this may mean you have to pay income tax if you use the property and do not pay a market rent to the company. If you seek professional advice as to the best way of setting up this arrangement, this might not be necessary.

What should people do to ensure the person selling the property abroad has the legal right to sell it and the rest of the buying process is legal?

Warburton: This is a point of law. There are many books available, including one from Which?, that can provide background information to local law issues. Foreign embassy websites may also be a useful source of information. Cross-border transactions will normally involve seeking professional advice in both your country of origin and abroad. There may also be disclosures needed for the tax.

Piedon-Lavaux: Countries such as France have a system of registered title and a land registry that ensures that the person selling is entitled to sell and has legal rights to do so. One should always appoint a lawyer to supervise this process. In addition, one should avoid making any payments directly to the vendor without the reassurance of the lawyer.

Boles: When buying property abroad, it is advisable to appoint your own local lawyer to safeguard your wider interests. Legal systems vary from country to country but in most they require a notary to be involved in the transfer of the title. This notary is not looking after the buyer’s interests but is effectively acting for the state, making sure paperwork is in order and the correct tax is paid. The notary probably will not check on matters such as planning permission so your own lawyer will be able to do this.

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