In recent years, many Israelis have invested in UK real estate and many more have taken their companies public, mainly on the London AIM market. The UK offers many advantages: a population of around 60 million English speakers, a gateway to the EU and a similar legal system (in fact, the basis of the Israeli legal system). However, concerns about climate change are growing around the world and the UK has begun to implement energy saving measures in its building and property laws. Therefore, it is no longer enough for Israeli investors to consider legal and tax aspects in both countries - they must take on board environmental requirements as well. Following is a short overview. Energy Targets: Britain is a signatory to the Kyoto Protocol to the United Nations Framework Convention on Climate Change, which demands that the UK generate 10% of its electricity from renewable sources by 2010 and 20% by 2020, Tony Blair, Britain's prime minister, has declared global warming a top third-term priority. In both the real estate sector, which accounts for 40% of energy consumption in the EU, and London, which consumes about the same amount of energy as Portugal or Greece, it is clear that things will have to change. On March 13, 2007, a draft Climate Change Bill was published after cross-party pressure over several years, led by environmental groups. If approved, the UK is likely to become the first country to set such a long-range and significant carbon reduction target into law. At the UK national level: When the UK government unveiled Planning Policy Statement 22 (PPS22) in August 2004, nobody took much notice but local authorities now know that they are on solid legal ground when making renewable energy demands of residential developers. Planning authorities can now require that up to 10% of a development's energy be derived from renewable sources on site, either specifying the sources themselves or leaving the decision to developers. At $3,000 per household, options include installing photovoltaic tiles, which can generate 25% of a home's electricity in winter and 75% in summer, or locating mini-wind turbines on rooftops. Alternatively, pumping heat from the ground to provide a building with central heating or hot water will set you back $10,000 per system. The Department for Communities and Local Government, the government body with ultimate responsibility for urban regeneration and planning, has stated in a recent guidance note that even if a particular local authority has yet to adopt PPS2, the council must still obtain an "energy statement" from developers. In March 2006, the government also strengthened the Code for Sustainable Homes, which requires builders to cut energy use in new residential and commercial buildings by 40% by installing windows that offer better insulation, more efficient boilers and using dual-flush toilets or spray taps to meet mandatory water-efficiency standards. A raft of EU legislation is also coming into force: carbon emissions in industrial buildings are to be reduced by storm water collection, on site power stations using renewable biomass fuels such as woodchips and the installation of ozone-friendly ammonia refrigeration systems while energy performance certificates will have to be presented on the sale and letting of all commercial and residential buildings. In a bid to create consumer pressure for eco-friendly housing, a voluntary code has been introduced that places new homes in one of five sustainability levels, with points awarded for efficient use of energy and building materials. At the London level: Ken Livingstone, the mayor of London, hoping to establish London as a global leader in sustainability developments, published an energy strategy in 2005. This imposes environmental targets on planning applications, requires all major developments to incorporate hydrogen fuel cells to allow for zero carbon emissions, encourages all insulation materials to be made from natural materials and goes as far as seeking to reduce the sodium glow emitted by outdoor lighting to improve Londoners' view of the stars. By 2010, 30% of construction materials are to be sourced from within 35 miles of construction sites to reduce transport pollution and new developments must recycle more than a third of their refuse. Smaller-scale developers should not rest in the knowledge that only the biggest projects have to be run by the Mayor's office. As far back as 2004 Merton council in south-west London devised the then groundbreaking requirement that new commercial developments should generate at least 10% of their own energy. This is fast becoming the norm in London and the message has travelled. Eighty-seven councils across England have now applied the "Merton principle" and the Scottish Executive has gone one step further, becoming the first part of the UK to include new public sector developments, such as schools and hospitals. Green projects on the go: The Beddington Zero Energy Development (BedZED), 82 residential homes with a strong emphasis on roof gardens, solar energy, waste water recycling and reduced energy consumption was the UK's first carbon-neutral eco-community, producing at least as much energy from renewable sources as it consumes. The reclaimed land on which it was built was sold by the London Borough of Sutton at below market value due to the planned environmental initiative. Inspired by BedZED, ministers in the UK are planning a town of 10,000 homes near Cambridge which will use half as much water and electricity as conventional developments with the intention of driving down the price of renewable energy equipment, such as borehole cooling technology, by drastically boosting demand. The prize for blue-sky thinking, however, must go to the proposal, which in the face of rising sea levels, advocates building Venice-style developments of 50,000 houses in the water along the Thames estuary, with electricity provided by renewable tidal energy. Incentives: Making a home "zero-carbon," a super-insulated construction reliant on microgenerators such as the latest solar systems built into south-facing roofs and wind turbines instead of conventional gas and electricity, generally adds $50,000 to building costs. The government seems to be coming to the conclusion that UK developers, who build about 150,000 houses a year, will not go green if this prices them out of the market. With plans for all new houses to be zero-carbon by 2016, the latest Budget will temporarily suspend from October 2007 stamp duty land tax (SDLT - see below) on the first sale of zero-carbon homes valued at less than $1 million ( 500,000). Consultation on energy audits and low-interest loans for existing homes, relevant to the overwhelming majority of the UK's housing stock, has also been promised. The Chancellor of the Exchequer (Finance Minister) has also extended the scope of the current landlords' energy saving allowances scheme from April 2007. Meanwhile, the government has pumped $82m. into grants for individual householders to install microgenerators and, in a boost to research and development, the Department of Trade and Industry has made it clear that the Low Carbon Building Program, the latest embodiment of the grant scheme, will not favor any particular technology. Industry and public reaction: The Chartered Institute of Building, a professional association for the construction industry, is concerned that developers are confronted by a muddle of different standards imposed by different local authorities, and is pressing for new national regulations that apply to both new and old properties. Some property companies, however, have sensed the change in the wind and grasped the opportunity of becoming market leaders. Quaintain Estates, already involved in the multi-billion pound regeneration projects around Wembley Stadium and Greenwich peninsula has joint ventured with Bioregional to build 500 houses a year based on the BedZED project. UK Taxes: On the tax front, things are also changing. Israeli and other non-UK residents typically invest in UK real estate via a non-UK company incorporated in the Channel Islands, Israel or elsewhere. In such a case, the advantages of a non-UK company may include: limited liability, lower UK tax on rental income, exemption from UK capital gains tax, exemption from UK inheritance tax (rates up to 40% where applicable). At the acquisition stage, Stamp Duty Land Tax is imposed in the UK at rates of up to 4%. Value Added Tax is imposed at a rate of 17.5% with some exceptions. With regard to financing, loan interest is deductible from income within certain limits for UK tax purposes. Withholding tax on interest may not apply if a UK lender or UK branch of a foreign lender is used. Depreciation ("capital allowances") is deductible from income for UK tax purposes on most items of plant and machinery at an annual rate of 25%, calculated on a reducing balance basis. It is common practice to depreciate electrical, heating and lift (elevator) systems in buildings in this way. However, the 2007 UK Budget contains proposals to reduce the 25% capital allowance rate to 20% generally, with effect from April 1, 2008, and to 10% on "fixtures integral to a building." The 4% rate of capital allowances on industrial and agricultural buildings and hotels is to be modified. Further details are awaited. Corporation tax rates in the UK on net rental income and capital gains, if a UK company is used, are currently as follows: 19% on annual profits of up to 300,000 per year, 30% on profits over 1.5m. (reduced if the company is a member of a group), with a "marginal relief" formula to facilitate a gradual tax rate increase between these two levels. The 2007 UK Budget proposes to drop the 30% upper rate of corporation tax in the UK to 28% from April 1, 2008. It is also proposed to increase the 19% lower rate to 20% on April 1, 2007, 21% on April 1, 2008 and 22% from April 1, 2009. If a non-UK company is used, net rental income may be subject to income tax (not corporation tax) taxed at a rate of only 22% if permission to apply the Non-Resident Landlords Scheme is obtained from Her Majesty"s Revenue and Customs ("HMRC"). Without such permission, the tenant and letting agent must withhold 22% tax from the gross income before any expenses, etc. Although there is nothing expressly on this point in the Budget documents, we expect that the new rate of 20% will also apply to rent received by non-UK landlords. Capital gains derived by non-UK residents should continue to be exempt from UK tax, but consider the Israeli side too. How will UK taxes interact with Israeli taxes for Israeli investors? This will depend mainly on individual circumstances - see, for example, our article "Tax issues to consider when investing abroad" (The Jerusalem Post , Oct. 18, 2006). There is a tax treaty in force between the UK and Israel. However, as mentioned above, a Channel Islands or other overseas holding company is often interposed and used to acquire UK real estate. Currently, in such a case, the UK rate of income tax on rental income is 22%. Thereafter, the Israeli tax on dividends would generally be: * 20% for an Israeli resident individual investor holding under 10% of the overseas holding company, resulting in a combined tax burden of 37.6% in principle (= 22% UK income tax plus 20% Israeli tax on 78%) * 25% for an Israeli resident individual holding 10% of the overseas holding company, or for an Israeli corporate investor, resulting in a combined tax burden 41.5% in principle (= 22% UK income tax plus 25% Israeli tax on 78%) Alternatively, if a regular Israeli company (not individual) holds at least 25% in an overseas holding company, the Israeli company may choose to pay the regular rate of Israeli company tax (29% in 2007) on its share of the pre-tax profit of the overseas holding company and claim a credit for the 22% income tax paid in the UK - leaving a balance of 7% approximately payable in Israel and resulting in a 29% combined tax burden. Israel's CFC (controlled foreign company) rules - aimed at taxing deemed dividends of passive overseas companies - may not apply so long as the UK income tax rate on rental income is 22%. However, the anticipated reduction to 20% in the UK may trigger Israeli CFC taxation on UK rental income derived via an overseas holding company. Capital gains from a sale of UK property may continue to be exempt in the UK and hence liable to Israeli CFC taxation. Various other rules apply in Israel. For example, an overseas company controlled and managed in Israel would be considered resident and fully taxable in Israel. Israeli investors must also report the existence of their shareholdings in an overseas holding company in their annual tax return Another possibility, where all shareholders are members of one family, is to invest directly in UK real estate via an Israeli company and elect "family company" status if certain conditions are met. If so, the largest shareholder may pay Israeli tax at the lower of: (1) 15% of gross UK rental income less a deduction for depreciation calculated according to Israeli tax rules; or (2) up to 48% of the net rental income less depreciation and a credit for UK taxes. Capital gains may be taxable at rates of 20% in the case of post 2002 gains (after Israeli inflation adjustment) and up to 48% for pre-2003 gains. Additional tax considerations may apply, in particular to active UK real estate development ventures, management fees and other matters. To sum up, there is now a steady stream of new environmental legislation, codes and visions from national, regional, city and council authorities, but who can tell whether any of this will help the UK hit its Kyoto targets? One thing is for sure, you may need more than a sturdy raincoat - a plethora of energy saving gadgets and a decent sustainability consultant may be required. As always, consult experienced UK and Israeli professional legal and tax advisors. firstname.lastname@example.org email@example.com With acknowledgements to Kyoto Protocol. (2007, March 30) in Wikipedia, The Free Encyclopedia. http://en.wikipedia.org/w/index.php?title=Kyoto_Protocol&oldid=119132188 Leon Harris is an International Tax Partner at Ernst & Young Israel. Paul Miller is a Corporate Finance Partner at Berwin, Leighton Paisner LLP, Solicitors, London.