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5 July 20229 minute read

UK consultation on sovereign immunity from direct taxation


On 4 July, the UK government launched a consultation on the UK’s regime for sovereign immunity from UK direct taxation. The UK government’s proposals are to dramatically curtail the existing immunity from UK tax as it applies to sovereign investors (other than with respect to income tax on passive interest income). If the proposals are enacted, sovereign investors will now be subject to UK tax on the vast majority of their UK source income and gains, including with respect to income and gains on their UK (direct and indirect) real estate investments. Further detail is set out below.

Current position

The UK’s current approach is that sovereign immunity is the principle borne out of international law, that one sovereign state cannot impose its law on another sovereign state, including with respect to taxation. Under current law, all UK sourced income and gains of sovereign immune persons, including income and gains from commercial activities, is exempt from direct UK tax. This means that sovereign persons who have been granted sovereign immunity do not pay any UK income tax, capital gains tax or corporation tax to which they would otherwise be liable.

Furthermore, an entity seeking to benefit from sovereign immunity is required to apply to HMRC in order to benefit from sovereign immunity. HMRC assesses applications for sovereign immunity on a case-by-case basis with reference to the particular circumstances of the government or entity in question.

Rationale for limiting the scope of sovereign immunity

The consultation document highlights three main reasons as to why the government is looking to limit the scope of sovereign immunity from UK direct tax:

  • The UK’s current regime is more generous than in many other jurisdictions, and (according to the consultation document) there is a trend in other jurisdictions to limit the application of sovereign immunity to profits generated from (passive) non-commercial activities only.
  • There is a global trend of sovereign investors increasing the size of their investments, including in the UK, and any tax exemption must therefore be “proportionate to sovereign investors’ structures and activities, and fair when compared to other institutional investors who may have similar structures and activities.”
  • Non-UK investors are now subject to UK tax on the (direct and indirect) disposal of UK real estate, and the disparity between non-UK investors and sovereign investors is therefore greater than previously.

Who is a sovereign investor

The government proposes that the definition of a sovereign investor should be codified into UK legislation. The immunity should therefore be simple to apply and easy to understand.

Furthermore, the definition of a sovereign investor should be extended to include states within a federal system of government. This can be contrasted with the current position, whereby each jurisdiction can only have one head of state (or sovereign) which, in a federal system of government, would be limited to the federal government only, and sovereign immunity would not apply to each local state within the federation. Accordingly, under the new proposals, each state within the USA or Switzerland for example, would be eligible to benefit from sovereign immunity status (as well as the federal government). It is, however, not proposed to extend the scope of sovereign immunity to municipal authorities.

Scope of exemption from UK tax

As mentioned, sovereign investors are currently exempt from liability to UK direct taxation in respect of all their UK sourced income and gains.

Under the government’s proposal, the sovereign immunity exemption would be limited to an exemption for UK sourced interest income to the extent that it does not relate to trading activities undertaken in the UK. This includes UK sourced interest on savings, interest on debt, income from government securities, bonds and debentures.

Sovereign non-natural persons (i.e. those that are not individual human beings) will, for tax purposes, be treated as an overseas company and subject to UK corporation tax, including with respect to the following:

  • all profits from carrying on the trade of dealing in or developing UK land for the purposes of disposing it;
  • all profits from a UK property business, including Property Income Dividends arising from interests in Real Estate Investment Trusts (REITS) and Property Authorised Investment Funds (PAIFs), and UK property income arising from interests in transparent for income Collective Investment Vehicles;
  • chargeable gains arising from the disposal of interests in UK land rights to assets, including interests in Collective Investment Vehicles, that derive at least 75% of their value from UK land (indirect disposals);
  • chargeable gains arising from the disposal of assets that are used in or for the purposes of the UK permanent establishment’s trade or the permanent establishment itself; and
  • profits from trades carried on through a UK permanent establishment.

Sovereigns that are natural persons (i.e. individuals) would have the same exemption mentioned above on UK source interest income to the extent that it does not relate to trading activities undertaken in the UK. Natural persons would be subject to UK income tax and capital gains tax at the standard rates with respect to other UK sources of income profits and gains, such as those mentioned above.


The government proposes that the new rules will apply:

  • from 1 April 2024: in respect of income recognised in accounting periods ending on or after that date for entities chargeable to corporation tax, and
  • from 6 April 2024: in respect of sovereign natural persons.

Apportionment rules would apply where a sovereign entity’s accounting period straddles 1 or 6 April.

Sovereign investors that are currently considered immune would, for capital gains tax purposes, be able to rebase the cost of their acquisitions to their market value on the date that the new rules come into force. The consultation document recognises that provision should be made for disposals that give rise to a capital loss, and a sovereign investor should be able to use the acquisition cost instead of the rebased value.

Other tax consequences

Currently, the tax system provides certain institutional investors with a different beneficial treatment to other investors, and a summary of these regimes is set out further in the consultation document. The consultation document explains that the operation of each of these regimes alongside a reformed sovereign immunity regime will need to be considered carefully.

The consultation document explains that the government does not propose to remove sovereign investors from the list of qualifying investors within the new Qualifying Asset Holding Company (QAHC) regime, as the list of these investors is not driven by tax exempt status but rather seeks to identify genuine investors for which holding companies are commonly used in making investments.

The consultation document also refers to the UK’s participation exemption (the substantial shareholding exemption (SSE)) which provides an exemption to capital gains tax with respect to share disposals in companies carrying on investments (e.g. property rental), to the extent that some or all of the shareholders making the disposal are qualifying institutional investors (QII). Sovereign investors is on the list of QII, alongside life companies, charities, pension funds and certain other investors. The likelihood is that the government will remove sovereign investors from the list of QII, on the basis that this exemption is driven by tax exempt status of the QII (the rationale for this exemption being that if the QII had invested in the underlying investment directly they would have been exempt on their gains).

Miscellaneous points

The consultation also highlighted the following points:

  • Inheritance tax: this will apply unless the individual foreign sovereign passed assets to his or her successor (as sovereign) in circumstances where the assets remain state property.
  • Transfer taxes (stamp duty, SDRT, SDLT): these will continue to apply, in line with the current regime that immunity from liability on these taxes is not available.
  • Application for sovereign immunity: formal application for sovereign immunity status will still be required, but once granted, the sovereign would remain immune (without the need for re-application), unless circumstances change.
  • Tax compliance: sovereigns with UK taxable income or gains will need to file UK tax returns to HMRC (and non-natural persons will need to register with HMRC for corporation tax), within the normal time frames (and the UK non-resident landlord scheme would also apply).

The government’s proposals, if enacted, will increase the tax burden for sovereign investors who have, until now, benefited from sovereign immunity on all UK direct tax.

As the consultation highlights, bringing sovereign investors’ UK property income and gains into scope of UK tax is likely to be the most significant expansion of the tax base, given the large UK property holdings of many sovereign investors. In addition to direct investment into UK property, the proposals would also impact sovereign investors’ ‘indirect investment’, for example through real estate Funds, in particular if the UK’s participation exemption (SSE) for qualifying institutional investors would be disapplied to sovereigns (it has become relatively common for the Fund manager to share the benefit of the capital gains saving with the sovereign and any other QII).

Sovereign investors receiving dividends from UK REITs that are subject to 20% UK withholding tax under UK domestic law, will no longer benefit from a nil withholding tax rate.

The proposals are presumably driven by the UK government’s need to raise taxes post-Covid. However, as the proposals will only come into effect from April 2024, and there will be a rebasing of capital assets to market value at that date (unless sovereigns elect to use the acquisition cost), there will be a number of years before the proposals will deliver any meaningful tax revenue to the Treasury.

Moreover, the UK government believes that the UK is likely to remain inherently attractive to sovereign investors as a result of factors other than tax exemptions, such as the UK’s strong rule of law and stable regulatory framework. Whilst this is true, many will question why in a post-Brexit business environment, and with a severe downturn in the world economy, the UK government has now chosen to make the UK a less attractive business environment for investment into the UK, and in particular investment into UK real estate.