A REIT for the UK

In his Budget, Gordon Brown took one more step towards the introduction into the UK of the Real Estate Investment Trust (REIT). Although the Government seems to have made its mind up on certain key issues there are still a number of other issues upon which the Government will continue to consult. Whilst the Government has not given an unqualified assurance that a UK REIT will be introduced it has said that provided that a workable solution to the "challenging issues" referred to in the latest discussion paper can be resolved without additional cost to the Exchequer it aims to legislate in Finance Bill 2006. It certainly seems to be the case that the Government is making every effort to avoid rules that are too prescriptive; something that the property market had feared might be the case given the content of the original consultation document.

Issues that seem to have been decided upon

• The new vehicle will be named "UK-REIT" and will be a closed-ended corporate.
• The activities of the UK REIT will be classified either as non-taxable ("ring-fenced property letting business") or taxable ("non-ring-fenced business"). At least 75% of the total gross income of the UK REIT must be derived from, and at least 75% of the gross value of the assets of the UK REIT must relate to, the ring-fenced property letting business. The precise demarcation of activities into ring-fenced and non ring-fenced business is still open to discussion but essentially the boundaries will equate broadly to activities within a Schedule A property letting business.
• At least 95% of the REIT's net ring-fenced income after appropriate deductions and capital allowances must be distributed.
• Single property vehicles would not qualify for REIT status.
• Investment would not be confined to investment in UK property; property located anywhere in the world would be eligible.
• The REIT may be externally or internally managed; the Government accepts that this is something best decided upon by the market.
• Limited development activity within the 75% tests would be permitted (but would, of course, be subject to corporation tax).
• The Government has decided not to exclude specific property sectors (e.g. hotels and leisure) from being held within a REIT although the income and asset tests will need to be satisfied to obtain REIT status.
• A UK REIT would not be obliged to hold a minimum proportion of its assets in residential property.
• A minimum holding period for assets held in a REIT structure would not be prescribed.

Issues that are still open

• The Government is still considering whether the UK REIT would be required to list on a recognised Stock Exchange.
• The Government is concerned that if it adopts the tax exempt model for the REIT this would result in a cost to the Exchequer if the UK is to meet its obligations under its network of double taxation agreements and European law. It accepts that the REIT could be either a UK or non-UK corporate. Under the exempt model ring-fenced income would be exempt from corporation tax, as would chargeable gains arising from the sale of property held for investment purposes within the ring-fenced business. Distributions made by a REIT (in respect of the ring-fenced business) will be treated as property income in the hands of the investor and subject to tax at the investor's marginal income tax rate. However, for non-UK investors in receipt of distributions, the distributions would be treated as ordinary company dividends and not as property income. The problem for the UK Exchequer is that where a relevant double taxation agreement is in place (and the UK has entered into more than one hundred) the UK could not require a non-UK resident REIT to withhold UK tax on dividend distributions made to non-UK investors. This would mean that the Exchequer neither obtains tax at the level of the vehicle (because of the exempt model) nor withholding tax (which a UK REIT would withhold from distributions made to UK investors). Further, even where the REIT is UK resident, where there is a relevant double taxation agreement, typically distributions to non-UK investors would be subject to a reduced withholding tax rate, often at a rate of 15% (rather than the higher rate of 22% that would apply to tax withheld under the non-resident landlords scheme). One alternative suggested by the Government is to consider retaining taxation at the level of the REIT but to apply a reduced rate of 22% on income from ring-fenced activities. Under this model distributions paid by the UK REIT to individual investors would be treated as ordinary dividends.
• Responses to the consultation pleaded for there to be no prescribed limits on level of gearing of the REIT on the basis that the market would decide the most appropriate level. However, the Government is concerned that if no levels are prescribed gearing could be manipulated for tax avoidance purposes. Higher levels of borrowing within a UK REIT would tend to reduce the amount of income distributed to investors (as the Government has settled upon 95% of net income), which would therefore reduce the overall level of tax receipts for the Exchequer.
• The Government wishes to consider further how group company structures would fit within the UK REIT model; for example, whether the rules for eligibility for UK REIT status should be applied to a single subsidiary or at group level.
• The Government is committed to levying a conversion charge on assets transferred into a UK REIT but is to consult further on the form in which that charge will take.
• The Government has reaffirmed that it will continue to assess proposed reforms to the taxation of collective investment schemes in tandem with its proposals on a UK REIT.

We will produce more detailed briefings in the coming weeks including a specific briefing focussing on the Hotels sector. As we did on the original consultation document we will be submitting a paper dealing with the remaining questions upon which the Government is inviting responses and will be liasing with interested clients so as to produce an informed response.