This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.
Summary and implications
When acquiring real estate, investors are increasingly turning to wrappers – the acquisition and holding of real estate through various types of corporate entities, instead of direct ownership. Real estate can be acquired and held in a number of different vehicles ranging from English limited partnerships to Luxembourg limited companies. The most suitable choice of entity will be determined by what the entity will be used for, the types of investors who are investing in the underlying assets and considerations relating to management, control and certain tax advantages.
Many jurisdictions offer flexible vehicles and a favourable tax environment, so fund location has tended to be a matter of familiarity and manager preference. Luxembourg is still the favourite domicile for vehicles holding pan-European real estate. For UK real estate funds, English limited partnerships are still the vehicle of choice with the assets held in Jersey domiciled unit trusts or companies.
Why wrap real estate?
There are several benefits of acquiring and holding real estate through corporate entities and partnerships over acquiring and holding real estate directly. One of the main drivers behind a corporate wrapped real estate acquisition is tax efficiency, however the opportunities to “ring fence” such assets and to facilitate joint ventures are also frequently cited as reasons for indirect acquisitions of real estate.
One of the main tax advantages of a corporate wrapped acquisition is the potential to acquire real estate without incurring Stamp Duty Land Tax (SDLT) – the tax payable by purchasers of interests in land. Currently, UK acquisitions of commercial real estate over £250,000 attract a rate of SDLT of 5 per cent of the consideration (with a slice system applied to the portion below that, and different rates for residential property). If the purchaser instead acquires the company which holds the interest in the real estate, SDLT is not incurred. In comparison, the acquisition of a UK company will attract stamp duty at a rate of only 0.5 per cent of the value of the shares being transferred, payable by the purchaser. Indeed, acquisitions of entities based in offshore jurisdictions, such as unit trusts in Jersey, may not attract any transfer taxes at all.
Once the initial acquisition is made, there are further tax advantages in relation to the rent obtained from the property. Investors from outside the UK who are not UK tax resident are only required to pay the basic rate of income tax (20 per cent) on the profits made from rent. In comparison, in addition to income tax on rent, UK tax residents will also be subject to capital gains tax on the sale of the property. An investor can benefit from this favourable capital gains tax treatment where the UK property is held in an offshore company and the company is properly managed and controlled outside the UK.
Reasons for acquiring real estate through a corporate entity go beyond tax efficiencies. Wrapping real estate allows investors to “ring fence” particular assets, usually through a limited company so as to keep them separate (for accounting, tax and insolvency purposes) from other assets and liabilities. In addition, acquiring and holding real estate through a corporate entity can facilitate a joint venture arrangement, where two or more investors come together and agree to invest in a particular asset or portfolio of assets. Investing in real estate by way of a joint venture can either be purely by contractual arrangement or by forming a project vehicle. Such an arrangement is an attractive option because of the prospect of raising further finance to fund a project, whilst at the same time spreading the risk between the partners. Corporate wrapped real estate acquisitions can help to facilitate these types of arrangements.
How do you wrap real estate?
Once an investor has decided that it wishes to establish a vehicle to acquire and hold a property, it must then consider which type of legal entity is most appropriate. There are several options available, but we have outlined the most commonly used legal structures.
English limited partnerships are widely used for real estate investment funds and joint ventures in Europe. They comprise general partner(s) who manage the partnership and have unlimited liability for the debts and obligations of the limited partnership. Usually a limited liability entity which is itself a member of the investment manager's group will assume the role of the general partner. Investors are usually admitted as limited partners, the chief advantage of which is that their liability is limited to their contribution to the partnership, provided that they do not participate in its management. English limited partnerships are a popular investment vehicle because they are tax transparent, i.e. the partnership is a “look through” entity for tax purposes: tax arises directly to the partners rather than at the level of the partnership. This means that non-UK investors can benefit from only paying the basic rate of income tax on rent and no UK capital gains tax. In addition, limited partnerships can easily accommodate carried interest vehicles which serve to return profits from the underlying investment to the management team at a favourable rate of tax (although it should be noted that the taxation of carried interest arrangements is currently the subject of a Government consultation).
Jersey Property Unit Trusts (JPUTs) are also transparent for income tax purposes and are not subject to UK capital gains tax. JPUTs are very commonly used, not just because of their tax treatment, but because of their potentially liquid nature. The underlying assets of the JPUT are held by the trustee(s) (usually a professional, regulated trust company) for the benefit of the investors, who are issued with units in the JPUT. The issue of units is conceptually similar to shares in a company and so this structure allows for easy transfer of interests in the JPUT and therefore enhanced liquidity. In contrast, transferring interest in a limited partnership can be more complex.
There is a wide range of companies that can be formed offshore. In Jersey, for example, there are private limited companies, public limited companies, companies limited by guarantee, hybrid companies limited by shares and protected cell companies. Typically, a company incorporated in Jersey will be subject to a rate of Jersey corporate income tax at zero per cent. There is no capital gains tax, corporation tax or value added tax in Jersey for Jersey companies or their shareholders. Save in certain circumstances, there is no tax on the transfer of interests in a Jersey company.
Ultimately the profile of the investor and its objectives will determine the jurisdiction to which the vehicle is best suited and the structure which is used. There are almost as many different structuring possibilities as there are different types of investor.
That's a wrap.