Tech talk
Real Estate Investment Trusts - TT12/06
Introduction
As part of the 2005 Pre-Budget Report in December, the Government
announced its intention to introduce Real Estate Investment
Trusts in the UK (UK - REITs) to improve the efficiency of
both the commercial and residential property investment market.
REITs are common to many economies with a developed property
market. Generally they are closed-ended companies (or trusts)
that hold, manage and maintain real estate for investment
purposes, which is leased to tenants. They tend to have a
broad shareholder base and are generally traded on public
stock exchanges.
Draft legislation was issued in December with a consultation
period which ended on 27 January 2006. The intention is to
introduce legislation in the 2006 Finance Bill (following
the March Budget) to allow companies to join the new regime
for accounting periods ending on or after 1 January 2007.
Background
The origins of this relate back to Kate Barker's independent
review of housing supply which was carried out in 2004. In
this she made it clear that to simply continue
building houses at the (then) current rate would lead to increasing
problems of "homelessness, affordability and social division
......"
Her review therefore set out a series of policy recommendations
to address the lack of supply and responsiveness of housing
in the UK.
She noted the limited role played by institutional investment
funds in the UK residential market, and recognised that increased
investment through a bespoke vehicle (such as a UK-REITs)
had a number of possible attractions:
- they could commission new build
- the commercial incentive to maintain their properties could
lead to a higher quality, more professional private rental
market
- greater stability may arise due to the better access UK-REITs would have to equity finance with less reliance on debt financing
- potential for institutional investment to play a greater
role in managing subsidised housing
Subsequently, the Government published two consultation papers
in 2004 & 2005. These have been followed up by the current
draft legislation, the key points of which are as follows:
Eight Key Features of a UK-REIT
- Must be a company that is tax resident in the UK
- Company must not be an OEIC (Open-ended Investment Company). Instead, it will be established
as 'closed ended' with a fixed and not fluctuating share
capital
- Shares must be listed on a recognised stock exchange.
(the Alternative Investment Market is not 'recognised)
- Must not be a close company unless it is only a close
company by virtue of its shares being owned by a limited
partnership (broadly a close company is controlled by five
or fewer 'participators')
- It must have only one class of ordinary shares in issue
- No person (individual or corporate) is able to own 10%
or more of the shares
- It must not be party to a loan that is not a 'normal commercial
loan'. Broadly, it will not be possible to enter into financing
arrangements where the lender is entitled to a return linked
to the profits of the business
- Accounts must be prepared in accordance with international
accounting standards
Benefits for the Shareholder
Investments in UK-REITs will be transparent in that shareholders
will be treated as owning a share of the underlying asset.
Investors will therefore be able to diversify their investments
and access commercial properties they might otherwise not
have had.
Investment Activity of a UK-REIT
It is a key principle for tax purposes that the ownership
and management activities are separated from other activities
that occur on the property. Therefore a UK-REIT will have
two separate operations taxed in different ways:
- Ring-fenced property letting business
Tax exempt - no tax will be payable on qualifying property
rental income or qualifying chargeable gains
- Non ring-fenced business (e.g. dealing in, developing
property or other activities)
Corporation tax will be payable on both income and gains
(at a rate to be determined)
The ring-fenced property letting business must account for
at least 75% of the UK-REITs total activity (by reference
to both income and assets).
At least 95% of the ring-fenced profits must be distributed
by way of dividend. Tax at basic rate (22% currently) will
be withheld. Regulations will be drawn up specifying classes
of shareholder to whom distributions may be made without deduction
of tax. This is likely to include UK resident companies and
various exempt bodies such as local authorities, charities
and pension schemes.
Taxation of Investors
Individuals
Dividends received from the ring-fenced business (net of 22%)
will be treated as profits of a UK property business in the
hands of the shareholder. Any income tax deducted is repayable
in appropriate circumstances. The income will be distinguished
from other property income such that shareholders cannot set
off losses from other Schedule A businesses against the UK-REIT distribution.
Other dividends received from the non ring-fenced business
will be treated as ordinary dividends in the hands of shareholders.
Investors will then pay tax at their marginal rate.
Corporates
Dividends received from the ring-fenced business will be treated
as property income (profits of a Schedule A business) and
included as part of ordinary taxable profits.
Other dividends received will be treated as ordinary dividends
in the hands of a corporate investor.
Non resident investor
A liability to tax will be calculated as if that shareholder
were UK resident.
Potential Investors
It is likely that shares in UK-REITs will be eligible to be
held in ISAs, PEPs, the Child Trust Fund and SIPPs.
What Happens Next?
The above outlines the Government's proposals contained in
the draft legislation. This may be subject to amendment before
inclusion in the 2006 Finance Bill which will be published
following the Budget on 22 March. As noted earlier, companies
will then be able to join the regime for accounting periods
beginning on or after 1 January 2007.
Graeme Robb - March
2006