On 14 December 2006 HM Revenue & Customs (HMRC) published draft legislation to enable the creation of real estate investment trusts (REITs) in the UK. The draft legislation which dealt solely with single company REITs, was updated on 27 January 2006 to deal with groups of companies. The legislation in its final form will be contained in the 2006 Finance Bill allowing the new regime to start on 1 January 2007. There are, however, still a number of key details yet to be announced, including details of the conversion and interest cover tax charges.
What are REITs?
REITs are property investment vehicles the purpose of which is to enable a tax efficient investment in a professionally managed portfolio of real estate. Many markets around the world, including the US, have developed REITs or an equivalent structure. It is thought that their introduction to the UK property market will encourage increased investment in the UK.
What does the draft legislation say?
Briefly, the draft legislation sets out the proposed tax treatment of REITs and the conditions companies have to satisfy in order to be part of the REIT regime:
- REITs will take the form of UK resident companies listed on a recognised stock exchange.
- The qualifying business must “ring-fence” investments in property forming a tax-exempt business (that is, broadly, treat it as if it was carried on by a separate business). Provided, however, they do not exceed 25% of the company’s activities, the company can still carry on other activities, including a development trade, as part of its residual business outside the ring fence. Assessment will be by reference to:
- - An “income test”: 75% of its total income must come from qualifying business.
- - An “assets test”: 75% of its assets, by value, must be involved in qualifying business.
- REITs will have to distribute at least 95% of net income profits from such business.
- The property rental business must include at least 3 commercial or residential properties or separately rented units, no single property may represent more than 40% of the total value of the properties involved in the business. (Separate rental units within one property would be treated as separate properties (eg shopping centre units).
- REIT status may be lost if any person obtains control of 10% or more of the REITs shares or voting rights.
- REITs will be exempt from corporation tax on the income profits and chargeable gains of their tax exempt business.
- Distributions of profits and gains will be subject to tax as UK property income and there will be a 22% withholding tax.
Entry Charge: There will be a charge for entry into the REIT regime; details will be announced in the 2006 Budget.
Borrowing: There will be a limit on how much REITs will be able to borrow expressed as an “interest cover tax charge” (instead of a conventional gearing ratio). The ratio (precise details of which have yet to be published) is essentially profits plus finance costs, divided by finance costs. The charge will arise where the ratio is less than 2.5. Compliance with this ratio, however, is not a pre-condition for entry to the REITs scheme.
Election for treatment as a REIT: A qualifying company will not automatically become a REIT. The company must serve written notice on HMRC before beginning of the accounting period from which it wants to be treated as s REIT. Usually the status will continue (provided the conditions are satisfied) until further written notice is served on HMRC.
Breach of conditions: Generally, REIT status will automatically cease in the event of failure to meet any of the qualifying conditions. If, however, there are minor or inadvertent breaches of qualifying conditions the status will continue. Detailed regulations have yet to be published but it is understood that a REIT will only be permitted 2 inadvertent breaches within a 5 year period.
SDLT: It appears that REITs will be subject to the normal Stamp Duty Land Tax (SDLT) rules in relation to UK real estate transactions.
ISAs, PEPs & CTFs: It is understood that the government is considering making shares in REITs eligible to be held in ISA’s (Individual Savings Accounts) PEPs (Personal Equity Plans) and CTFs (Child Trust Funds). This would make REITs the only vehicle available for sheltering rental income in this way.
REIT or direct investment in real estate?
It is not clear from draft legislation whether it is intended that income taxpayers should be able to offset interest on loans taken out to purchase shares in a REIT against REIT distributions. If not this would clearly be a major tax disadvantage of investing in a REIT rather than directly in real estate.
Further information:
For further information click here
Who can help?
IIf you would like further advice about any of the issues considered above please get in touch with your usual contact at plainlaw or Philip Horn on 01865 240202 or e-mail him at philip.horn@plainlaw.co.uk
This edition of “The law made plain” is written to provide you with general information. It is recommended that you seek specific professional advice before taking any action.
© Copyright plainlaw 2006
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