With 92 UK REITs already in existence and more anticipated, following extensive industry discussions, the government is keen to ensure that the rules facilitate use of the regime and make it more attractive by removing certain constraints and administrative burdens.
Finance Bill 2022 (FB) – amendments to the REIT regime
Accordingly, the FB contains various measures, to come into effect from 1 April 2022.
- Introduction of unlisted REITs for institutional investors
The requirement for REIT shares to be admitted to trading on a recognised stock exchange will be removed in cases where one or more "institutional investors" hold at least 99% of the REIT's ordinary share capital.
Importantly, the definition of "institutional investor" for this purpose does not track exactly the usual REIT definition, limiting it, where the shares are being held for a limited partnership which is a collective investment scheme, by inserting a requirement that the scheme meets a "genuine diversity of ownership" (GDO) condition. The reason for the government not applying this additional requirement for all REIT purposes may be concerns that it would adversely affect existing REITs which had been relying on a less stringent test of "institutional investor" status. However, the new rule could be made a bit more practical by using a wider test than just the proposed GDO condition, so as to include an alternative limb that would automatically cover partnerships held by non-close entities. This would no doubt be welcomed.
The ability to have unlisted REITs will be welcomed by many, facilitating their use for suitable single investors or as an onshore joint venture vehicle for such investors. However, the change does not go as far as many hoped due to its restriction, effectively, to institutional investors.
- Restriction of ‘holders of excessive rights’ charge
Under current rules, a REIT can face a tax charge when it pays a property income distribution (PID) to a "holder of excessive rights". Broadly, these are corporates who hold at least a 10% interest in the REIT (so the mechanism is sometimes called the "corporate 10% rule). The logic behind the charge is that such corporates, if non-UK resident, could potentially benefit from relief under a double tax treaty from withholding tax on PIDs, so the charge on the REIT ensures that the Treasury still gets its cut. Government concerns at the time as to how to carve out UK companies without EU challenges, led to the unexpected breadth of the charging provision, which to date has also included UK corporation paying entities.
It is therefore good news that the charge is to no longer apply to PIDs paid to investors who are entitled, under relevant UK domestic REIT withholding tax rules, to gross payment (such as UK tax resident companies). It will still, however, apply to PIDs paid to those who are only entitled to be paid gross by virtue of provisions outside the REIT code, such as by making a treaty relief claim. Therefore, the charge will continue to apply to PIDs paid to most offshore corporate investors holding shares as an investment, including, oddly, (given that they are exempt from UK direct taxes generally) to sovereign wealth funds, though we may see the latter come with the ambit of the change as the FB progresses, given the purpose of the charge.
- Relaxations of the "balance of business" test
Under the balance of business test, broadly, at least 75% of a REIT’s profits and assets must relate to property rental business. This test is to be amended so as to disregard non-rental profits ("profits of residual business") arising because a REIT has to comply with planning obligations under section 106 the Town and Country Planning Act 1990. While a start (and at least likely to be helpful in terms of assisting in the provision of housing), this change is narrower than many would have wished for.
An administrative simplification is to be made to the balance of business test, so that, if group accounts for a period show that property rental business profits and assets comprise at least 80% of group totals, a REIT will not have to prepare the additional statements which would be required to meet the full test.
- Change to what constitutes an overseas equivalent to a REIT
One of the categories of "institutional investor" in the REIT regime is, broadly, an overseas equivalent to a REIT. The concept of "institutional investors" is important, as, essentially, they are treated as good investors for the purposes of the regime in that the "close company" requirement is relaxed in relation them and they will be able to benefit from the unlisted REIT rules (discussed above).
Under the FB proposals the definition of an overseas equivalent of a UK REIT will be simplified so that the overseas entity itself, rather than the overseas regime to which it is subject, needs to meet the equivalence test. This is a helpful change giving more certainty than the current rules.
REITs and the qualifying asset holding company (QAHC) regime
The FB also contains exciting proposals for a new tax privileged regime for QAHCs (read more information).
Following intense lobbying and discussions with HM Treasury and HMRC, the QAHC regime has incorporated some provisions that will be very helpful to certain UK REITs.
- The UK REIT will be a "relevant qualifying investor" for the purposes of the QAHC regime. It will therefore be able set up its own dedicated QAHC as well as counting as a good investor in a QAHC established by somebody else.
- The QAHC regime is to include provisions that could make the vehicle an attractive one for holding non-UK land, in particular, a complete exemption from tax on gains on such land and an exemption from tax on income from it (provided the income is taxable locally (i.e. not tax exempt or taxed at a zero per cent rate)). In addition, there is to be a complete exemption for QAHCs from tax on gains on shares (broadly, provided the relevant underlying company is not UK property rich). These are likely to be the main attractions of the QAHC for a UK REIT, allowing it invest directly in offshore property or in offshore companies holding property (provided that they are not UK property rich), in each case, without UK tax in the QAHC on the property income or any gains.
- Helpfully in terms of offshore property investment, profit from associated loans and derivatives will also be UK tax exempt in the QAHC.
The full exemption from UK tax on (qualifying) overseas property income, is an improvement on the current position under which relief for foreign tax has to be claimed. This is because it both fully eliminates the UK tax liability and administratively should be much simpler (as claiming double tax relief can be an extremely complicated process, involving tax calculations under the rules of both jurisdictions). Indeed, the complete exemption will be even more efficient once the UK corporation rate rises to 25% in 2023. The jurisdiction most cited where the exemption for overseas property income will be of interest is Germany, but there are others.
As a practical point, given that a QAHC's tax benefits do not apply to all its assets (in particular, UK land), when investing in a QAHC (especially one run by others) a REIT should carefully consider the proposals to ensure that the full anticipated benefits of using such a vehicle are realised.