REITs – how could they work in future?

For some years now the government has been conducting a review of the wide-ranging and complex UK funds regime – aiming to enhance the UK’s attractiveness as a location both for funds and the associated asset management activities.

Qualifying Asset Holding Companies (QAHCS)

Notable progress to date includes a new tax regime for qualifying asset holding companies (QAHCS) which is due to commence in April 2022. This is aimed at persuading asset managers to locate their asset holding structures in the UK rather than use entities located in non-UK jurisdictions such a Luxembourg. However, QAHCS is primarily intended to offer potential tax exemptions for structures holding non-UK property. The parallel structure for UK real estate is a UK REIT.

So where do UK REITs fit into the ongoing funds review, and will this lead to benefits for investors in UK real estate via UK REITS?

The good news is that “a perception that there are unnecessary barriers and complexity within the existing Real Estate Investment Trust (REITs) rules” is a central theme of the funds review.

Positive changes have begun to filter through: the most eye catching being the removal of the need for REIT shares to be admitted to trading on a recognised stock exchange provided institutional investors hold at least 70% of the ordinary share capital in the REIT. This clears the way for more so-called “private REITS” by removing significant cost and administrative burdens for pension funds, unit trusts and certain other collective investment schemes.

What more reforms are proposed for UK REITs?

REITS feature prominently in the latest instalment in the funds review process although it is disappointing that the government has deferred any immediate decisions but instead set up a “new workstream…to further evaluate the options”.

More encouragingly, a number of potential changes put forward by consultation respondents are under active consideration including:

  • Removing the requirement for REITs to be subject to both the Corporate Interest Restriction test and the Interest Cover Test
  • Amending the 3-year development rule
  • Removing the requirement for a company to hold at least 3 properties (instead allowing REITs to hold only a single property)
  • Amending the rules so that where a REIT holds overseas property in a UK company and suffers tax in the overseas jurisdiction, withholding tax should not be applied when paying relevant property income distributions to investors
  • Broadening the definition of qualifying assets for the REIT regime such as property backed debt, operational income from infrastructure and renewable energy assets
  • A seeding relief from Stamp Duty Land Tax (SDLT) for REITs, to ease transition into the REIT regime
  • A proposal to make the requirement to calculate capital allowances optional
  • Amending the proportional basis on which the capital gains exemption applies to disposals of rights in UK property rich assets
  • Extending the changes made to remove the ‘holders of excessive rights’ charge in respect of payments of PIDs to cover certain qualifying exempt entities.

Our analysis of the latest proposals for setting up UK REITS

The first four here seem relatively straightforward and are the prime candidates for inclusion in the next Finance Bill. As to the other proposals, the outcome is much harder to predict, mainly because implementation would in most cases be more complex and the wider impact harder to assess. Some proposals would clearly take years to implement, for example, the suggestion for an SDLT seeding relief would be a big step.

Making the requirement to calculate capital allowances merely optional seems sensible. It does seem odd that REITs have to go to the expense of calculating CAs but at the same time, they don’t actually save tax, because the property business profits are exempt in any case. The only real benefit is that the PID is reduced which for some REITS will be important although others may value the corresponding increase in capacity to pay normal dividends.

Finally, the government’s Responses paper mentions two other possible changes being considered for QAHCs, which will also impact REITs. These are a review of the definition of “institutional investors” and a more general review of the non-close condition – although both of these are being considered over “a longer timetable”.    

Contact a member of the BDO team if you have any queries.

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