The prospect of a UK Real Estate Investment
Trust or "REIT" first arose as part of Budget 2004 with the publication
by HM Treasury of a consultation paper, "Promoting more flexible
investment in property: a consultation" (although initially labelled a
Property Investment Fund or "PIF").  Recognising the importance of
a stable, healthy property market to a strong economy and noting the
contribution made by similar vehicles in many other jurisdictions to
develop property markets, the Government set four key objectives for

  • improving the quality and quantity of finance for investment in both commercial and residential property;
  • expanding access to a wider range of saving products on a stable and well regulated basis;
  • ensuring the payment of a fair level of tax by the property sector, to protect all tax payers;
  • supporting structural change in property markets by reducing costs and improving flexibility and quality for tenants.

the consultation process began.  The first round closed in July
2004 and at the same time, the term "PIF" was abandoned for the
industry-preferred term, "REIT".  This consultation resulted in
the Government assuring the property sector of its continued commitment
to the introduction of a UK REIT that meets the key objectives while
imposing no overall cost to the Exchequer.  However, the process
had identified three major stumbling blocks to the introduction of
REITs, relating to:

  • non-UK resident investors
  • borrowing
  • group structures

Over a year later, these issues remain problematic, although progress has been made in developing some of the details.

initial consultation, a working group including industry
representatives set about considering  the detail, with specific
focus on the three areas referred to above and the related tax
technical issues arising from them.  At the time of the launch of
the joint working group, the stated intention was to report back during
the course of 2005 and "….subject to finding a workable solution to the
challenging issues raised and meeting the stated objectives, including
reform at no overall cost to the Exchequer, the Government aims to
legislate for a UK REIT in Finance Bill 2006".

Where are we now?

broadly, it is proposed that a REIT will take the form of a closed
Companies Act company.  Its activities will be divided into two
pools – one for property ownership and the income it generates (which
will be ring-fenced), and one for all other activities (for example,
property development and management).  To qualify as a REIT,
ring-fenced business will have to generate at least 75% of the
company's gross income with 75% of its capital value comprising real
estate used in that ring-fenced business and 95% of the income arising
from it must be distributed, although capital gains need not be. 
It is not clear how these tests will operate in practice, how
fluctuations in asset management will be monitored and what sanctions
will apply if parameters are breached.

A number of aspects still have to be finalised including:

Conversion charges
is a big issue for offshore investors who will consider a tax charge to
put a property into a tax exempt REIT unacceptable.  The question
is whether the Government should benefit from a “sweetener” on
conversion for foregoing standard corporation tax on inherent gains on
realisation and if so, how much and how it should be calculated. 
The matter of entry tax is understood to be fundamental to the
Government in agreeing the economic case for REITs but it may impact on
their popularity.

Whether REITs should be listed
view of the property sector is that all UK listed and potentially
non-listed property investment companies should be allowed to form
REITs.  The Government has not yet decided but it is thought that
initially, only listed REITs will be permitted with unlisted REITs
following later, in conjunction with the introduction of borrowing
restrictions and anti avoidance measures.

Borrowing levels
Government is concerned that gearing is not used to manipulate returns
and so avoid tax by gearing up through non-UK sources and directing
interest payments to lenders with tax capacity or who are able to
receive interest tax free and passing capital growth to equity
holders.  However, if the Government imposes restrictions instead
of allowing the market to decide what gearing levels should be, this
could adversely affect the popularity of REITs while preventing only a
low level of abuse.

Group structures
It is unclear how
a conversion charge would apply to group companies transferring into a
REIT, although it is generally assumed a REIT could not be part of CGT
group except as principal member.
Treatment of distributions comprising capital gains
under consideration is whether REITs should be obliged to reinvest
gains within a specified period to avoid a charge to corporation tax at
the full rate.

Treatment of non-resident investors
the biggest outstanding issue is the taxation of distributions in the
hands of non-resident investors.  If a UK REIT is tax exempt
(which is assumed must be a primary feature) the Exchequer would lose
revenue from offshore investors who can claim exemptions or partial
exemptions from UK tax on distributions through double tax agreements
or under EU law.  Such exemptions can restrict HMRC's ability to
withhold tax on distributions.  There are a number of potential
solutions to this issue. 
One choice would be for the REIT to
be exempt and to impose tax at the investor level (as for direct
property investments).  Withholding tax at 22% would be deducted
and distributions could then carry a tax credit which UK investors
could set against Schedule A liability on distributions from a REIT's
ring fenced activity.  Non-resident investors would get a net of
tax distribution and if they can obtain credit for underlying taxes,
this would come from non-resident tax authorities and not HMRC. 
However, in order to use a tax credit system a receipt must be a
dividend and there may be discrimination issues if resident and
non-resident investors are treated differently.  There could also
be UK company law issues arising from the hybrid tax treatment of

Another model would tax rent at 22% at the REIT
level and 0% on dividends out.  However, this does not align tax
treatment with direct property investment and would require the
introduction of a complex tax refund system to achieve alignment. 
There would also be EU competition and treaty non-discrimination issues
for non-UK investors and the resultant entity would not look like the
kind of REIT that has been introduced in other jurisdictions.

third possibility is an internal trust that would be designed to give
investors a REIT distribution which is income from land even though
investors would only deal in the purchase or sale of REIT shares. 
This would require new tax legislation and also give rise to numerous
non-tax issues including accounting, regulatory, trust law and
corporate law issues.  The REIT would set up a trust for rental
income which would be held on trust for the benefit of the shareholders
from time to time.  The trust would receive dividends and rental
income but again, there would be issues to address sunder double
taxation agreements and problems such as the non-recognition of trusts
by many European civil law jurisdictions to overcome.

What next?

conference organisers are already busy promoting winter conferences on
REITs, it is not impossible that the UK REIT could still be scrapped if
the Government cannot get more comfortable than it is at present that
its introduction will not result in grand scale tax leakage.  The
property sector's views is that leakage in fact will not be that great
as the main investor base will be UK residents from whom tax can be
collected.  Non-UK resident investors are not, in the industry's
view, likely to swap from their current investment form to a
potentially volatile share in a listed REIT merely to get liquidity.

is anticipated that the Chancellor's pre-Budget Report in mid November
will provide an update.  If the UK REIT is to move forward, then
most likely draft legislation will be published at that point, for
consultation and included in Finance Bill 2006.  In summary then,
the UK REIT is not yet a given.

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