As anticipated in our blog of 11 November 2011, last week HM Treasury published the draft Finance Bill 2012 containing proposed changes to the UK’s Real Estate Investment Trust (REIT) regime.
REITs are tax-efficient property investment companies. They were first developed in the US but were introduced in the UK in 2007. Australia, France and Germany also have developed REIT regimes. In a bid to support the property industry, and in particular the expansion of the private rented sector, the UK Government aims to ease some of the conditions of entry and other restrictions applicable to REITs in the UK.
What are the proposed changes?
The headline change proposed remains the abolition of the 2% entry charge on existing property assets for companies becoming REITs.
Another important change is the relaxation of the listing requirement so that REITs will soon be able to be listed on alternative trading platforms such as AIM, Plus and their foreign equivalents. This may encourage the establishment of more specialist REITs primarily aimed at institutional investors.
Non-close company requirement
In addition, a new REIT will be given more time, namely three years, to comply with non-close company requirement. If the non-close company rules are not met by the end of this period for legitimate reasons, then the company will lose its REIT status without any further penalty. However, where the company is considered to have joined the REIT regime in order to gain a tax advantage, the tax benefits obtained during this period may be retrospectively withdrawn. There will be no discretionary extensions to the three year period.
It is also proposed that the holdings of certain institutional investors, e.g. life insurers, authorised unit trusts and pension funds, will not make a company “close” for the purposes of the REIT regime, because of the diverse nature of their underlying ownership. The current list of institutional investors to which the exemption applies has been criticised in some quarters for being too narrow. It does not, for example, include banks or real estate private equity funds. Although not unexpected, not including a wider pool of institutional investors does perhaps restrict the flow of potential capital sources into REITs which could, in turn, relieve some of the real estate exposure of UK banks. However, the Treasury will have power to add, modify or remove categories of institutional investors to or from the list, so this may be an area for further reform.
Balance of business test
Under current REIT rules, not less than 75% of the profits and assets of a UK REIT must derive from its property rental business. It is proposed that cash will count towards the assets of the property rental business for this purpose. This will make it easier for companies comply with the Further changes have been proposed to make investment easier for institutional investors and Section 531 has been amended to allow cash to be added to the assets of the property rental business for the purpose of the balance of business test.
However, the balance of business test will still prevent those property companies more focused on development from becoming REITs. For so long as this remains the case, I find it hard to believe that the existence of the REIT regime (in its existing or proposed new form) will make any material difference to the recovery of the UK construction industry.
The draft legislation also clarifies some of the other proposed changes to the REIT rules, including to the application of the 90% profit distribution requirement, the definition of financing costs for the interest cover test (and consequences of breach).
When will they come in to force?
The Bill is open for technical consultation until 10 February 2012. The changes will take effect once the Bill receives Royal Assent, likely to be in late July 2012.
As I have commented before, I don’t think these changes do enough to encourage the establishment of residential property REITs, both because of the restriction on trading activities and the effect of the 90% distribution requirement coupled with the absence of capital allowances for residential property which means that fewer deductions can be made for the profits to be distributed.
These changes are in many ways “old news” as they arise from a consultation that started last April. The industry has already moved on to thinking about other new changes to the REIT regime, such as the creation of mortgage REITs. The British Property Federation’s Liz Peace has recently said she is pretty sure that these are on HM Treasury’s agenda and she hopes that the UK could have its own version of the mortgage REIT in 2013. If she’s right, expect to see a fresh raft of REIT measures for consultation in the Spring.
(With thanks to Maria Wall who co-authored this blog.)