A real estate investment trust is a tax-efficient holding structure for real estate. Companies (or company groups) that meet the qualifying conditions for REIT status benefit from an exemption from corporation tax on the income profits and capital gains of their qualifying property rental business.
From April 2023, the main rate of UK corporation tax increased from 19% to 25%. Significantly, this means the exemption provided by REIT status is now worth almost a third more than it was previously. The table demonstrates the benefit of REIT status for different kinds of investors receiving distributions from a REIT and a non-REIT company.
Liberalisation of the regime
Historically, REIT status was limited to large listed investors with diverse property portfolios. Prior to 1 April 2022, it was a requirement that the shares of a REIT company were admitted to trading on a recognised stock exchange and listed on the Official List of the London Stock Exchange (or a foreign equivalent) or traded on a recognised stock exchange. However, since 1 April 2022, this condition may be ignored if at least 70% of the company’s ordinary shares are owned (directly or indirectly) by one or more institutional investors. Given the tax benefits available, every institutional investor should now consider a REIT as a prospective property holding vehicle.
Facilitating private REITs for institutional investors is part of a recent trend towards liberalising the REIT regime. On 15 March 2023, as part of the Spring Budget, the chancellor announced a number of further changes, the legislation for which was included in the 2023 Spring Finance Bill. These amendments are designed to enhance the competitiveness of the REIT regime by addressing unnecessary barriers to entry, ensuring the rules are operating as intended and reducing administrative burdens for certain partnerships investing in REITs.
Perhaps the most significant change is the removal of the requirement that a REIT must hold a minimum of three properties. This rule will be amended so that a REIT may hold a single commercial property worth at least £20m. This amendment was previously announced by the chancellor as part of the so-called “Edinburgh Reforms” in December 2022 and it will have effect from the date of royal assent of the Spring Finance Bill.
Net investment returns after tax: REIT v non-REIT company investor
|
REIT |
Non-REIT |
Tax benefit from REIT status |
|
|
Company position |
|||
|
Rent |
£1,000,000 |
£1,000,000 |
|
|
Less: interest expense |
-£400,000 |
-£400,000 |
|
|
Net rental income |
£600,000 |
£600,000 |
|
|
Corporation tax on income |
Nil |
-£150,000 |
|
|
Net profit after tax |
£600,000 |
£450,000 |
|
|
Investor position |
|||
|
Tax on distributions to investors (PIDs): |
|||
|
UK pension fund/LGPS/sovereign wealth funds |
Nil |
Nil |
|
|
Net receipt |
£600,000 |
£450,000 |
£150,000 |
|
US/Canadian large pension schemes |
Nil |
Nil |
|
|
Net receipt |
£600,000 |
£450,000 |
£150,000 |
|
UK individual HNW – income tax additional rate |
-£270,000* |
-£177,075** |
|
|
Net receipt |
£330,000 |
£272,925 |
£57,075 |
As part of the Edinburgh Reforms, the chancellor also announced the government would “amend the rule that applies to properties disposed of within three years of significant development activity, to ensure that this rule operates in line with its original intention”. This rule provided that if a REIT disposed of a developed property within three years of completing a development costing more than 30% of the fair value of the property (tested at entry to the REIT regime or acquisition of the property, whichever was later), the property was deemed to be sold in the course of a trade, and any gain arising on the disposal was subject to tax. With effect for disposals of assets made on or after 1 April 2023, this rule has been amended so the value of a property for the purposes of the rule is now the highest of the fair value of the property on entry into the REIT regime, at the time of acquisition of the property, or at the beginning of the accounting period in which the development commenced. This amendment goes some way towards mitigating the effect of the current high levels of inflation.
The government is also amending the rules for the deduction of tax from property income distributions paid by REITs to partnerships so that, where certain conditions are met and with effect from the date of royal assent of the Spring Finance Bill, a PID may be made with tax deducted only from the proportion of the payment which relates to the partners in the recipient partnership which are not entitled to gross payment. This puts on a statutory footing treatment which some in the industry have been getting cleared by HMRC on a case-by-case basis.
Finally, the government is legislating to amend the genuine diversity of ownership condition in the rules governing REITs (as well as the qualifying asset holding company and non-resident chargeable gains rules) so that, where an entity forms part of multi-vehicle arrangements (the definition of which encompasses a group of entities that form part of a wider fund structure where an investor would reasonably regard its investment to be in the structure as a whole), the GDO condition can be treated as satisfied by the entity if it is met in relation to the multi-vehicle arrangements. This change will take effect from royal assent of the Spring Finance Bill.
Summing up
REITs can generate much higher returns for investors than non-REITs, particularly given the recent hike in the main rate of corporation tax. REIT status is no longer the preserve of large listed companies, as REITs may now be held by institutional investors, and the attractiveness of REIT status has been enhanced further by the recent changes announced in the Spring Budget, in particular, the ability for a REIT to own a single commercial property worth at least £20m.
REITs may now represent the ideal property investment vehicle. Owing to a winning combination of onshore status and tax efficiency, REITs could enable attainment of the holy grail – the unitisation of property for retail investors.
Paul Beausang is a partner, Camilla Spielman is a legal director and Charlotte Stodell is a principal associate at Eversheds Sutherland
