After two years of confinement to tax professional circles, the OECD’s Base Erosion and Profit Shifting initiative has finally broken out of its conceptual prison and into real estate boardrooms as the prospect of increased tax costs looms.
BEPS is a system to counter tax avoidance. Essentially, the aim is to stop multinationals ‘shifting’ profits between different jurisdictions in order to take advantage of the lowest tax rates.
The OECD consulted on this extensively over the last two years, and released a series of recommendations last October, endorsed by G20 finance ministers with the strong support of the UK government, which has since consulted on proposals to adopt these recommendations.
There is one proposal in particular that the British Property Federation is interested in as it could have a profound impact on real estate. It would make debt finance more expensive by restricting the tax deductibility of interest to between 10% and 30% of a business’s earnings.
In other words, if you had earnings of £100, the most you would be able to deduct for tax purposes in respect of your interest expense is £30, even if you actually paid £50 to whoever lent you some money.
This is problematic for highly capitalised industries like our own. For good or ill, real estate has always relied more heavily on debt to finance its operations than most other industries.
According to analysts, real estate businesses spend on average more than 40% of their earnings on debt interest. A restriction at 30% would therefore result in a considerable tax hike for many, with those whose business models rely more heavily on debt the hardest hit.
It could also put REITs in a tricky position by increasing the distributions they are legally required to make every year.
Using figures from the De Montfort study of commercial property lending and making some reasonable assumptions about how much debt real estate businesses use, we estimate that under the new proposals real estate businesses could be paying an additional £660m a year in tax. That is the equivalent of the construction costs of Westfield London being taken out of the economy every year!
All to the good, some might say. After all, we should all be paying our fair share of tax – and landlords are not exempt from that. The government’s proposals, however, do not tax existing profits more heavily; they effectively tax the running costs of a business.
In this way they run counter to one of the most fundamental principles of corporation tax – that a business should receive tax relief for its business costs.
Our industry has a huge contribution to make to society through the economic success it facilitates, the essential infrastructure it provides and the great places it creates.
These proposals, which would disproportionately affect real estate businesses and hit hardest the very schemes that are turning around long-neglected town and city centres, will make it far more difficult to deliver that contribution.
Melanie Leech is chief executive of the British Property Federation
