Budget 2017: UK REIT conversion – why now?

The world of tax is in a state of flux. The Base Erosion and Profit Shifting project launched by the OECD has brought more than 100 countries together in an unprecedented effort to combat international tax structures that aim to move profits to lightly taxed jurisdictions, says Nicola Westbrooke, partner, EY. [caption id="attachment_897699" align="alignright" width="150"] Nicola Westbrooke[/caption] The result is the biggest shake-up in tax rules ever seen and the effects are only just beginning to be properly felt in investment appraisals. Political upheaval, perceived inequality and media focus has also shone a light on tax in a new way and brought the debate into the limelight, making it a reputational matter for businesses. So where does this leave investors who own or are considering acquiring UK property? One of the key BEPS recommendations is that countries adopt a restriction on tax deductions for interest to no more than 30% of EBITDA. These rules have been effective in the UK since April 2017, including a rule that allows a “group ratio” to be substituted for the 30% figure. There is also the possibility of an infrastructure election to recognise that many capital-intensive industries – such as property – are often more highly geared than others for sound commercial reasons beyond tax planning. For many years, it has been popular for some investors to own UK investment property through non-UK entities, not least because the UK does not tax gains arising to non-residents disposing of most UK assets, including commercial property. Until now, these vehicles have been subject to UK income tax on rental profits at a rate of 20%. However, we are currently waiting for the results of a UK government consultation to bring non-resident landlord companies within corporation tax rather than income tax. While the rate of corporation tax is not significantly different (actually currently lower at 19%), it will bring corporate NRLs within the ambit of all of the corporation tax rules, including the new corporate interest restriction – which is largely why the government is looking to make the change in the interests of consistency and fairness across the various classes of investors. This could potentially be the catalyst for non-resident companies to consider opting to become a UK REIT. There is no doubting that there has been a real uptick in interest in UK REIT status recently, driven by these new rules and also by the view that the UK REIT offers a closed-ended, on-shore, effectively tax-transparent structure in a “wrapper” that carries less perceived reputational risk than offshore options. However, whether an REIT conversion makes sense depends on your investor profile, commercial aims and what your critical drivers are. The REIT regime offers exemption from income or corporation tax on rental profits and property gains in return for mandatory payments of dividends, potentially subject to a 20% withholding tax. This tax is not payable by UK-exempts and non-resident investors may be able to recover some of it under the terms of a tax treaty. The regime also imposes a number of conditions in return for REIT status, including that at least 75% of profits and assets need to be investment in nature, rather than trading. It currently requires that the top company is managed and controlled in the UK and traded or listed on a “recognised” global exchange. Some of the issues debated around the choice between offshore and UK REITs include maintenance costs, investor returns and flexibility of business. On maintenance, the UK REIT regime requires a listing, with all the costs, regulation and transparency requirements that come with that. Saying that, exchanges such as the International Stock Exchange in the Channel Islands offer a relatively flexible and affordable option. Maintaining offshore status can also can be costly with, for example, Jersey unit trusts requiring the input of both Jersey resident trustees and administrators. With regards to returns, the relative benefits of offshore or REIT structures will depend on the mix of investors, income types and which offshore structure you are looking into, so it is difficult to generalise. With an investment into a pure UK rental business, structured either as a REIT or a Jersey company, the financial comparison will need to be modelled for each case. There is, however, the potential for higher returns from an REIT structure, especially for exempt investors. Finally, The REIT regime has a number of conditions attached to it, including a restriction on the amount of trading activity that can be undertaken, and these restrictions may not suit all businesses. It also has restrictions relating to the number or type of investors that it may have, although “institutional investors” are favourably viewed by the REIT regime and can take large stakes. While the exemption from UK tax on gains from commercial property persists, offshore structures will always have their place, or even offshore subsidiaries of UK REITs, to mix the benefits and downsides of two regimes. However, the shifts within the tax system are pushing people to look again at the benefits of the REIT. Nicola Westbrooke is a partner at EY Click here for all the news, data and analysis affecting real estate in the Budget