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SJ Berwin LLP - REITs Update: A Welcome Response to the Industry

Monday 27th March 2006

The Chancellor confirmed in the 2006 Budget on 22 March 2006 that the Government will introduce legislation in the Finance Bill for the establishment of Real Estate Investment Trusts (“REITs”) so that companies can elect to become REITS with effect from 1 January 2007.

According to corporate and commercial law firm SJ Berwin LLP, REITs should bring a wide range of benefits to the UK property market including:

(a) creating a new tax efficient investment product for retail investors in real estate which is exempt from tax on rental income and tax on disposals of investment properties;

(b) reducing the outflow of funds to non-resident vehicles and structures;

(c) facilitating the further raising of capital for the real estate sector with the potential for increased supply of accommodation and improvements in quality; and

(d) creating the opportunity for London to establish itself as the REIT centre of Europe.

While the exact details will be contained in the Finance Bill to be published shortly, a detailed commentary on the clauses published in the Budget indicated that the Government has adopted a number of the representations made by the property industry. The Chancellor stated that:

(a) the conversion charge will be an amount equal to 2% of the market value of the investment properties at the date the company or group joins the regime. This is subject to an election to spread the charge over 4 years in instalments of 0.5%, 0.53%, 0.56% and 0.6%;

(b) the ratio of interest on loans to fund the tax-exempt business to income of the tax exempt business must be less than 1.25:1. Income for this purpose will be calculated prior to deduction of capital allowances. This is a significant improvement from the previous ratio of 2.5:1 and the requirement that income be calculated after deduction of capital allowances;

(c) a REIT must distribute 90% of net profits on tax exempt income as calculated for tax purposes i.e. after deduction of capital allowances. This is a reduction from the 95% originally proposed. There is also an effective 6 month extension on the period of time before which the distribution must be made;

(d) the requirement that no one investor may be beneficially entitled (directly or indirectly) to 10% or more of distributions or the share capital or control 10% or more of the voting rights has been retained. However, the effect of a failure to comply with this requirement is no longer that REIT status is lost, but that the REIT becomes subject to tax on the proportion of its income payable to the relevant shareholder, unless it can show it has taken reasonable steps to avoid paying distributions to the shareholder;

(e) distributions of property rental income profits and gains on investment properties are treated as though they were rental income for UK tax purposes and will be paid after deduction of tax. There will be provision for distributions to be made gross to UK resident companies, pension funds and charities.

(f) REITs can have non resident subsidiaries and can invest in non UK property;

(g) REITs can issue fixed rate preference shares and loan notes convertible into ordinary shares;

(h) REITs will be entitled to enter into capital allowance elections on acquisitions;

(i) the requirement that the value of the assets in the tax exempt business equal at least 75% of the value of the total assets of the company will be measured for on a fair value basis rather than historic cost;

(j) exempt income for REITs can now include income from income transparent collective investment schemes;

(k) there are changes to the general approach to breaches of conditions for REIT status so that most breaches will not result in automatic removal from the regime but will normally trigger an increased tax charge in the REIT;

(l) the requirement that REITs must derive 75% of its total income from tax exempt business is measured by reference to accounting profits, net of realised and unrealised capital gains or losses.

David Ryland, Head of Property Funds and Real Estate Partner at SJ Berwin said, “Some proposals have not been adopted. For example there is no provision for an UP REIT structure. The Chancellor has also retained provision that if a REIT develops a property and sells it within 3 years of completion, any gain or loss on the disposal will form part of the non-tax exempt business of the REIT, even if the original intention had been to hold the property as an investment.”

But he continued, “On the whole, the revised proposal should be broadly welcomed as a constructive response to concerns expressed by the industry.”

For further information, please call David Ryland on +44 (0)20 7111 2252, email david.ryland@sjberwin.com or Karen Roberts on +44 (0)1628 521 818, email karen.roberts@sjberwin.com


Notes:
  • On 1 June 2005 SJ Berwin LLP, an English limited liability partnership, took over the business of the SJ Berwin general partnership. SJ Berwin LLP or an affiliated undertaking has an office in Berlin, Brussels, Frankfurt, London, Madrid, Milan, Munich and Paris.
  • SJ Berwin LLP was named ‘UK Firm of the Year’ at the 2005 Legal Week Awards on 30 November. The award recognised SJ Berwin’s five years of international expansion and its involvement in a series of high quality deals.
  • SJ Berwin's Real Estate Division totals 118 staff of which 22 are partners (3 of which are tax partners), and 50 assistants, encompassing the disciplines of Commercial Real Estate, Construction, Planning & Environment, Property Litigation, Real Estate Funds and Tax. There is an increasing emphasis on cross firm activity with related areas of Banking and Corporate. The division acts for blue chip clients including British Land, Royal Bank of Scotland, the Hilton Group, Brixton plc, AXA, The Crown Estate, Marks & Spencer and Gazeley.
  • The Real Estate Team is Legal Business Real Estate Team of the Year 2005. It was also named "Real Estate Team of the Year" in the Lawyer Magazine Awards 2004, following its advice on the RBS/Canary Wharf transaction the highest-value property investment transaction in the UK in 2004.
  • Revenue from Real Estate represents approximately 23% of the firm's total revenue.
 
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