Back to basics - UK Real Estate Investment Trusts (UK-REITS)

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and implications

From a relatively slow start in 2007, the number of UK real estate investment trusts (UK-REITs) is growing. There are now over 30 UK-REIT vehicles, which together invest across an increasingly broad range of real estate activities.

Many of the largest listed property companies quickly converted to UK-REIT status when the regime was introduced in 2007. However, the UK-REIT population has further flourished since HMRC's abolition in 2012 of a 2 per cent entry charge on seeding assets. Our 2015 Real Estate Fund Trends Survey suggests their numbers may continue to grow.

Qualifying as a UK-REIT is now increasingly recognised as an attractive option for many different listed real estate strategies. The principal attraction is exemption from UK tax on property investment income and capital gains, but this method of investing in real estate also offers liquidity through share trading and the ability to access capital markets. Unsurprisingly, there is a raft of conditions that must be met.

Nabarro has led the field in REITs (click here to learn how). Below we look at the detail.

Qualifying as a UK–REIT

In order to qualify as a UK-REIT, a company must:

• be a UK tax resident (it can have subsidiaries and form a REIT group);
• be listed or traded on a recognised stock exchange (including AIM and the Channel Islands), as unlike the US the UK has no private REIT regime (although it is a possible to have UK-REITs that are controlled by institutional investors);
• not be a close company (there are exemptions for certain institutional and other investors);
• only have ordinary shares, or permitted non-participating fixed-rate preference shares, or convertible preference shares; and
• not have profit participating loans.

Understandably the company/group's business must also be focused on real estate. This is deemed the case where at least 75 per cent of the assets and profits relate to a "property investment business". There are also diversification rules requiring the business to hold at least three properties, each representing no more than 40 per cent of the total value of the portfolio. Legal form is flexible, with interests in joint ventures, unit trusts and limited partnerships permitted, as is the location of holdings overseas real estate can be held as part of a "property investment business" (although resulting profits will be subject to local tax).

Taxation

The exemption from UK tax on income and capital gains is naturally limited to a UK-REIT's real estate business, so any other business activities are taxable at the normal rate. It is worth warning that property development profits may also be taxable, depending on the circumstances.

The tax exemptions do nevertheless extend to double REIT structures, and UK-REITs may hold up to 10 per cent of another UK-REIT without paying tax on any dividends received.

There are no special stamp duty exemptions for a UK-REIT. The normal rates of stamp duty land tax apply in relation to acquisitions of UK real estate, and transfers of shares in a UK-REIT are typically subject to stamp duty at 0.5 per cent.

It should be noted that a withholding tax of 20 per cent is imposed on all distributions made to investors, although this is subject to certain reliefs. One of these applies where the UK-REIT has reasonable belief that the person who is to receive the dividend is subject to UK corporation tax or is otherwise exempt. There may also be a tax charge on the UK-REIT where it makes a distribution to a corporate shareholder that is entitled to receive 10 per cent or more of dividends.

Operating a UK-REIT

At least 90 per cent of net income from the UK-REITs property investment business, after capital allowances, must be distributed. This requirement can be satisfied by issuing share dividends. Where a UK-REIT receives dividends from another UK-REIT, it must distribute 100 per cent of those dividends to investors.

The UK-REIT regime does not impose any specific restrictions on borrowing. However, tax deductions for borrowing are restricted. The UK-REIT will be required to pay tax to the extent that the income profits of the tax-exempt, real estate investment part of the business do not cover the costs of borrowing at least 1.25 times. HMRC does have the power to waive the taxable charge in certain circumstances (such as where the ratio is exceeded because of unforeseen circumstances).

Just as companies must submit their annual accounts to Companies House, a UK-REIT is also required to prepare separate REIT financial statements for HMRC for each accounting period.

Losing UK-REIT status

Breach of the UK-REIT regime can ultimately lead to loss of UK-REIT status and its favourable tax treatment. UK-REITs are under an obligation to notify HMRC as soon as they become aware that they have breached the regime. HMRC then offers grace periods for breaches, and a certain number of minor breaches are allowed before HMRC will decide to terminate the company's status as a UK-REIT. Companies may also decide to leave the regime voluntarily, and this is achieved by simply providing HMRC with written notice.

Where next?

The UK-REIT sector includes some of the UK's largest real estate companies such as British Land, Great Portland Estates, Hammerson, Land Securities and SEGRO. These companies are internally managed and premium listed by the United Kingdom Listing Authority (UKLA). However, the number and range of REITs is growing, including externally managed UK-REITs (which may need to consider the impact of the EU's Alternative Investment Fund Managers Directive).

Sector coverage is also expanding in sectors such as student accommodation, healthcare and logistics. There is still scope for further growth and development of the regime, especially in the residential property space.