Draft Finance Bill 2021-22: key tax changes for the real estate sector

The publication of draft legislation to be included in the Finance Bill 2021-22, alongside several consultations and responses, heralds significant changes for tax in the real estate sector.

Real Estate Investment Trusts (“REITs”)

Changes to certain conditions for those within, or aiming to join, the UK REIT regime are intended to alleviate particular constraints and administrative burdens, thereby enhancing the attractiveness of the regime for real estate investors (and particularly institutional investors). These will take effect from 1 April 2022.

The planned changes are:

• to remove the requirement for shares of a REIT to be admitted to trading on a recognised stock exchange in cases where specified categories of institutional investors hold at least 99% of the ordinary share capital of the REIT; qualifying institutional investors for this purpose include sovereign wealth funds, UK and overseas pension funds and life companies, UK REITs and equivalent non-UK REITs and limited partnership collective investment schemes with genuine diversity of ownership. In determining whether a non-UK REIT is “equivalent”, this will be assessed by reference to the entity itself rather than the overseas regime (which may not include an equivalent of the UK close company provisions);
• to remove the “holders of excessive rights” penalty charge, where property income distributions (“PIDs”) are paid to investors entitled to gross payment, such as UK resident companies; this penalty charge applies to PIDs paid to shareholders entitled to 10% or more of the share capital, dividends or voting rights in the REIT and is primarily designed to prevent loss of UK withholding tax on PIDs due to claims under the dividends articles of double taxation treaties.
• to amend the “balance of business” test in two respects:
  • allow non-rental profits arising because a REIT has to comply with planning obligations under section 106 of the Town and Country Planning Act 1990 to be disregarded when calculating whether at least 75% of a REIT’s profits relate to its property rental business; and
  • introduce a new “simplified” test so that, if group accounts for a period show that property rental business profits and assets comprise at least 80% of group totals, a REIT will not have to prepare the additional financial statements for each group company which would be required to meet the full test.

It was anticipated that the changes might also include a relaxation of the “close company” rule, which prevents close companies from being REITs unless they are close only because they have a participator who is an institutional investor. The second consultation raised the possibility of both extending the list of institutional investors, and introducing a close company “look through” approach similar to that used in non-resident capital gains tax rules.

However, the draft legislation contains no such change, with the response to the second consultation on the tax treatment of asset holding companies stating that this is due to general concern that such changes would have consequences beyond the immediate REIT rules. Due to the widespread support for extending the list of institutional investors and introducing a close company “look through”, the Government confirms it will continue to consider these changes as part of the wider funds review.

The policy paper, draft legislation and explanatory notes can all be found here.

Asset Holding Companies (“AHCs”)

A new measure will introduce a regime for the taxation of qualifying asset holding companies (“QAHCs”), and certain payments made by them. This follows an extensive consultation process to increase the attractiveness of the UK as an asset management hub, and is part of the Government’s wider review of the funds regime.

In brief, a QAHC must be at least 70% owned by diversely owned funds managed by regulated managers, or by specified categories of institutional investors, and exist to facilitate the flow of capital, income and gains between such investors and underlying investments.

The intention behind the regime is to minimise tax leakage in the QAHC. It seeks to provide investors in QAHCs with after-tax returns similar to those which they would receive if they invested in the underlying assets direct, and for the intermediate holding company (a QAHC) to pay no more tax than is proportionate to the activities it performs. The current design of the regime facilitates this by (very broadly) exempting certain profits and gains on disposals by QAHCs from corporation tax, allowing deductions for certain interest payments made by QAHCs to its investors that would usually be disallowed as distributions, and removing the obligation to withhold basic rate income tax from certain payments of interest to investors.

However most of the advantages of QAHCs will not apply to the extent that the company invests in UK real estate directly or indirectly. While real estate investments are permitted, UK real estate income and gains on disposals will be subject to corporation tax in the usual way – and similarly, many of the other tax benefits offered to, and for payments by, QAHCs will not apply to the extent that these relate to UK property. Further, any disposals by the QAHC of “UK property rich assets” (i.e. shares that derive at least 75% of their value from UK land) will be taxed in the usual way. As such, a UK REIT remains, in many cases, a preferable structure for real estate investment in the UK. Any capital gains or losses arising to a QAHC from non-qualifying items (eg UK real estate and shares in UK property rich companies) will be able to be reallocated to another member of the corporate group that is not a QAHC, or to the non-qualifying activities of a QAHC, as normal.

However, it is proposed that:

• the profits of an overseas property business of a UK resident QAHC will be exempted from corporation tax, where those same profits are subject to tax in an overseas jurisdiction; and
• there will be an exemption for gains on shares (other than shares in UK-property rich companies) and on interests in overseas real estate (although losses generated from such disposals will not be allowable against chargeable gains). Note in particular that it is not currently proposed that this exemption will be contingent on the disposal being subject to tax in an overseas jurisdiction – and so in this respect it is more generous than the analogous exemption for revenue profits.

Future detail may be provided on the need to accommodate REITs holding interests in AHCs and vice versa, as officials continue to work with stakeholders on this topic.

More detail can be found in our Law-Now on this topic here.

The policy paper, draft legislation and explanatory notes can all be found here.

Capital Allowances – Structures and Buildings Allowances (“SBAs”)

A relatively minor change has been made to the requirements for allowances statements necessary to claim SBAs, which are available for the cost of constructing, renovating, converting or acquiring non-residential structures and buildings.

Currently, the statements must include certain details such as the date the asset is first brought into non-residential use. Normally, this will be the date that the SBAs allowance period of 33 and 1/3 years commences. However, where qualifying expenditure is incurred (or treated as incurred) after the asset is brought into non-residential use, the allowance period starts on that later date. The change will add an additional requirement to record, where relevant, this later date on the allowance statement, to ensure that the correct amount of SBAs may be claimed over the allowance period.

VAT grouping – no changes

The Government was consulting on proposals for radical changes to the VAT grouping rules, including:

• potential mandatory group treatment for eligible entities;
• restricting the ability of managers to form VAT groups with limited partnerships. Currently this is possible if the manager is a group relationship with the general partner but under the proposed changes, the grouping test would have to be satisfied by reference to the partners as a whole; and
• possible changes to the grouping of companies with headquarters in one jurisdiction and a branch in another.

It has confirmed in its response to the consultation that it will not be proceeding with these changes.

What’s missing?

VAT treatment of lease break and dilapidations payments: guidance awaited

No updated guidance has been provided on whether HMRC considers that dilapidations and lease break payments are subject to VAT. By way of background, in September 2020, HMRC issued a Business Brief explicitly stating that (following two ECJ decisions) they now considered lease break payments and dilapidations payments to be within the scope of VAT. This was a reversal of their previous position. In January 2021, following several discussions with the real estate industry, HMRC withdrew this guidance with the stated intention that the revised position would be introduced in the near-future (and would no longer apply retrospectively). Several months later, no update has been provided.

Though HMRC has stated that any change in its view on the subject would no longer apply retrospectively, many landlords and tenants feel “left-in-limbo”, making it increasingly difficult to agree on an acceptable VAT position for both parties in relation to VAT on break payments and dilapidations. It was hoped that HMRC might use this opportunity of the publication of numerous drafts of legislation, new consultations, and responses to confirm its position.

Simplification of the VAT rules for land and property

No update had been provided in relation to the ongoing consultation process on the simplification of land and property VAT rules. The current call for evidence is focused particularly on the cost and administrative burden of complexities caused by (i) the exemption from VAT for most supplies of land and property (and specifically the many exceptions to this rule) and (ii) the availability of the option to tax and its associated process.

The call for evidence does not close until the beginning of August 2021, so it is perhaps not a surprise that no update has yet been provided, and this is one to watch out for later in the year.