Taxation of REITs ringing in the changes

United Kingdom

The UK REIT regime is widely regarded as the government’s flagship property investment regime. Given the growing trend to use ‘onshore’ vehicles for UK property investment and the impending increase in the corporation tax rate to 25% from 1 April 2023, tax-exempt REITs are likely to be used more and more. The draft Finance Bill 2021/22 contains some proposed changes to the REIT regime, which are being made alongside the introduction of the asset holding company rules, to remove unnecessary barriers and make it more competitive internationally. A further comprehensive review of the REIT rules is intended to form part of the government’s wider funds review.

The proposed changes to the REIT regime

Schedule 1 to the draft Finance Bill 2021/22 contains the first tranche of potential changes to the UK REIT regime in Part 12 of CTA 2010, namely:

  • a relaxation of the listing condition for REITs owned by ‘institutional investors’ (para 2);

  • an amendment to the definition of ‘overseas equivalent of a UK REIT’ for the purposes of the relaxation of the close company condition for REITs owned by institutional investors (para 2);

  • simplified balance of business profits and assets tests utilising an 80% gateway test; and an exclusion for profits resulting from various planning obligations (paras 3 and 4); and 

  • a relaxation of the holder of excessive rights provisions (commonly known as the ‘10% rule’) for shareholders who are entitled to receive gross ‘property income distributions’ from a REIT (para 5).

The amendments in paras 2–4 are intended to apply in relation to accounting periods that begin on or after 1 April 2022, and the amendment in para 5 with effect from 1 April 2022.

Background to the REIT regime and the proposed changes

The proposed changes in draft Finance Bill 2021/22 are dealt with in more detail below. However, to put them in context, it is worth first exploring the history of the REIT regime. For those who are less familiar with the REIT regime, a short summary of the conditions is included under ‘REITs explained’ (see the overview at the end of this article).

The REIT regime was introduced by the UK government on 1 January 2007 for a variety of reasons, including the need to have a tax efficient UK property investment vehicle to compete for global capital. International competition for capital was, and still is, an important driver; the burgeoning US REIT regime was established in 1961 and France had just introduced its own REIT regime in 2004, with a number of other countries having either recently introduced tax efficient REIT regimes or having substantially progressed their design. It was therefore important for the UK not to be left behind.

In 2007, 16 of the listed property groups converted to REITs, paying a conversion charge of over £1bn. The number of UK REITs slowly crept up to just above 20 where it remained until 2012, when the government made some significant improvements to the regime. As well as abolishing the REIT conversion charge, the government introduced a relaxation to the close company condition, which now allows REITs to be owned by one, or a small number of ‘institutional investors’ such as sovereign wealth funds, collective investment schemes operated as limited partnerships, UK and overseas pensions schemes, life companies, REITs, authorised unit trusts etc. (CTA 2010 s 528(4A)). The reason for this change was to attract, particularly overseas, institutional capital into the UK built environment. These, and other improvements, revitalised the UK REIT regime and now there are circa 100 REITs, around 30 of which are owned by institutional investors.

REITs were originally intended to be widely held by retail and institutional investors, with a public listing on a stock exchange providing liquidity for those investors and a platform for REITs to raise additional capital from those investors. However, the new breed of post-2012 REITs owned by institutional investors were still required to have their ordinary shares admitted to trading on a recognised stock exchange (the ‘listing condition’ in CTA 2010 s 528(3)), despite them not requiring any immediate liquidity in their shares. Because such REITs still needed to satisfy the listing condition, they would typically list their shares on The International Stock Exchange (TISE), which does not require there to be any trading in the shares, nor does it require 25% of a UK REIT’s shares to be held by the public (unlike, for example, the London Stock Exchange). For those REITs owned by institutional investors, the listing is of no obvious benefit to the REIT or its investors, so the legislation in Schedule 1 para 2 of the draft Finance Bill attempts to relax the listing condition for such REITs. This is examined in more detail below.

Relaxation of the listing condition is the change which is most likely to enhance the attractiveness of UK REITs to UK and overseas institutional investors. Although the other changes (contained in paras 2–5 of Sch 1) are likely to have less impact in this respect, they are nevertheless very welcome. These changes are also examined in more detail below.

The changes in more detail

All references to sections are to CTA 2010 and to ‘paras’ are to Sch 1 of the draft Finance Bill 2021/22, unless otherwise stated.

Relaxation of the listing condition (para 2)

The government is proposing to remove the listing requirement for REITs that are wholly or almost wholly (that is, at least 99%) owned by institutional investors. Where an institutional investor is a collective investment scheme operated as a limited partnership, it will be subject to a genuine diversity of ownership (GDO) requirement for this purpose.

To avoid creating a cliff-edge where REIT status could be terminated immediately following a change of ownership (for example, if a pension fund sold some or all of its holding in a REIT exempted from the listing requirement to a non-institutional investor), a period of one year for the REIT to meet the listing condition in s 528(3) (i.e. for its shares to be admitted to trading to a recognised stock exchange) after such a change of ownership is proposed.

However, the proposed relaxation as currently drafted would seldom be of benefit in practice for a number of reasons:

  • Institutional investors often invest in a REIT via a limited partnership because it provides a flexible way for regulating the commercial relationship between themselves (and between themselves and the fund managers, if applicable). However, usually such limited partnerships would not satisfy the GDO requirement so, as currently drafted, the REIT and its investors would not be able to enjoy the benefit of the listing condition relaxation.

  • Institutional investors are not normally the direct owners of a REIT’s shares, but instead invest via a ‘topside’ structure for legal reasons, or simply because they need to fragment their interests in order to comply with the ‘10% rule’.

  • Non-institutional investors may well own more than 1% of a REIT, either as fund managers ‘with skin in the game’ or because they are investors that do not fall within the strict legislative definition of an ‘institutional investor’ in s 528(4A).

The simplest solution here would be for the government to link the proposed relaxation of the listing condition for REITs owned by institutional investors to the pre-existing relaxation to the close company condition for such REITs, which is found in s 528(4)(b). If this were done, the listing relaxation would always apply when the close company condition relaxation applies.

An alternative solution would be to introduce a tracing provision into the current draft legislation set out in para 2, which would allow ownership to be traced up to the ultimate (institutional investor) owners of a REIT. This could be along the lines of the ‘indirect participator’ provisions in the non-resident CGT legislation in TCGA 1992 Sch 5AAA para 46. However, this would involve additional complex legislation and, because it will differ from the close company relaxation in s 528(4)(b), would mean that the listing condition relaxation and the close company condition relaxation could be out of step with each other: a REIT owned by institutional investors might enjoy one relaxation but not the other. Furthermore, the 99% threshold would need to be reduced to enable the majority of such REITs to enjoy the listing condition relaxation.

The government is informally consulting with stakeholders in relation to the draft legislation in a constructive way, so hopefully any redraft of the legislation will result in the listing requirement being removed where listing brings no obvious benefit to REITs or their investors.

Overseas equivalent of a UK REIT (para 2)

The government says that it will consider making changes to the close company condition for institutional investors in due course, as part of the ‘wider funds review’. However, in the meantime, it has proposed to make a change to the ‘overseas equivalent’ rule by removing the reference to the ‘law of the territory’ and by providing updated guidance in the Investment Funds Manual. The guidance would reference the OECD Commentary on article 10 of the Model Treaty which states that a REIT may be loosely described as a widely-held company, trust or contractual or fiduciary arrangement that derives its income primarily from long-term investment in immoveable property, distributes its income annually and does not pay income tax on the income related to immoveable property that is so distributed.

This a welcome change. HMRC interprets the current legislation as requiring a comparison of the relevant overseas REIT regime with the UK REIT regime and, in particular, whether the overseas REIT regime contains rules which are as restrictive as the UK close company legislation in CTA 2010 Part 10 (as modified for REIT purposes by s 528(5)). This ‘overseas regime versus UK REIT regime’ approach has resulted in HMRC treating a number of REITs from well-established overseas REIT regimes as not being institutional investors, despite them not being close companies under UK legislation.

The balance of business condition (paras 3 and 4)

The balance of business condition ensures the focus of a REIT is on holding and managing property, while recognising that it might undertake some ancillary activities. In order to meet this condition, a REIT must pass both a balance of business ‘profits test’ and an ‘assets test’ which, very broadly, require at least 75% of a REITs profits and at least 75% of its assets to relate to its property rental business (s 531). These tests require detailed REIT financial statements (together with mandatory adjustments) to be prepared for each group member (ss 527(2)(e), 532, 533 and SI 2006/2865), which can be an onerous administrative exercise, particularly because most REITs pass the 75% threshold by a large margin.

The proposed change is to introduce a gateway test based on consolidated accounts, so that a REIT would only have to prepare all the required financial statements for each group member if it failed the gateway test. This gateway test would allow completion of a single statement for the group’s property rental business and a single statement for the group’s residual business. If these statements show group property rental business profits or assets to be 80% or more of total group profits or assets, the full financial statements for each group member will not be required. The proposal is that this is a two-part test, with one part for profits and one for assets. If only one part is failed, then the full test is only required for that part.

A further change to the balance of business condition is to extend the list of exclusions from profits taken into account for the profits test, by adding to that list residual business profits resulting from compliance with planning obligations entered into in accordance with the Town and Country Planning Act 1990 s 106. This would mean that such profits would be left out of account when applying the balance of business profits test. Currently the draft legislation only excludes such profits from the balance of business profits test, but hopefully the draft legislation will be amended so that it also excludes related assets from the assets test.

Relaxation of the holder of excessive rights provisions (‘10% rule’) (para 5)

The holder of excessive rights (HoER) rule in ss 551–554 prevents loss of tax to the UK exchequer that might otherwise arise as a result of the operation of the UK’s double taxation agreements. A holder of excessive rights is defined in s 553 as being a person who is beneficially entitled to at least 10% of the distributions, at least 10% of the share capital or controls at least 10% of the voting rights; where that person is a company or body corporate (as defined).

A company or body corporate that is a HoER typically fragments its shareholdings to remain under the 10% limit, so that the REIT does not need to pay a penalty (‘HoER charge’) under s 551 on distributions made to such shareholders. This is even the case where those investors are entitled to receive gross property income dividends (commonly known as PIDs) where there can be no loss of tax. Accordingly, it is proposed that changes are made to the HoER rules to exclude those investors to whom PIDs can be paid gross under SI 2006/2867 reg 7, when considering whether a HoER charge should be applied.

Interaction of the asset holding company and REIT regimes

The draft legislation may need to accommodate REITs holding interests in asset holding companies and vice versa. The government will continue to work with stakeholders in this respect.

What next?

The welcome changes set out above should only be the first tranche of changes to make the UK REIT regime more attractive. The government is also carrying out a wider funds review, under which it is considering some further changes such as:

  • abolishing the REIT interest cover test in s 543, which is regarded as unnecessarily burdensome since the introduction of the corporate interest restriction in TIOPA 2010 Part 10;

  • modernising the ‘three-year development rule’ in s 556, which applies when a REIT carries out significant development and disposes of the property within three years of completion of the development;

  • abolishing the requirement in s 529 for a REIT to hold at least three properties, which has proved an obstacle to holding, for example, a substantial single logistics warehouse in a REIT; and

  • removing some unfair tax inefficiencies that arise where a UK member of a group UK REIT holds overseas property.

The government should also seize the opportunity in the wider funds review to broaden the asset classes that a REIT can invest in; for example, to support the government’s net zero carbon agenda and its communication and infrastructure strategy.

REITs explained


Broadly, a UK REIT is a normal UK resident company that simply elects into a special tax regime which exempts property investment profits and gains; together with some (or all) of the UK gains on disposals of shares in ‘UK-property rich’ companies. All other activities are taxable in the usual way.


In return for the tax exemption, a REIT must meet various conditions, which are summarised below in relation to a group UK REIT.


Company conditions


The principal company of a group UK REIT must satisfy the following:

  • tax resident only in the UK (although it can often be incorporated elsewhere);

  • not be an OEIC;

  • share capital admitted to trading on a ‘recognised stock exchange’ (and shares either ‘listed’, or traded each accounting period);

  • not be a ‘close company’, or only be close because it has a shareholder that is a qualifying institutional investor;

  • one class of ordinary share capital (non-voting restricted preference shares also permitted); and

  • no ‘non-commercial’ loans (e.g. profit participating loans).


Distribution condition


The principal company of a group UK REIT must distribute:

  • 90% of the group’s property rental business profits (calculated on a tax basis);

  • 100% of distributions received from other REITs; zwithin 12 months of the end of each accounting period;

  • by way of cash dividend, or shares issued in lieu of cash; and

  • exempt capital gains on disposals of properties or shares do not need to be distributed.


A key concept behind the REIT regime is to move the incidence of tax on profits and gains of a REIT’s property rental business from the REIT itself, to its shareholders. To facilitate this, withholding tax is deducted from distributions of a REIT’s exempt profits (except, for example, to pension funds), but this withholding tax can usually be:

  • recovered in full by some investors (e.g. tax-exempt investors and sovereign wealth funds);

  • recovered in part (e.g. under a tax treaty); or

  • deducted in calculating a shareholder’s tax liability.


Property rental business conditions

The property rental business of a group UK REIT must:

  • involve at least three properties (broadly, three lettable units); and

  • no single property (or unit) must represent more than 40% of the value of those properties.


The group’s balance of business:

  • profits of property rental business (which excludes specified items) must be at least 75% of the aggregate profits of the group for each accounting period; and

  • the fair value of assets of property rental business (which includes all cash and investments in other REITs) must be at least 75% of the fair value of the aggregate assets of the group at the beginning of each accounting period.


Further points

  • The REIT regime allows for ‘minor breaches’ of some of the above conditions.

  • A REIT must produce special REIT ‘financial statements’ each accounting period to help HMRC monitor compliance with the above conditions. These are submitted electronically using HMRC’s REIT financial statement tool.

  • In some circumstances, gains on the disposal of a property within three years beginning with completion of development, may not be exempt (including by way of disposal of shares).

  • A REIT may suffer a penalty tax charge if it makes a distribution to a company or body corporate which, very broadly, has a beneficial interest of at least 10% in the REIT. However, HMRC has approved several ways for such investors to hold their shares so that a REIT does not suffer a penalty in practice.

  • A REIT may also suffer a penalty tax charge to the extent its ratio of property rental profits to finance costs is less than 125% (capped in some circumstances).


This article was originally published in the 3rd September issue of Tax Journal.