Taking a broader view, these changes, combined with changes to the UK's Double Taxation Treaty with Luxembourg now in force, may increase the attractiveness of holding UK real property in a UK REIT.
Why a REIT?
Qualifying UK REITs are exempt from UK corporation tax on profits and gains from UK property rental business, but must distribute at least 90% of that income to investors. UK REITs are therefore potentially attractive as UK real property investment vehicles that are not looking to roll up any gains.
Historically, however, the conditions for becoming a REIT had made the regime unsuitable in many cases. For example,REITs were required to hold multiple properties and be listed on a recognised stock exchange. This made it difficult for REITs to be owned by partnerships and caused potential issues for UK REITs owned by complex corporate structures. As such, the take up of REITs was, for a long time, rather limited.
It became possible for UK REITs to be unlisted from 1 April 2022 (subject to conditions on ownership). Since then, the Government has implemented two further rounds of relaxations.
What recent changes has the Government introduced?
Effective from 11 July 2023 (or from 1 April 2023 in some cases), the Government introduced a number of important relaxations to the UK REIT rules and in particular:
- a UK REIT can now be established holding only a single commercial property valued at £20 million or more (rather than being required, in all cases, to hold at least three properties); and
- a UK REIT can now distribute income from its corporation tax exempt property rental businesses to partnerships without applying the usual 20% withholding tax to the extent that the members of that partnership would have been entitled to be paid gross (e.g. UK corporation tax paying companies) if payments were made directly to them.
More REIT changes ahead
From other prospective changes announced, it appears that the Government's relaxation of the UK REIT regime is part of a genuine direction of travel.
Notable changes that are intended to take effect from the date of Royal Assent of the Finance Bill 2024 include:
- making it easier for a UK REIT holding a single property to meet the £20 million value condition discussed above (by broadening the period within which that requirement can be met); and
- relaxing the ownership conditions applying to unlisted REITs so that they can more easily be met in the context of complex corporate structures.
The overall effect of these changes has not been to make the REIT regime simple; the rules remain complex. They do, though, fundamentally broaden the range of scenarios in which REITs can be used. Before 2022, REITs were effectively forced to operate as funds with both a diverse ownership and a diverse portfolio.
REITs can, of course, still be used in the traditional way as listed entities but can now also operate as a vehicle for a single institutional investor to invest in a single property, very much moving REITs into the world of private investment.
Other tax changes influencing the UK real estate landscape
Alongside the Government's reform of the UK REIT regime, there are other changes that could make UK investment vehicles, such as UK REITs, more attractive to UK real property investors.
Historically, it had been common for UK property to be held by offshore vehicles. While this may still be appropriate in some cases, recent changes have substantially reduced the potential benefit. The most significant of these was the introduction of rules taxing the gains on disposals of UK property and UK "property-rich" vehicles by non-UK residents from 6 April 2019. This followed narrower rules in place from 6 April 2015 that taxed non-UK residents only in relation to the disposal of residential property.
These rules were designed to ensure that disposals of UK property would always be subject to UK taxes regardless of how the property was held or the residence of the holding structure. In reality though, it was relatively easy to subvert their application through the use of certain double tax treaties. The most notable, and widely used, example of these was the treaty with Luxembourg, which trumped UK domestic law and relieved Luxembourg residents of UK tax on gains on shares, regardless of the underlying assets those shares represented.
It is notable, therefore, that a new UK/Luxembourg double tax treaty was signed in 2022, and will be fully in force by April 2024. The new treaty results in Luxembourg tax-resident property holding vehicles now being within the scope of UK tax on chargeable gains on indirect disposal of UK real property.
There does, therefore, appear to be a concerted strategy on the Government's part to both remove tax advantages for non-UK vehicles and to increase tax advantages for UK vehicles (the recent introduction of the Qualifying Asset Holding Company is another example of this).
Even post relaxation, REITs remain complex vehicles subject to detailed rules and conditions. The tax advantages they offer are significant, but fall short of true transparency. They are, however, an increasingly viable and attractive structure and should now always be given realistic consideration when considering any new UK property holding structure. It remains to be seen whether any further changes will increase their attractiveness even further.
Taking advantage of these changes
The DWF Tax team has extensive experience of working with REITs and would be happy to discuss the tax consequences and practicalities of converting your business into a UK REIT. To find out more, please contact Jon Stevens, Tom Rank, Alex Tolcher or speak to your regular DWF contact.