A UK REIT is a highly tax efficient vehicle for property investment.
Unfortunately one of the qualifying conditions for a company to be a REIT is that the whole of its ordinary share capital must be listed on a recognised stock exchange (s 106(5), FA 2006). Accordingly it is not a practicable option for most property investment opportunities. A recognised Stock Exchange is the London Stock Exchange (although it needs to be remembered that AIM shares are dealt in but not listed on the LSE so do not qualify) and a number of designated overseas stock exchange. A list of these can be found in the HMRC Company Taxation Manual at para 60310. The other conditions for a company to qualify as a UK REIT are –
- it must carry on a UK property rental business,
- it must be resident in the UK (and not also resident in another country),
- it must not be an open-ended investment company
- it must not be a close company (or one that is non-close only because it is controlled by a non-close company or because shares held by a close company are treated as being held by the public) – indeed no person can beneficially own more than 10% without adverse tax consequences,
- it must have only one class of issued ordinary share capital and must have no other issued shares other than non-voting fixed rate preference shares,
- it must not have a loan creditor who is entitled to interest the rate of which depends to some extent on the results of all or part of the company’s business or on the value of any of the company’s assets or whose interest rate or rights on repayments exceed a reasonable commercial return.
A REIT is an ordinary limited company that notifies HMRC that it wishes to be taxed as a REIT. There are a number of administrative rules governing REITs a serious breach of which will enable HMRC to exclude the company from the REIT regime. A company that opts for the REIT regime is taxed as if it carried on two distinct activities, its tax-exempt property rental business and its other activities (if any). No tax benefits attach to the other activity.
The property rental business is exempt from tax on both rental income and capital gains. However the REIT is required to distribute at least 90% of its property rental income (but not capital gains) and those are taxed as property income, not as dividends in the hands of the shareholder. If the REIT distributes capital gains they are treated as income at shareholder level. The REIT is required to deduct tax at 20% on distributions (with exceptions, inter alia, for those paid to UK companies, charities and pension schemes). When a company comes into the REIT regime it has to pay an entry charge of 2% of the value of its rental properties. This charge can be paid by four annual instalments, but if this is done the overall charge increases to 2.19% to reflect the loss of interest to HMRC.
It is not possible to have a single property REIT. It must have at least three rental properties no one of which can exceed 40% of the combined value of all of its rental properties. There is also a limit on the REIT’s borrowings. There is a tax charge to the extent that the ratio of the REIT’s tax exempt profit (before capital allowances and financing costs) to its financing costs is less than 1.25 times.
A REIT is an ideal purchaser for a property investment company that is pregnant with substantial gains. Once it becomes a subsidiary of the RIET it can form a group REIT and, in effect, substitute the 2% REIT entry charge for the unrealised gains.
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