The UK legislation in relation to the taxation of Real Estate Investments Trusts (REITs) was introduced some time ago now in Finance Act 2006, with the first date a company could become a REIT being 1 January 2007.
The general rules around the taxation of these types of companies has remained broadly the same, although minor aspects of the legislation have been amended over the years, and HMRC recently reformed an aspect of the compliance requirements that apply to REITs.
In this article we will look at an overview of these rules.
What is a REIT?
A Real Estate Investment Trust (REIT) is a property investment company that allows an investor to obtain similar returns from their investment to that which they would have received had they invested directly in property themselves. This provides an opportunity for people who would not want to or be able to buy a property outright to invest in a share of properties and benefit from receiving a return on the portion they own.
The concept of a REIT was first created in the United States in the 1960s, and a number of countries have since introduced equivalent provisions. In the UK, the relevant rules comprise CTA 2010 Part 12.
In order to become a UK-REIT, a company or a group of companies must comply with qualifying conditions set out in the legislation, being:
Company conditions – s528:
A. The company is a UK resident company
B. The company is not an open-ended investment company
C. The shares are listed on a recognised stock exchange
D. The company is not a close company or is a close company only because an institutional investor is a participator
E. The company has a single class of ordinary shares
F. The company is not party to certain non-commercial loans
Balance of business conditions – s531
A. At least 75% of the group’s profits must derive from the property rental business
B. At least 75% of the group’s assets must comprise assets or cash involved in the property rental business
How does a company become a REIT?
Where a company of group of companies satisfies the conditions above, they may apply to become a REIT which must be done in writing to HMRC, confirming the above conditions have been met and the accounting period from which the company wants to apply the REIT legislation.
Further conditions are required to be met in each accounting period to ensure the company remains in the regime. These are:
- The company must own at least three separate rental properties.
- No one property can be more than 40% of the total value of all properties in the business.
- At least 90% of the profits arising from the property rental business must be distributed.
Failure to meet these conditions may result in removal from the REIT regime at HMRC’s discretion. Failure to meet the first two of these conditions will not always result in immediate removal from the regime; as long as the condition is not breached repeatedly and it is a minor breach, the company will remain a REIT. However, failure to meet the third condition will result in an additional tax charge on the company.
A group REIT has an additional requirement to submit financial statements for each accounting period (see below for further details).
Withdrawal from the REIT regime
As well as automatic withdrawal from the regime, a company may choose to leave the regime at any time. This can be done by either the REIT company or principal company giving notice of withdrawal to the tax office that normally deals with the company or group. HMRC must be given the date the company wishes to leave the regime, which must be in the future.
Tax treatment of REITs
The property rental business (tax-exempt business) is ring-fenced from the rest of the activities (residual business) the company carries out. Therefore, losses arising in the exempt business cannot reduce profits of the residual business.
No corporation tax is paid on profits arising from the property rental business within a REIT. However, any profits arising from other residual activity will be taxed under the normal corporation tax rules.
As well as income arising in the property rental business being exempt from tax, any gains arising on disposal of assets that are used in the property rental business are also exempt. Similarly, a loss on disposal of such assets is not an allowable loss. Disposal of assets used in both the property rental and residual business are apportioned between the two businesses to determine how much of the gain or loss is taxable. However, if the total residual business use amounts to less than one year, this can be disregarded and the whole gain or loss may be exempt.
Where a company has invested in a REIT, any property income distribution (PID) it receives is taxed as income from a property business (as opposed to being exempt like normal company distributions).
Where an individual has invested in a REIT any PID they receive is treated (and is therefore taxable) as property letting income (as opposed to dividends).
REITs financial statements
For a group of REITs, the principal company must submit annual financial statements to HMRC on behalf of the group (s532 CTA 2010).
This submission must consist of the following:
- Financial statement for the group’s property rental business for the period
- Financial statement for the group’s property rental business in the UK for the period, and
- Financial statement for the group’s residual business for the period
where the ‘group’s property rental business’ includes property rental business of UK members of the group and UK property rental business of other members.
For statements 1 and 3 above the following information must be included for each member of the group:
- profits before tax (excluding gains or losses on property), and
- assets valued
- at the beginning of the accounting period,
- in accordance with IAS
- using fair value
- ignoring liabilities secured against or otherwise relating to the assets.
For statement 2 above the profits (calculated in accordance with s599) of each member of the group must be presented.
The first two statements are also used to determine whether the REIT has satisfied the balance of business condition and the financing cost ratio test. The third statement is also used for the financing cost ratio test.
Over the years REITs companies have been supplying the above information but as there was no prescribed format HMRC have been having difficulties assessing this information.
Therefore, recently HMRC have provided a tool that all REIT companies are required to use to ensure all REITs provide the relevant information in a consistent format. The tool will also calculate whether the balance of business conditions and the financing cost ratio tests have been met.
This tool is sent to the principal company once the company’s application to join the REIT regime has been accepted. Once populated it can be submitted electronically to HMRC.
Alphatax has been updated to allow this tool to be populated with ease. A group file with all REIT members within it will pick up most of the relevant data from within the company files and present this in a report in a format that resembles HMRC’s tool. Inputs are available to allow amounts not available in Alphatax to be entered and where possible a reconciliation check is applied to these amounts.
The values from the completed report can then be copied and pasted into the tool ready for submission.