Budget 2006 - Items of interest to the property industry
22 March 2006
Items of Interest to the Property Industry
REITS: Better than expected news
The Chancellor of the Exchequer announced the introduction of UK REITs with effect from January 2007, together with some important modifications to the rules previously announced in draft legislation. The Treasury has clearly listened to representations from the property industry in the course of the consultations that have taken place.
In summary:
- a REIT will be required to distribute 90% (rather than the previously suggested 95%) of its tax exempt income each year
- the ratio of interest on loans to rental income has been reduced to 1.25:1 (from the previously suggested 2.5:1)
- the conversion charge will be by reference to gross assets on the day of conversion ¨C a 2% charge payable in instalments over four years
- there has been a softening of the line on breach of the rules
The other requirements to qualify as a REIT have remained largely unchanged.
The lower distribution requirement will make it easier to manage a REIT's affairs and its cash flow requirements. The reduced interest cover test means that there will be much greater flexibility in gearing a REIT ¨C depending on the rental yield and financing cost involved, the new test represents a loan to value ratio in the region of 60%.
Breach of the conditions for being a REIT will no longer lead to automatic removal of the company from the REIT regime. For example, the rule that no shareholder can directly or indirectly own more than 10% of the share capital or voting rights of the company is no longer a condition for being a UK REIT. It is now a test for which failure leads to a tax consequence. That is, if a UK REIT did make a distribution to a person owning more than 10% of its shares, this will not result in the REIT losing its status. Rather, the REIT will be liable to tax in proportion to the interests of the 10% owner. Significantly, no tax consequence will follow if the REIT can show it had taken "reasonable steps to avoid paying distributions" to substantial shareholders. HMRC have commented that provisions in the REIT's Memorandum and Articles of Association requiring a person holding more than 10% of the shares to "enter into a transaction that removes beneficial ownership of the dividend" will constitute "reasonable steps" taken by the REIT.
Similarly, a tax charge will arise for breach of the finance ratio, while in the case of breach of other conditions there will be a grace period to enable the company to rectify the situation.
The conversion charge is impossible to comment on and it will be for each company contemplating conversion to decide whether it is acceptable or not. The converting company will be able to elect to pay the charge by instalments of 0.5% (year one), 0.53% (year two) 0.56% (year 3) and 0.6% in the final year. However, although this looks as though it may be an acceptable cost of conversion it has to be compared with the particular assets on any company's balance sheet and the gains that would be crystallised if they were sold. Companies may find that the capital gains tax they would incur if they disposed of all their properties would be less than the conversion charge.
Whether the concessions the Chancellor has now made are enough to entice the investment market place remains to be seen, given that there are still considerable attractions in setting REITs up offshore and out of the UK tax net (and its attendant complications) altogether.
Stamp duty land tax measures
The Chancellor's Budget Statement includes a number of new measures and reforms affecting SDLT.
S64A: Withdrawal of "Seeding Relief"
The Government considers that there has been misuse of the relief enabling properties to be transferred to a unit trust with no existing assets and in consideration only of an issue of units. In extreme cases it would have been possible to simply transfer a property into a unit trust and sell the units immediately, with the result that no SDLT or Stamp Duty was payable.
The relief has been withdrawn with effect from 2pm on 22 March, but with the promise of transitional provisions that may protect existing contracts. Going forward, the transfer of property to a unit trust will give rise to a tax charge by reference to the market value of the property.
Whether the transitional provisions will assist in many cases remains to be seen. The relief will still apply where a contract to transfer the property to the trustees has been entered into and substantially performed (that is, completed) before 2pm on 22 March, or where the transfer is pursuant to a contract entered into before that time as long as the transfer is not an "excluded transaction". According to the HMRC press release, excluded transactions include circumstances where the unit trust was not established before the time the relief was withdrawn, or the trust contained no assets (or virtually no assets). If that condition is enshrined in the legislation then it is difficult to see how any transaction could attract the transitional relief proposed since one of the conditions of the exemption in S64A was that the unit trust should have no assets prior to the contribution. It is understood that HMRC are re-drafting the transitional provisions to remove this apparent nonsense.
SDLT: simplifications and clarifications
A number of common transactions that give rise to difficulties from an SDLT point of view are to be taken outside the scope of the tax altogether. These include situations such as the payment of a landlord's costs on the grant of a lease, or the variation or termination of a lease.
More significantly, partnerships that are carrying on a trade (other than dealing in or developing land) or a profession and which own land are to be taken out of the SDLT regime. Under the existing rules applying SDLT to partnerships, changes in the make up of a partnership or changes of interests in a partnership give rise to potential tax charges where the partnership owns land. This has led to huge complexity and potential financial hardship, for example where farming partnerships are involved.
The decision to take partnerships that own land as an incidental to their trade or profession out of the SDLT net altogether is to be welcomed.
Other welcome clarifications concern the rules on variations in rent so that tax charges are restricted to variations in the first five years, the rules on backdating leases expressed to commence on the expiry of a previous lease and the notification of assignments of leases of less than seven years.
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Robert Field
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