Budget: Open or closed property - a question of trust?

Details of the Promoting more flexible investment in property consultation - which forms part of the Budget announcement - suggests the Treasury will require 90% of income – before depreciation – from all investments, along with a potential 100% of rental income, to be given to investors in the PIF, in order to qualify products under corporation tax rules.

At the same time, however, the Treasury suggests elsewhere within the document PIFs could also be set to be exempt from corporation tax, so no firm tax route has yet be taken.

Following this morning's publication of the barket review into property development, the Treasury reveals proposals to try and open the UK rental property market to retail investment, as just 10% of UK property is in the buy-to-let market, compared with almost 50% in Germany and 25% in Denmark.

It is assumed rental income would not be chargeable through the PIF property management activities, and would therefore pass all income over to investors.

That said, there are several complex tax positions the Treasury could take, so guidance is being sought to establish whether PIFs could be treated in a similar fashion to unit trusts – where any income from investments are treated as a deductible expense within taxable profits.

The Treasury notes, for example, stamp duty land tax and stamp duty reserve tax are currently applied to property at between 1% and 4%, however, such a high level of tax could impact the investment potential of PIFs.

There is one route in particular the Treasury could take, however, that is unlikely as the government is likely to lose tax revenue if it chooses the capital gains route.

The Treasury suggests PIFs could be exempt from tax on realised capital gains and the PIF would be prevented from distributing capital to investors at least, until the investor’s units or share is sold.

This would allow investors to distribute their advantageous capital gains over several years rather than in one annual allocation, says the Treasury, but doing so will lose revenue for the Exchequer.

An additional complication is these “distributions” of income could also be classified as dividends, which would require only higher-rate tax payers levy the 32.5% dividend rate.

Non-UK-residents – or offshore funds - might also be able to find the advantages of PIF vehicles, as the Treasury says non-UK residents are not required to pay capital gains tax on the disposal of property.

Other changes to existing property vehicle rules already pull FSA consultation proposals, which have been looking at ways of widening the property asset restrictions on existing property funds.

Under current FSA rules, property investment funds are required to hold at least 20% of assets in “more liquid assets” to provide some form of liquidity and operational flexibility.

The Treasury recognises 100% investment in property could create problems for fund managers as assets would have to be disposed of in order to redeem an investor’s funds.

However, the Treasury suggests it could find a way around this problem perhaps by leaving the investment fund open rather than closing the fund.

Alternatively, the PIF could be set up as a listed company structure which pools investments as a new tranche of the fund, to open liquidity.

This has one major disadvantage in cost terms, suggests the Treasury, as a new prospectus would have to be issued each time additional capital is added.

The Treasury says it also needs guidance to determine whether PIFs should be allowed to invest in other PIFs, and how property within the new funds should be managed, as complications over trading and investment might make it difficult to assess what taxes are being paid and where.

IFAonline

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