The UK real estate investment trust will pay an income net of 22% tax, even to offshore investors, so the existing Guernsey Reit, which pays at gross, has a big advantage
The booming global property investment market has made Real Estate Investment Trusts (Reits) one of the fastest expanding areas of stock markets since 2000, particularly in the US, but also in Japan and France where they were launched in 2001 and 2003 respectively.
The UK Government has now committed to introducing UK Reits in the 2006 Finance Bill and they are the most hotly anticipated investment vehicle in the UK property sector.
However, Guernsey Real Estate Investment Trusts (Greit) have always been available to UK investors and it is estimated more than £3bn is now held by listed property companies in Guernsey.
These companies are readily available to UK investors and provide most of the benefits of a Reit not only from a taxation perspective but also from an investment diversification perspective.
The considerable increase in Greits illustrates the potential for an onshore equivalent structure. But within this, there are a number of conditions a company must satisfy in order to become a UK Reit as well as problems with the current draft legislation and the issues affecting a conversion of a Greit to a UK Reit.
To qualify as a UK Reit an entity must:
Be a closed-ended, but not a closely-held company, resident in the UK, which is publicly listed on a recognised stock exchange.
Separate out its income between taxable and non-taxable portions, referred to as ring-fenced (non-taxable) and non ring-fenced (fully taxable).
Distribute at least 95% of its ring-fenced profits to investors and to withhold basic rate tax on these distributions to all shareholders whether UK resident or not.
In addition to this, the ring-fenced portion of the UK Reit should represent at least 75% of the entity's activity by income and assets. The Reit will also be subject to an interest cover test on the ring-fenced part of the business and no person (including an individual or body corporate) will be allowed to control, either directly or indirectly, 10% or more of the UK Reit's share capital or voting rights.
Although the draft legislation has been welcomed as a step forward for the UK, there are still a number of important questions that remain unanswered.
The UK Government is keen to ensure the switch to Reits is revenue neutral for the Exchequer but that the tax effect of the regime should replicate, so far as possible at shareholder level, direct investment in UK property. Consequently, a conversion charge will be imposed on property companies wishing to convert to a UK Reit.
The cost of entry is likely to be the key consideration for most UK companies and any existing offshore property funds in the short term, but the Government has given no indication how the conversion charge will work in practice. For companies wishing to convert to Reit status the cost will need to be measured against the benefits of the new regime.
A UK Reit will treat all distributed income and capital gains from property investment as income and will withhold a 22% basic rate tax on distributions made to shareholders including non-UK residents.
This is unlikely to be attractive to non-UK residents as they currently pay no tax on gains. It is also not clear how this condition relates to the UK's obligations under certain double taxation treaties.
In the past, success for property companies has been demonstrated by increased net asset values and, as such, companies have tended not to pay significant amounts of dividends.
All Reit for some
However, in other countries Reit shares are held as an income stock and investors expect a high dividend flow from them. Property companies that want to convert to a UK Reits will therefore have to adopt a significantly different business model. The costs of doing so could be prohibitive.
The Government has opted not to specify mandatory gearing requirements. Instead, in relation to its ring fenced business the UK Reit will be subject to tax on any amount where the interest payable exceeds an interest cover ratio of 2.5, on its ring-fenced business.
It is not clear how or why shareholders holding more than 10% of current UK property companies would want to reduce their holdings so that the company in question could convert to a UK Reit.
Given the problems with UK Reits, Guernsey continues to be attractive to promoters of real estate funds. Over the years Guernsey's administrators have developed a sophisticated infrastructure for the administration of Greits and have developed considerable expertise in this area and the regulatory process for these is well understood and clear.
There is a fast track process for the approval of funds with the recent introduction of 'qualifying investor funds', which enables funds to be self-certified by the Guernsey administrator.
The Channel Islands Stock Exchange (CISX) also provides a listing route for Greits, which means Guernsey can act as a one-stop-shop for their establishment and admission to listing. The CISX is recognised by the Financial Services Authority and the HM Revenue & Customs, which allows Sipps and Isas to invest in CISX listed Greits. There are already more than 20 property vehicles listed on the CISX.
Greits can also be listed on the LondonStock Exchange or the Alternative Investment Market. They can be established as closed-ended companies or open-ended investment companies and qualify for tax exempt status. Any income from dividends is paid gross and any capital disposal within it is free from capital gains tax.
There is also no restriction on the diversification of a portfolio provided there is an adequate spread of risk and there is also no restriction on the type of property business a Greit can undertake. There is also no gearing levels imposed on Greits.
However, Greits listed on the London Stock Exchange cannot borrow more than 65% of the company's gross assets. But the UKLA listing rules do not preclude a company from seeking shareholder consent to alter its articles of association after admission. Therefore, the shareholders can, in theory, set whatever level of gearing they feel is prudent.
There is no requirement under Guernsey law or regulations for a shareholder in a Greit to be limited to only a 10% holding.
Greits that are already readily available to UK investors provide most of the benefits of a UK Reit not only from a taxation perspective but also from an investment diversification perspective. For this reason, it is unlikely the introduction of Reits in the UK will have any significant effect on the number of Greits coming into Guernsey.
Even if the legal framework for UK Reits goes as far as the UK funds industry wants it to, it is likely the two will happily co-exist alongside each other.
There is also nothing to stop clients formulating their own plans for UK Reits by setting up Greits that closely mirror the conditions laid down in the draft legislation in preparation for converting them into a UK Reit in the future.
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