Government’s response to the REITs consultation
REITs update, 4 October 2011
HM Treasury update
Following the consultation on proposed changes to the REIT regime announced in this year’s Budget, HM Treasury has today published an overview of the results of the consultation and an update on further policy decisions.
The only significant announcement is that a fixed grace period of 3 years has been set for meeting the non-close company requirement. Other areas of reform have been confirmed in line with the original Budget proposals. Draft legislation containing the detailed provisions will be published on 6th December 2011.
Although the new rules will not take effect until the Finance Bill becomes law (expected late July 2012), this is a welcome update. In particular, it will enable those considering REIT conversion in light of the proposed changes to plan ahead with greater certainty.
The proposed changes to the REIT regime are far-reaching and will significantly increase the attractiveness of the regime to a wider investor pool than has previously been the case. The changes are aimed at reducing barriers to entry and investment in REITs, and reducing the regulatory burden for current and future REITs. Tax efficient REITs may soon become the default investment vehicle of choice.
Confirmed policy decisions, and our initial reaction to them, include:
- Diverse ownership rule for institutional investors. This change to the current ‘blunt’ close company rule will enable small ‘clubs’ of diversely-owned institutions to form REITs. However, the definition of ‘institutional investors’, and whether this will be an amendment to the existing close company rule or a new REIT-specific rule akin to the US 5/50 test, has yet to be confirmed.
- Fixed 3 year grace period for new REITs to meet the non-close company requirement. This grace period will enable start-up or closely held / family-owned REITs to build sufficient reputation to attract new shareholders without prejudicing their ability to enter the regime. HM Treasury has confirmed that, other than a loss of REIT status, there will be no further penalty if the close company rules are not met by the end of the grace period (assuming no initial tax advantage motive). The listing requirement will still apply during the grace period.
- Abolition of the 2% conversion charge for companies entering the regime. This is welcome news for all current and future REITs, and in particular will make the ‘on-shoring’ of UK properties that are currently held offshore (and already outside the scope of Capital Gains Tax) much more attractive.
- Relaxation of the requirement for a REIT to be listed on a ‘recognised stock exchange’. This relaxation will enable AIM and PLUS market (and EU equivalent) traded companies to obtain REIT status without requiring e.g. a full London listing.
- Cash to be a ‘good’ asset for the purposes of the balance of business assets test. This will make it easier for start-up REITs to raise funds to be spent over time, as well as for existing REITs to raise additional capital from shareholders.
- Redefinition of “financing costs” for the REIT interest cover test. HM Treasury has confirmed that it is interest paid on excessive borrowings that will be measured in the test, rather than the total finance costs incurred in borrowing. However, we will have to wait for the draft legislation to see how ‘interest paid’ is defined, e.g. whether it is a tax or accounting based definition.
- Extending the time limit for complying with the distribution requirement from 3 months to 6 months.
We also understand that HM Treasury is looking into proposals to introduce mortgage REITs and social housing REITs. In the current economic environment, extension of the REIT regime to include these forms of investment would be a positive move for both property lenders and investors.