REITs - the new regime takes shape
The Government has announced the full details of the Real Estate Investment Trusts (REITs) regime, which will be available from 1 January 2007. Most of the details had already been published, but the recent announcement filled in some crucial gaps and made some other important changes.
REITs are part of the Government’s strategy to encourage investment in property by a wide range of investors. They are intended to allow small investors to invest in property more efficiently and more flexibly than at present. Significantly, they are intended not to cost the Exchequer any money, and they are intended to give broadly the same tax result as direct investment in property.
The key features of REITs will be:
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REITs will be UK resident companies and will be listed on a “recognised stock exchange”;
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No shareholder will be allowed to hold more than 10% of the shares in a REIT;
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When an existing property company converts into a REIT, it will have to pay a tax charge of 2% of the value of the property owned by the company;
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REITs will not pay tax on property rental income or chargeable gains;
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REITs will have to distribute at least 90% of rental profits to investors, who will pay tax at their normal rates;
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REITs will have to have rental profits of at least 1.25 times their loan interest payable.
The 2% conversion charge has attracted much comment, and the general feeling is that it is low enough to make it worthwhile for many existing companies to convert. However the 10% upper limit on shareholdings, though less remarked upon, will have a very large impact on which companies become REITs, and which investors are interested in using them. The basic position is that most family companies cannot become REITs. Very wealthy investors who are in a position to buy large commercial properties will not start to use REITs for such purchases. However a great many fairly wealthy individuals will be able to invest in property and spread their risk far more widely than at present. It will be possible for a group of people to come together and form their own REIT. Shares in such an entity may not be a very liquid investment, as it may take a long time to sell them, but this could nevertheless be a suitable vehicle for investment in a small property portfolio.
Although REITs are not intended to be tax-saving devices, they will create a saving for many investors. Large companies pay Corporation Tax at 30%, leaving 70% of profits for distribution to shareholders. The income tax on dividends is, for higher-rate taxpayers, 25% of the dividend, which is 17.5% of the pre-tax company profit distributed. This gives an overall tax charge of 47.5%. By contrast, REITs will not pay any tax on their property profits or gains, and the shareholders will pay tax at 40% on distributions. Similar savings will arise for basic rate taxpayers, and tax-exempt investors such as pension funds will not pay any tax at all on REIT dividends. This may encourage existing listed companies to convert into REITs.
It seems that REITs will be attractive for many investors, allowing them to receive the benefits of investing in property while spreading their risk across a large portfolio.
FOR FURTHER INFORMATION PLEASE CONTACT: ALASTAIR JOHNSTON
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