Section 66 and Schedule 34: Real Estate Investment Trusts
Summary
1.Section 66 and Schedule 34 amend provisions in Part 4 of the Finance Act (FA) 2006 relating to Real Estate Investment Trusts. The following areas are covered in the Schedule:
a new measure to stop exploitation of the Real Estate Investment Trust (REIT) regime where businesses restructure to gain the benefits of the regime;
the Schedule removes an unintended barrier to joining the regime;
the Schedule allows that a charge to tax incurred by a REIT for breaching the profit finance cost ratio may be waived in particular circumstances; and
the remainder of the Schedule clarifies and makes more consistent the existing legislation.
Details of the Schedule
2.Paragraph 2(1) amends section 104 of FA 2006 by introducing a new subsection (3). Subsection (3) allows a business with ‘tied premises’ to treat the rental income from those premises as part of the property rental business of a REIT. (‘Tied premises’ are where a company supplies goods to a third party for sale on premises which the company rents to the third party. For example pubs may be tied premises.) Before the amendment such income would have been trading income and not eligible to be in the REIT regime.
3.Paragraph 3 amends two subsections of section 106 of FA 2006 (Conditions for Company).
4.Paragraph 3(2) allows that two of the conditions of section 106 do not have to be met on the first day the REIT joins the regime.
5.Paragraph 3 (3) and (4) allow REITs to issue convertible preference shares where previously they could not. The amendments also make consequential amendments concerning the definition of these shares arising from changes to Income and Corporation Taxes Act 1988.
6.Paragraph 4 amends section 108 of FA 2006 (Conditions for balance of business) to align the conditions for the balance of business asset test for a single company REIT with those for a group REIT.
7.Paragraph 4(1) amends the condition for single companies by removing the condition that the asset has to be property involved in the relevant property rental business and inserting the condition that the asset has to be one that would be in the accounts of the tax exempt property rental business.
8.Paragraph 5 amends section 109 of FA 2006 (Notice), which is about the conditions in section 106 that are to be met on joining the REIT regime. Section 109 allows that Condition 3 of section 106 (the company being listed on a recognised stock exchange) and Condition 4 (that the company is not a ‘close’ company) do not have to be met on joining the regime provided that:
Condition 3 is met on the first day the REIT is in the regime; and
Condition 4 is met after the first day in the regime.
Previously section 109 tied these two conditions together. The amendment breaks this link.
9.Paragraph 5(2) inserts into section 109 subsections (2A)-(2C) to allow that Condition 3 of section 106 (the REIT not being listed on a recognised stock exchange) can be relaxed if the REIT provides assertions that this condition will be met apart from on the first day and the other conditions of section 106 will be met throughout the accounting period.
10.Paragraph 5(3) amends section 109 by removing the subsection that resulted in the two conditions being tied together.
11.Paragraph 5(4) amends section 109(5) to change the assertions to be provided by the REIT in the circumstance when Condition 4 of Section 106 (the company not being a close company) is not met on joining the REIT regime.
12.Paragraph 5(5) allows, having separated the two conditions, the possibility that both conditions are not met on the first day and details the assertions to be provided in this circumstance.
13.Paragraph 5A (1) amends section 115 by introducing new sub sections 3A and 3B.
14.Section 3A allows HMRC Commissioners to waive the charge incurred by a REIT for breaching the profit: financing- cost ratio in particular circumstances. The charge arises if the financing costs of the property rental business exceed 80% of the profits from that business. The charge, which is to Corporation Tax, is on the amount by which the limit is exceeded.
15.The Commissioners may only waive the charge if they think that the REIT is in severe financial difficulties at a time in the accounting period for which the charge arises; the REIT breached the profit: financing-cost ratio because of circumstances which arose unexpectedly; and the REIT could not reasonably have taken action to avoid the breach.
16.Section 3B allows regulations to be made to specify the criteria to be applied in determining whether to waive the charge.
17.Paragraph 5A (2) allows the amendments to apply with retrospective effect.
18.Paragraph 6 makes a change to section 118 of FA 2006 (Funds awaiting re-investment). Section 118 allows that where a REIT disposes of a property used in its tax exempt property rental business, then the funds from the disposal are regarded as an asset involved in the property rental business for two years for the purpose of the balance of business asset test of section 108.
19.Paragraph 6(1) clarifies how such funds can be apportioned where there has been some tax exempt use and some non exempt use. The result is that such periods totalling in aggregate at least a year will be recognised for the apportionment.
20.Paragraph 7 inserts a new section 136A into FA 2006. This section deals with restructuring by companies with the aim of meeting REIT conditions and tests.
21.New section 136A(1) grants HM Treasury a power to make regulations about the application of the REIT regime where there is a connection between a REIT company and another person.
22.New section 136A(2) explains what is meant by a REIT company for the purpose of section 136A.
23.New section 136A(3) gives examples of what may be included in the regulations.
Background Note
24.Real Estate Investment Trusts were introduced with effect from 1 January 2007. The rules for the regime are contained in part 4 of the Finance Act 2006 and in regulations.
25.Companies and groups of companies whose main business is the rental of property can elect to become Real Estate Investment Trusts (REITs), subject to meeting certain conditions relating to the REIT itself, the properties being rented and the business of the REIT.
26.A REIT has to distribute 90 per cent of the profits from its property rental business as distributions to shareholders. There is also a charge on entering the REIT regime.
27.A REIT is exempt from UK tax on income and gains of its property rental business but pays tax on the profits and gains from other activities.
28.The changes announced in the section and Schedule will:
prevent (in certain circumstances specified by regulations) companies from restructuring with the aim of meeting the REIT requirements and conditions. The amendment will not apply to restructuring where control of non qualifying activities is severed to result in the property rental business qualifying as a REIT;
remove a barrier to entry for businesses with ‘tied premises’;
allow the charge incurred for breaching the limit of the profit finance cost ratio to be waived in certain circumstances; and
clarify and make consistent parts of the existing legislation.
