UK real estate investment trusts (UK REITs) benefit from certain tax exemptions that have the effect of putting their shareholders in a tax position broadly equivalent to that of a direct investor in UK real estate. Those exemptions apply to both the rental income of, and gains arising in relation to, a UK REIT’s “qualifying property rental business”. In addition, the distribution of the income profits and capital gains from that business will be treated as UK property income (rather than a dividend) in the hands of those shareholders as if the entity were tax transparent, meaning that tax-privileged investors, such as registered pension funds, do not suffer any UK tax leakage as a result of investing in the UK REIT as opposed to the underlying real estate directly.

When the regime was first introduced at the start of 2007, there were very strict conditions which companies needed to meet in order to become UK REITs, including that their shares be admitted to trading on a recognised stock exchange. While a summary of all the various conditions and tests that need to be met by UK REITs is outside the scope of this note, the overall trend over the last decade and a half has been one of a gradual relaxing of many of these conditions to encourage more widespread use of the UK REIT as a structure for investment in UK real estate.

In 2010, the ability to pay rental income distributions as stock dividends was introduced.

In 2012, the 2% entry charge on the market value of a UK REIT’s assets upon joining the regime was abolished; the stock exchanges on which UK REITs’ shares could be listed was expanded to include AIM and other alternative markets; and UK REITs were given a grace period of up to three years to achieve that listing, thereby reducing three significant barriers to entry.

In 2019, further amendments were made to exempt UK REITs from corporation tax on sales of qualifying UK property-rich companies (those that derive at least 75% of their value from UK land), when wider changes were made to the UK capital gains tax regime to remove the former exemption from taxation on capital gains on UK property enjoyed by non-UK tax resident investors.

Following a 2020 UK government consultation on the tax treatment of asset holding companies, including investments in real estate, additional amendments took effect in 2022 to loosen the requirements of the UK REIT regime further, most impactfully in relation to the listing criteria. For accounting periods beginning on or after 1 April 2022, it is no longer mandatory for a UK REIT’s shares to be listed or admitted to trading on a recognised stock exchange where either:

• Institutional investors hold at least 70% of the ordinary share capital of the UK REIT (and, in determining whether the 70% requirement is met, ownership can be traced through companies, partnerships, and other types of entities including unit trust schemes and contractual co-ownership schemes); or
• The UK REIT is owned by a collective investment scheme limited partnership and the “genuine diversity of ownership” condition (which relates to how the fund is marketed to investors) is satisfied.

Other changes were also made at the same time to allow property income distributions to be paid to certain investors with more than a 10% shareholding in the UK REIT without a “holders of excessive rights” charge, where those investors are entitled to gross payment of distributions from the UK REIT (such as UK-resident corporates and registered pension funds). This will now avoid the need for many investors, including UK tax resident companies, to fragment their shareholdings using complex and costly structures simply to remain under the 10% limit.

Last but not least (for now), the rules were further relaxed with effect from 1 April 2023 to allow a UK REIT to hold a single property, where that property is a commercial building with a minimum value of £20 million. This should make it easier to set up single-asset REITs, including those listed on the IPSX. Certain other changes were also made at the same time to amend the rules around valuing properties that have been significantly developed so that there is less risk of a UK REIT falling foul of certain restrictions on selling a property within three years of significant development work, and also to provide more flexibility in the rules for deduction of tax from property income distributions paid to partnerships to prevent certain partners in those partnerships from being worse off than if they had invested directly in the UK REIT.

The result of all these revisions to what was originally a very strict regime is that UK REITs are now more attractive as a property investment vehicle for institutional investors, and so-called “private REITs” are consequently becoming more commonly used as joint venture vehicles for UK real estate investments for those kinds of investors. The UK government is on the right track, though there are still further changes that could be made to reduce barriers to entry and to ensure that UK REITs can be used more extensively and in different contexts.

One of the most burdensome features of the UK REIT regime remains the requirement that a UK REIT has to be “widely held” and not “close” (meaning, broadly, a company that is controlled by five or fewer investors) unless at least 35% of the shares are freely available to the public and certain other conditions are met. New UK REITS can be close for the first three years but will lose their REIT status if they remain close at the end of that period.

In addition, there would ideally be an extension to the definition of qualifying activities beyond traditional property rental businesses, e.g., to include sustainable real estate investments such as forestry, habitat creation, nature restoration, and similar projects, and also measures to facilitate investment by UK REITs in overseas property, to make the regime attractive as a vehicle for cross-border real estate investment. We hope that such proposals will be considered by the UK government in the near future as it looks for ways in which a more flexible UK REIT regime can both facilitate adherence to the UK’s 2050 net zero commitment and help attract international investment in post-Brexit Britain.

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