Amongst the usual round of rate changes and technical measures (including replacement of the capital allowances “super-deduction” regime with full expensing for companies incurring expenditure on plant and machinery over the next three years), the UK Spring Budget delivered on Wednesday 15 March contained several announcements that will be of particular interest to real estate fund managers and investors.    

1. Sovereign immunity consultation

The outcome of the recent consultation regarding the potential removal of sovereign immunity from UK tax has been announced. It has been decided that the current rules will remain unchanged so that non-UK sovereign entities (i.e., those that have had this status formally confirmed by HMRC) will continue to benefit from a tax-exempt status. Some key real estate-related impacts of this are as follows: 

• A sovereign will, therefore, continue to be exempt from UK tax on real estate-related capital gains (NRCGT) and rental income, and also from tax on property income distributions (PIDs) from a UK REIT.
• We anticipate, per HMRC published guidance, that a sovereign-immune entity that holds 10% or more of interests in a UK REIT should continue not to be treated as a ‘holder of excessive rights’ for the purposes of the UK REIT rules (such that distributions of PIDs to any such sovereign should not trigger a tax charge within the REIT). 
• A sovereign should continue to qualify as a ‘good’ category of institutional investor for various UK tax purposes — in particular:
• as an “institutional investor” (II) for the purposes of a REIT meeting the ‘non-close’ condition and in determining whether a UK REIT is 70% owned by IIs (such that it qualifies for the new regime, allowing the creation of unlisted REITs); and
• as a qualifying institutional investor (QII) for the purposes of several UK tax laws, including the UK substantial shareholding exemption from corporation tax (available on the sale of shares in a non-trading entity) to the extent that the seller is owned by QIIs, and the ownership requirements under the new UK qualifying asset holding company (QAHC) regime. 

2. UK REIT rules

As anticipated, the UK Government has made positive changes to the tax rules governing the UK real estate investment trust regime to “enhance its competitiveness.” Taking effect from 1 April this year, the UK REIT rules will be amended to:

• remove the requirement for a REIT to hold a minimum of three properties where it holds a single commercial property worth at least £20m;
• change the rule (i.e., the ‘three-year development rule’) that deems a disposal of property within three years of being significantly developed as being outside the property rental business so that the valuation used when calculating what constitutes a significant development better reflects increases in property values; and
• amend the rules for deduction of tax from property income distributions paid to partnerships to allow a property income distribution to be paid partially gross and partially with tax withheld.

We currently have many clients setting up REITs beneath limited partnership fund structures, so the changes to the REIT rules and, in particular, the proposed relaxation of withholding tax on certain PIDs paid to a partnership are both timely and welcome. That said, the current proposal seems to only benefit investors entitled to gross payment and that technical category is actually quite limited; for example, it does not cover underlying tax-exempt investors, such as sovereigns or certain overseas pension schemes. It will be interesting to see whether this opens the door to considering if a more flexible system could work that allows for differential withholding rates on PIDs paid to partnerships, by reference to underlying investors’ effective UK withholding tax rate and treaty status. 

3. Genuine Diversity of Ownership (GDO) condition

The question of whether a fund is genuinely widely marketed and can meet this GDO condition is relevant across several areas of the UK tax code, notably as regards the ownership conditions in the NRCGT exemption election regime, as well as in the new QAHC and unlisted REIT regimes. As a result of discussions with HMRC in this context, amendments to the GDO condition are being made to allow it to be more clearly met in the context of “multi-fund arrangements” (e.g., funds using parallel or feeder vehicles that may not have been separately marketed). The changes being made by this measure provide that, for the purposes of the QAHC, REIT and UK real estate related non-resident capital gains tax rules, where an entity forms part of multi-vehicle arrangements, the GDO condition can be treated as satisfied by the entity if it is met in relation to the multi-vehicle arrangements as a whole. The definition of multi-vehicle arrangements encompasses a group of entities which form part of a wider fund structure where an investor would reasonably regard their investment to be in the structure as a whole. 

4. Carried interest changes

UK resident individuals who pay tax on carried interest are sometimes unable to claim double taxation relief from other countries, which tax citizens on their worldwide income (notably, the US), when carried interest is recognised and charged to tax at a different time in the two jurisdictions.

In order to counter this issue, a new elective basis of taxation for carried interest has been announced, whereby an election can be made by executives to tax carried interest at an earlier time than under the current UK tax rules. This should enable any individual who expects to receive carried interest to make a voluntary and irrevocable election for their carried interest to be taxed in the UK on an accruals basis. 

5. New investment zones

The government has announced the creation of 12 new “investment zones” across the UK, which are intended to drive economic growth and assist in “levelling up” the country. The confirmed locations include the West Midlands, Greater Manchester, the North-East, South Yorkshire, West Yorkshire, East Midlands, Teesside, and Liverpool. In addition to grant funding to address local productivity barriers, new investment zones will benefit from a five-year tax package matching the current regime in Freeports (i.e., enhanced rates of capital allowances, structures and buildings allowance, and stamp duty land tax relief, business rates and employer national insurance contributions). 

We only have announcements in relation to the above measures at this stage and will need to wait for the draft legislation (expected towards the end of next week) to find out how the detailed implementation of these proposals matches up with the announcements.

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