UK REITs and The International Stock Exchange
13 September 2017
In this briefing we focus on the changes to the UK Real Estate Investment Trust (REIT) regime introduced by the UK Finance Act 2012 and the way in which Jersey companies and The International Stock Exchange (TISE) (formerly known as The Channel Islands Securities Exchange or CISE) may be used to facilitate REIT structures. Since the relaxation of the UK REIT regime, Bedell Cristin has acted as Jersey counsel and/or TISE listing sponsor in relation to the majority of new REITs that have been listed on TISE.
- The changes introduced by the UK Finance Act 2012 have encouraged the formation of a number of new REITs, including REITs which would not have met the qualifying conditions under the old regime, such as joint venture and captive REITs and REITs formed for the purpose of making specific asset and portfolio acquisitions.
- REITs formed for a specific pool of investors can obtain their primary (or only) listing on TISE with significant cost and other advantages, including a streamlined listing process, reduced disclosure requirements and the absence of a compulsory requirement to appoint an independent corporate advisor. New REITs seeking some level of liquidity without the associated cost of a main market listing, may seek admission on the Alternative Investment Market (AIM). In these circumstances, a low-cost dual listing on TISE may also provide certain advantages as TISE is a recognised stock exchange while, for instance, AIM is not.
- Jersey incorporated companies are a popular choice for London listings and may be used as a vehicle for new REITs regardless of the choice of stock exchange.
- Among the various legislative changes, the 2% entry/conversion charge was abolished, there is now a three-year grace period to qualify as a non-close company for UK REIT purposes and cash is considered a 'good' asset for the balance of business assets test. These changes were designed to facilitate the entry into the REIT regime of start-ups and SME property companies.
- REIT status affords certain benefits, including the possibility of effectively extinguishing latent CGT liabilities and joining a globally-recognised brand, hence improving the ability to attract international capital. REITs may now also invest in other REITs, which should make it easier for REITs to raise funds through joint ventures and co-investment arrangements.
- REITs are one of the few investment structures excluded from the non-resident CGT charge on the disposal of UK residential property, which affords foreign investors the opportunity to maintain tax neutrality in relation to their UK residential real estate investments.
REITs were introduced by the UK Finance Act 2006 in order to provide investors with a tax-efficient way of gaining exposure to commercial property. This special tax regime came into force on 1 January 2007 and, by February 2007, nine of the UK's largest listed property companies had converted to REIT status. The relaxation of the REIT regime introduced by the Finance Act 2012 has attracted the interest of small and medium property companies, as well as small clubs of, or joint ventures between, institutional investors. Recent figures show that before 2012, nearly three-quarters of REIT investors were domestic, whilst today nearly three-quarters are from overseas.
The UK Government further relaxed the UK REIT regime in April 2014 by including REITs in the definition of 'institutional investor'. This means that both UK REITs and their foreign equivalents will be able to invest in a REIT without causing it to violate the non-close company rule (see below).
In addition to the appeal of the globally-recognised REIT brand, which should improve the ability of new qualifying companies to raise capital from a wider international investor pool, converting into a REIT may also be attractive to existing companies with latent capital gains, as on conversion they can effectively wipe out contingent CGT liabilities that they may have on their books without incurring any additional charge or penalty.
The REIT model was initially pioneered in the US in 1960 to make investments in large-scale, significant income-producing real estate accessible to a wide spectrum of investors, but by 1992 the US REIT market had only achieved moderate success and was worth a mere US$2 billion. However, following the simplification and modernisation of the US REIT regime, where limits on expanding portfolios were removed, investments took off and the size of the US market is now in excess of US$1 trillion.1
Taxation of REITs
In the UK, a REIT is essentially a UK tax-resident listed company carrying on a 'property rental business', within the meaning of section 104 of the UK Finance Act 2006. The REIT's rental income and capital gains arising from its qualifying letting business are not subject to UK corporation tax (any non-qualifying business is subject to corporation tax in the usual way). Dividends from the qualifying REIT business are known as property income distributions (PIDs) and are taxed at the REIT shareholder level, with UK resident individuals being taxed on PIDs at their applicable marginal rate of income tax and corporates being taxed at the prevailing corporation tax rate. PIDs are subject to withholding tax at the basic rate of income tax (which are set against the investor's total liability to tax on the PID), although there is an exemption from the withholding tax where the investor is subject to corporation tax or is tax exempt.
REITs are particularly attractive to exempt bodies such as charities and pension funds, as investment in a REIT minimises the tax costs of indirect investment through a corporate vehicle by removing the 'double-layer' of taxation, hence mirroring the tax treatment of investing into real estate directly or through a tax-transparent vehicle. Holding real estate in a REIT enhances shareholder value by approximately 27% for a UK pension fund, ISAs and Sovereign Investors, compared with returns from real estate held through an ordinary taxable UK company.2
A REIT will be subject to a tax charge if it makes a distribution to a person that is either beneficially entitled to 10% or more of the REIT's shares or dividends or controls 10% or more of voting rights. However, this tax charge can be waived or reduced if the company takes appropriate preventative action.
UK CGT on residential real estate
Following a consultation by the UK Treasury and HMRC which ended in June 2014, aimed at addressing the imbalance between tax treatment of UK residents and non-residents, the UK government introduced a CGT charge for non-UK resident investors in UK residential property in relation to any disposal completing on or after 1 April 2015. The charge is levied on all UK in-scope dwellings of any value and affects both individual investors and a wide range of property ownership structures such as partnerships, companies and trusts. The charge is in addition to the existing CGT charge for properties that are subject to the UK Annual Tax on Enveloped Dwellings (ATED).
Unlike the ATED regime where there is a specific exemption for property rental businesses, the new CGT charge applies to the disposal of all types of properties, regardless of their use. In addition, disposals of multiple dwellings in one single transaction are not excluded from the new CGT charge. This contrasts with the UK SDLT regime where a sale transaction involving six or more separate residential properties is treated as a non-residential land transaction attracting a reduced rate of tax.
However, the UK Government has confirmed that it does not intend to extend the new CGT charge to REITs and diversely-held investment funds and closed-ended companies.
Main qualifying criteria for a REIT
In order to qualify for the current REIT regime, a company holding real estate must meet the following 'company' conditions:
- Tax residency: regardless of its place of incorporation, it must be resident only in the UK for tax purposes.
- Closed-ended: it must be a closed-ended investment company.
- Listing: it must have its shares listed or admitted to trading on a qualifying stock exchange (which includes, amongst others, the LSE, TISE and AIM).
- Close company: it must have a diverse share ownership such that the company is not a 'close' company (broadly, a close company is a company controlled by five or fewer shareholders). Institutional investors, sovereign governments and other diversely-owned investors are able to hold shares in a REIT, without being concerned about the REIT breaching the close company rule. The company has three years from making the REIT election to meet the non-close company requirement. At the end of the three-year period, if the requirement has not been met for legitimate reasons, the company will be allowed to leave the REIT regime without penalties.
- Single company or group: a REIT can be a single company or a group of companies with the main company and all of its 75% subsidiaries forming part of a 'REIT group'. A REIT may also enter into a joint venture with other investors, provided that the REIT is entitled to at least 40% of the profits that are available for distribution in relation to the underlying qualifying assets.
- Share classes: it must have only one single class of ordinary shares (although non-voting, fixed rate preference shares are permitted in addition to the ordinary shares).
- Loans: any loans made to the REIT must be on terms such that the interest payable is not dependent on the results of the company's business or exceeds a reasonable commercial return. The terms of the loan must not entitle the lender to a profit share.
In addition, the following 'business' conditions must be met:
- Letting business: it must own at least three properties generating rental income. A single property with at least 3 letting units will be acceptable.
- Single property value: no single property must represent more than 40% of the total value of the REIT's qualifying letting business.
- Property occupancy: the letting business must not include any properties occupied by the REIT or any company whose shares are 'stapled' to those of the REIT.
- Distributions: at least 90% of its taxable income from its qualifying letting business must be distributed to the REIT's shareholders each year, whether in cash or by way of stock dividends. 100% of PIDs received from another REIT must be distributed to the REIT's shareholders.
- Gross income: at least 75% of its gross total income (not capital gains) must be from its qualifying letting business.
- Gross assets: at least 75% of a REIT group’s gross assets must comprise assets involved in the property rental business. Cash can now be included in the 75% gross asset test, which makes raising funds and accessing the regime by start-up REITs easier.
- Profit/financing cost ratio: REITs are required to maintain a profit to financing cost ratio of at least 1.25:1. Only loan interest and regular swap payments are used for the purpose of calculating the profit to financing cost ratio, whilst other accounting finance costs are disregarded.
Establishing a REIT using a Jersey company
The use of a Jersey company as the REIT vehicle may provide certain advantages over its UK equivalent. When considering the choice of jurisdiction the following factors are relevant:
- Tax residency: Jersey tax law specifically permits a Jersey incorporated company to be solely tax resident in the UK. Accordingly, the REIT tax residency test can be met.
- CREST: CREST settlement is available for shares in a Jersey incorporated company.
- Stamp duty: no stamp duty or stamp duty reserve tax is payable on the transfer of shares in a Jersey company provided the share register is maintained offshore.
- Jersey company law: Jersey company law is based on UK company law but with additional flexibility, particularly regarding dividend payments and maintenance of capital provisions. Dividends may be paid from any source (other than a capital redemption reserve or nominal capital account) on satisfaction of a cash-flow solvency test and there is no requirement for payment to be made out of distributable profits. In addition, there are no statutory pre-emption rights or financial assistance rules.
- Takeover Panel: the City Code on Takeovers and Mergers will apply to a Jersey incorporated REIT on the basis that its central management and control will be in the UK (in order to satisfy the tax residency test).
- Jersey tax: a Jersey incorporated REIT is not be subject to Jersey income tax.
- Corporate vehicles: in addition to standard companies, Jersey law also provides for protected and incorporated cell companies. A cell company structure may be attractive for a REIT seeking to ring fence assets and liabilities attributable to different properties or to provide different sets of investors with exposure to different types of property within a single platform.
- Regulation: Jersey unregulated funds represent a suitable investment fund vehicle where a REIT is to be formed by a small number of institutional investors. With a minimum investment of US$1 million or currency equivalent, they are aimed at sophisticated investors and are specifically designed for use as an exchange-listed product, though without an additional level of regulation in Jersey. For REITs wishing to attract investors by offering or placing listed shares, Jersey offers several funds products with different levels of regulation. The most suitable for REIT structuring are Jersey expert funds (generally with a minimum investment of US$100,000 or currency equivalent) and Jersey listed funds (no minimum investment, but a higher degree of scrutiny in respect of the sponsor and manager/directors of the fund). For additional information, please see our briefing Jersey investment funds: an overview.
Listing a REIT on the Official List of TISE as operated by The International Stock Exchange Authority Limited (TISEA)
The relaxation of the UK REIT regime has encouraged new REITs wishing to enjoy the benefits of REIT status but not necessarily requiring the level of liquidity or wishing to incur the costs associated with a London main market listing, to use TISE to satisfy the listing requirement. TISE is designated by HM Revenue & Customs as a "recognised stock exchange" and is therefore suitable for listing REITs.
TISE, based in Guernsey, Jersey and the Isle of Man, provides a listing facility and a market for companies to raise capital from international investors based on a bespoke trading platform. The key benefits of listing on TISE in the context of a REIT, and more generally, are as follows:
- Investment vehicle listing rules: new REITs can utilise Chapter 7 of TISEA Listing Rules applicable to investment vehicles and TISE has the discretion to waive the requirement for historic audited accounts.
- Responsive and approachable: the Listing and Membership Committee meets daily to consider applications for listings.
- Speed: TISEA offers a streamlined listing process.
- Pragmatic: TISEA takes a pragmatic approach to disclosure requirements while maintaining international standards of issuer regulation.
- Non-EU: TISEA operates outside the EU and therefore EU directives do not apply.
- Flexible: TISEA is flexible in its accounting requirements and will not require the adoption of international accounting standards or international financial reporting standards, provided that an appropriate accounting standard is used which is acceptable to TISEA.
- Recognised: TISE is formally recognised by numerous UK and international authorities.
- Listing costs: TISEA offers a very competitive pricing structure.
- No corporate advisor: there is no requirement for companies listed on TISE to appoint an independent corporate advisor.
Since the relaxation of the UK REIT regime in 2012, Bedell Cristin has acted as Jersey counsel and/or TISEA listing sponsor in relation to the majority of new REITs that have been listed on TISE. Bedell Channel Islands Limited (BCI) was admitted to membership of TISEA in 1999. BCI is a Category 1, 2 and 3 listing member, enabling it to act as a sponsor on all categories of listings. BCI has experience of acting as sponsor and/or adviser to a significant number of TISE listed debt securities and investment funds.
 Source: REIT.com/NAREIT. Data as of May 2017
 Source: Comparison of Investor Return from a UK REIT and a UK Taxable Company - Deloitte August 2014
 For a complete list of international recognition, please visit: www.tisegroup.com