Real estate: issues difficult to resolve as Treasury anxious that tax take does not drop

Property lawyers have welcomed the government's commitment to introducing a UK version of the real estate investment trust (REIT), but warned that there is still a lot of work to do.


A discussion paper issued by the Treasury last week alongside the Budget, which follows up a consultation published with last year's Budget, said that subject to finding workable solutions to various problems, it aims to legislate for a UK REIT in the Finance Bill 2006.


There is an important rider that the introduction should impose 'no overall cost' to the Exchequer.


The property industry has long called for the introduction of the REIT, a company that owns and, in some cases, operates income-producing real estate, both commercial and residential. The aim is to free funding for property by unlocking barriers for smaller investors and institutions.


The discussion paper in particular highlights three 'challenging issues' around the tax treatment of REITs, relating to non-UK resident investors, borrowing and group structures.


Cathryn Vanderspar, a partner at City firm Berwin Leighton Paisner, said the Treasury has moved a long way in the past year to allow a flexible and viable commercial vehicle, without which the proposal would have been a 'non-starter'.


However, she said there is still 'a long way to go', and expressed concern that the paper is silent on the major outstanding non-technical issue - that of any conversion charge, which she predicted as likely, given the need for the reform to be cost-neutral. She said the level of this could dictate the success or failure of the whole scheme.


She said: 'My own bet is that the charge will not be in the form of a capital gains tax, in order to ensure it cannot effectively be avoided through the use of losses and that a considerable tax levy is raised. There will, of course, be cries of horror from several quarters if this is the case, as such losses would effectively be lost. Non-resident entities would of course be reluctant to come on-shore if the UK-REIT gave rise to a charge which they would not otherwise suffer.'


Lee Nuttall, a partner at Birmingham firm Wragge & Co, welcomed the steps that have been taken, but said the outstanding issues will be difficult to resolve, especially with the Treasury's concern not to see the tax take reduced.


This could lead to limits on the level of borrowing within REITs - which he opposes - because higher levels of borrowing would reduce the amount of income distributed to investors, and therefore tax receipts.


David Ryland, a partner at City firm SJ Berwin, said that among the issues to be resolved is the relationship between REITs and authorised investment funds, which can now invest all their assets in real estate. He added that it was unclear how the Treasury will be able to ensure there is no tax loss from establishing REITs.