Last Updated: 26 January 2006
Article by Arthur Lovitt

As part of the 2005 Pre-Budget Report, the Government announced in December 2005 that it would bring forward legislation for the introduction of Real Estate Investment Trusts in the UK (UK-REITS) to improve the efficiency of both the commercial and residential property investment markets.

Legal structure for a UK-REIT

A UK-REIT will take the form of a closed-ended public company incorporated in the UK. Alternatively, if registered abroad it will need to be tax resident only in the UK.

Public listing and Share Capital

A UK-REIT must be listed on a recognised stock exchange - including overseas exchanges.

Only ordinary shares may be issued and a UK-REIT will be permitted only one class of shares.


Despite industry pressure, unlisted UK-REITS will not be allowed. This suggests the Government is targeting UKREITS at the retail market. Established investors (individual or corporate) who have achieved ‘virtual REIT’ status through non-domiciled unit trusts or other structures and to whom the historic price uncertainties of a stock market listing for property companies are unattractive, may well avoid UK-REITS.

The Government was clearly conscious of the number of real estate companies who have de-listed in recent years. There seems to be an implicit desire to encourage the development of the listed company sector.

Recognised stock exchanges include the UK Official List and its equivalents in other EU Member States and other exchanges (such as NYSE) designated by HMRC also qualify. Secondary markets such as AIM or over the counter markets, do not count as recognised stock exchanges.

UK-REITS listed in the UK will therefore be subject to compliance with UK Official List reporting standards, continuing obligations and all applicable parts of the Listing Rules (or their equivalent).

UK-REITS seeking to list in the UK, if newly established, will not be able to demonstrate a trading record and will therefore have to list under one of the categories of ‘investment entities’ in Chapter 15 of the Listing Rules (or a newly created Chapter).

Currently, Chapter 15, dealing with property investment companies stipulates:

  • Directors of a property investment company and any property manager must be able to demonstrate sufficient and satisfactory experience in property investment over at least a three year period involving the management of a portfolio of a similar type and size as is proposed for the company.
  • A board of directors of a property investment company must be independent of any property manager or property adviser of the company.

A review by the FSA of the Listing Rules will be needed, though it would be expected that UK-REITS would fit within the existing regime for property investment companies (Chapter 15 of the Listing Rules).

The FSA may take the view that retention of UK-REIT status should be a listing condition, but we would expect some discretion to be retained as a UK-REIT may cease to qualify as tax exempt, but still be considered suitable for listing.

Shareholding conditions

The company cannot be a ‘close company’ - broadly, under the control of five or fewer shareholders. No person can control directly or indirectly 10% or more of the company's share capital.


The 10% restriction on shareholdings is likely to cause serious problems to many companies looking to convert into a UK-REIT and has already been severely questioned by major companies likely to consider conversion. This provision has been included principally to avoid overseas investors being able to reclaim UK tax withheld distributions. Most double tax treaties allow overseas holders of 10% or more of shares in a UK company to recover UK tax withheld on dividends.

The general principle for a listing is that shares should be freely transferable. However, restrictions on transfer may be imposed in certain cases and we envisage that the FSA and Treasury will liaise on this. If the 10% limit is breached the taxation treatment of the UK-REIT is potentially prejudiced, but there is no clawback of any tax reclaim obtained by the 10% plus holder - any tax cost arising from the breach will effectively be borne by all investors. Note that the 10% limit applies to any shareholders, not just those who may potentially be able to benefit from double tax treaty claims.

Assuming the Listing Rules will permit this, a UK-REIT may need to take additional powers in its Articles of Association to prevent registration of share transfers or to force disinvestment if this 10 per cent rule could be breached.

Though the City Code on take-overs and mergers would apply to UK-REITS listed in London, it is hard to see why a bidder would make a bid for a UK-REIT to take it private, thereby losing its UK-REIT status, but a share exchange offer governed under the City Code could be effected, provided that no holder emerged with a holding in excess of 10 per cent of the enlarged capital, without loss of UKREIT status.

Schemes of Arrangement to facilitate the merger of two or more UK-REITS could be made under the Companies Acts, though UK-REIT status could only be preserved if the overall percentage limit of 10 per cent would be observed, once the scheme had been implemented.

Income and assets condition; distribution of profits

At least 75% of the UK-REIT's total gross ‘income’ must be derived from ring-fenced activities. For that purpose ‘income’ is the taxable income profits.

The taxable profits of the ring-fenced business will still be calculated in order to compute the profits which are covered by the exemption from corporation tax for UKREITS, and also for the purposes of the gearing, income conditions and 95% distribution tests. Capital allowances will automatically be taken into account in calculating profits. In essence, a ‘shadow’ capital allowances regime will operate within the ring-fenced business. The taxable profits will also include profits from loan relationships and derivatives which relate to the ring-fenced business. Exchange gains and losses will also be brought into account as taxable profits in line with the accounting treatment.


Chapter 15 of the Listing Rules stipulates:

‘Income receivable from any single tenant or tenants within the same group in any one financial year must not exceed 20 per cent of the total rental income of a property investment company in that financial year.’

The FSA and the Treasury will need to liaise as to the applicability of this rule to UK-REITS.

At least 75% of the UK-REIT's gross value of assets must be property allocated to the ring-fenced business. Liabilities secured on or relating to the properties are ignored. Value is based on the value which the property is carried in the accounts, although the value is deemed to be cost where there is an option to account for property at cost or market value.


Chapter 15 of the Listing Rules stipulates:

‘At least 90 per cent by value of the property held by a property investment company must be in the form of freehold or long leasehold or the equivalent.’

The FSA and the Treasury will need to liaise as to the applicability of this rule to UK-REITS.

Loans which are convertible into shares or securities or which provide returns on a profit linked basis or on noncommercial terms are prohibited.

A UK-REIT will be required to distribute at least 95% of its ring-fenced profits to investors. This test is based on taxable profits i.e. ‘Schedule A’ profits (and its equivalent for overseas properties) after appropriate deductions and capital allowances. The distribution test will not be breached if it cannot be met because of a legal restriction e.g. lack of distributable profits.

Property Condition

A UK-REIT will be required to hold at least three properties with no single property exceeding 40% of the total value of its property assets.


This does not prevent a UK-REIT holding a single asset as long as it is not designed to be let out as a single unit. Each lettable unit constitutes a ‘property’ for the purposes of this test. Accordingly, a UK-REIT will be able to own as its only asset a multi-let shopping centre.

Chapter 15 of the Listing Rules stipulates:

‘No single property can at the time of initial listing constitute more than 15 per cent of the total assets of the property investment company.’

The Listing Rules go on to clarify that a single property includes all adjacent or contiguous properties. There is a six month grace period before a property acquired by a listed property investment company needs to be counted in. This would allow for a phased acquisition programme of properties which might otherwise cause the 15% limit to be breached. However, the Listing Rules do not envisage counting a multi-let property as several properties, rather than a specific property.

The FSA and the Treasury will need to liaise as to the applicability of this rule to UK-REITS.

Group company structures

Details of how the regime will apply to group company structures will be published later on this year. However, the draft legislation appears to envisage a single company UKREIT although this will presumably be clarified in the group company legislation. Because of the 10% limit on shareholdings (see above), a UK-REIT could not be within the corporate group of a shareholder.

Gearing Test

A limit on gearing was expected following the consultation papers. However, instead of the gearing test being a normal loan to value test (e.g. the principal amount of the loan may not exceed x% of the value of the property portfolio of the UK-REIT) or a rental cover test (e.g. interest payable in any year must be no more than x% of the rental income receivable), the test is a ratio of profits to finance costs (interest and other costs payable on any loans taken out by the UK-REIT).

Finance costs cannot exceed two-thirds of the profits of the UK-REIT in any one year. This means that gearing is limited so that no more than 40% of rental income received can be paid out in interest (i.e. the interest: profit ratio must be less than 40:60). This is obviously simplistic as it presumes that out of the rental income there is only interest to be paid out leaving any residual amounts as profit and therefore the proportion of rental income which can be applied to finance costs will be less than 40%.

It had been anticipated that gearing would be limited to a figure around 40% so this is not a surprise.

‘Profits’ are taxable profits, not accounting profits, so projected tax cashflows will be required in monitoring the gearing test.

Capital allowances will be deemed to be claimed in calculating taxable profits for certain parts of the UK-REIT rules and it is not clear from the draft legislation whether this applies to the gearing tests. If it does, this will have the effect of reducing taxable profits, and hence the gearing that can be supported. The capital allowances impact will be more significant in relation to commercial property, as allowances cannot generally be claimed in relation to residential property.

Breach of the gearing test will not cause the UK-REIT to lose its tax exempt status, but there will be a tax charge likely to be by reference to the element of finance cost which causes the formula to be exceeded.

Examples are annexed.


One potential issue is what happens if there is a tenant insolvency, or other problem affecting the UK-REIT which results in its profits being reduced from the expected level.

It will be interesting to see whether or not the Regulations to ensure that minor or inadvertent breaches do not have disproportionate consequences, cover such a situation.

This formula will mean hedging interest rates will be inevitable and the hedging costs will impact on yield. Clearly at the expiry of the hedging arrangements,UKREITS will need to ensure that the test continues to be complied with. This could conceivably force UK-REITS to sell assets and/or introduce share price volatility where a hedge is to expire.

Banks lending into UK-REITS will need to fully understand the implications of these tests and will doubtless include provisions in their loan documents to ensure that the profits ratio test is not breached. It is likely that they will encourage UK-REITS to enter into long-term hedging arrangements.

It is likely that other innovative financing solutions will be examined in order to improve gearing. However, these will need to be reviewed carefully so as to ensure a full understanding of the risks involved. One example may be foreign currency mortgages. However, the taxation implications of currency fluctuations will need to be carefully examined.

Investment activity of UK-REIT

A UK-REIT's activities will be split into:-

  • The ring-fenced property letting business which will broadly equate to properties generating rental income taxable under Schedule A, and its equivalent for overseas properties. However, this expressly excludes income from wayleaves, pipelines, wind turbines and perhaps of most relevance mobile telephone masts. Income from ‘rent factoring’ is also excluded.
  • The non ring-fenced business comprising all other activities that fall outside the ring-fence definition, including income generated from ancillary services associated with the property letting business. Profits, capital gains and subsequent corporation tax liability would be computed and payable on the non ring-fenced activities in the normal way.

Expenditure and allowances incurred in support of ringfenced and non ring-fenced activity will need to be apportioned on a just and reasonable basis.


As qualification for ‘ring fenced’ status is linked to schedule A profits, non-rental income (such as returns on mortgage backed investments) will not qualify for UKREIT status. Income from most PFI projects is not within schedule A. Income from property will not include dividends from companies although dividends from UK companies would normally be exempt from tax - this may be clarified in the group company legislation.

No specific property sectors will be excluded from being held within a UK-REIT, provided that the income and asset rules set out above are satisfied, and provided that the activity of a UK-REIT reflects traditional property investment, and is not a proxy for purely financial transactions. In particular,UK-REITS will not be constrained to hold a minimum proportion of residential property. However, property occupied by the UK-REIT (or a company which is linked to the UK-REIT in such a way that it is advantageous for the two companies' shares to be traded together (i.e. ‘stapled’) will be outside the ‘ring fence’. This restriction is presumably intended to prevent property based trading businesses (such as hotels, storage, nursing homes etc) being split into property rental (within a UK-REIT), and trading elements and marketed as a combined investment.

The conversion charge

Details of the conversion charge will be announced in the 2006 Budget and it is understood further information will be provided before then. There is a deemed disposal for capital gains purposes on a company becoming a UK-REIT which may give rise to a capital gain (or loss). It is not clear whether this deemed disposal will form the basis of the conversion charge, although this must be likely.


A UK-REIT can be either internally or externally managed.

Property development

Property development is not prohibited within a UK-REIT but to the extent the activity is taxed as a trade, income and gains will be in the non-ring fenced business and the non-ring fenced business must not breach the 75% income and assets tests applying to the ring-fenced activities of the UK-REIT.

Rental income which is incidental to a property development trade is non-ring fenced business.


Development to invest can be a ring fenced activity but development with a trading motive will be outside the ring fence. It is likely that guidance will be given on when development will be regarded as trading in order to give some certainty to the position rather than relying on the case law tests. It will be important to establish a clear audit trail demonstrating that the ‘sole or main object’of the activity was not realising a gain from the disposal of an interest in land.

Chapter 15 of the Listing Rules stipulates:

‘The proportion of a property investment company's portfolio which is unoccupied or not producing income or which is in the course of substantial redevelopment or refurbishment must not exceed 25 per cent of the value of the portfolio.’

The FSA and the Treasury will need to liaise as to the applicability of this rule to UK-REITS.

Taxation at the vehicle level

Income profits of the 'ring-fenced business' will be exempt from corporation tax.

Chargeable gains arising on the sale of property held for investment purposes within the ring-fenced business will be exempt from corporation tax.

Other income and gains outside the definition of the ringfenced business will remain within the charge to corporation tax at a rate of 30%. Profits from dealing in property, or from any other activity outside the ring-fenced business, would remain subject to corporation tax.

Income and expenditure relating to both ring-fenced business and other activities will be apportioned reasonably.

Any losses arising in relation to the ring-fenced business will not be able to be used to offset taxable profits in the other business activity of the UK-REIT. Similarly losses in the non ring-fenced business cannot be set against ring fenced profits.

Stamp Duty Land Tax would be payable at normal rates on the acquisition of property assets.

Taxation at the investor level

Distributions made by a UK-REIT will fall into two categories.

Distributions made in respect of profits (including capital gains) arising from the ring-fenced business will be treated as property income in the hands of investors, chargeable at the taxpayer's marginal tax rate. These distributions will be known as property income distributions (PIDs). PIDs received by corporate investors will also be subject to tax (and will not be treated as exempt distributions). PIDs will be payable under deduction of basic rate income tax, currently at the rate of 22%. It is suggested that certain investors such as UK companies, local authorities and charities will be able to receive gross distributions.

Distributions attributable to profits arising from activity that falls outside the ring-fenced business will be treated as ordinary dividends. It is understood that legislation will be introduced to determine when a distribution is made from the profits of the ring-fenced business as opposed to other activities.

Capital allowances will not be available at the investor level.

Stamp Duty Reserve Tax will be paid on UK share transactions at the normal rate, currently 0.5%.

Breach of conditions

Breach of the conditions required for UK-REIT status will automatically result in loss of UK-REIT status from the beginning of the period in which the breach occurs. This is subject to powers to be included in regulations to allow UK-REIT status to be retained following a ‘minor or inadvertent breach’. It is likely that a tax charge will be imposed in such cases.

Breach of the gearing test will not result in loss of UK-REIT status though it is likely that a tax charge will be imposed by reference to the ‘excess’ financing costs.


Gearing Test Examples

Example 1 (Prime Property)


Property Portfolio value - £100m

Yield (as prime property) - 5%

Administration and other charges and costs - 1%

Interest on any gearing (hedged so fixed rate) - 5% (note this is for illustrative purposes and at current rates would probably be nearer to 5.25% which is 75bps over current Base Rate)

Income (after deducting costs) = 4% x £100m = £4m

Maximum interest payable to meet test in Clause 12 is £1,600,000 so that profit net of interest is £2,400,000 and the sum in Clause 12(2) is exactly equal to 2.5

At an interest rate of 5% £1,600,000 annual interest equates to a principal amount of the relevant loan equal to £32,000,000 and so maximum gearing is 32%

If capital allowances are to be taken into account in computing profits, assume 10% of purchase price (i.e. £10 m) qualifies for plant and machinery allowances. Year 1 allowances are £2.5 m (£10 m x 25% writing down allowances). This reduces taxable profits in Year 1 to £1.5 m (£4 m - £2.5 m) so gearing test for this year would appear to be breached.

Example 2 (More risky portfolio)


Property Portfolio value - £100m

Yield (as more risky property) - 8%

Administration and other charges and costs - 1%

Interest on any gearing (hedged so fixed rate) - 6% (higher interest rate due to more risky portfolio)

Income (after deducting costs) = 7% x £100m = £7m

Maximum interest payable to meet test in Clause 12 is £2,800,000 so that profit net of interest is £4,200,000 and the sum in Clause 12(2) is exactly equal to 2.5

At an interest rate of 6% £2,800,000 annual interest equates to a principal amount of the relevant loan equal to £46,666,666 and so maximum gearing is 46.66%

This assumes no capital allowances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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