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The pressure on the real estate sector to deliver on ESG commitments - and to unlock value from underutilised rooftop space has made large-scale solar deployment an enticing prospect. But there's a potential problem for UK REITs, and those that would wish to deal with UK REITs: integrating significant renewable energy generating income into the portfolio may directly conflict with the fundamental tax principles governing the UK REIT regime.
The problem
The heart of the issue is simple: a UK REIT is designed to be a passive investment vehicle, enjoying exemption from corporation tax on profits derived from its Property Rental Business (PRB). Operating a commercial solar facility, whether selling power to the grid or supplying to tenants, is functionally a utility or energy trading activity - a taxable 'Residual Business'. This distinction is not just technical; it creates a compliance risk.
Keeping in the shade: asset value and income tests
For a UK REIT group to maintain its valuable tax-exempt status, it must continuously meet the stringent Balance of Business tests:
- Profit Test (Condition A): At least 75% of the group's total profits must come from the qualifying PRB.
- Asset Test (Condition B): At least 75% of the group's total assets must be related to the qualifying PRB.
Scaling a solar business risks non-compliance with either or both of the profit and asset tests, as the revenue and installations can consume the statutory 25% allowance for non-qualifying activities.
1. The immediate constraint: non-qualifying assets
The solar infrastructure itself presents the most immediate structural problem. For UK tax purposes, solar PV panels are generally classified as plant and machinery or integral features. If these assets are related to the active trade of energy provision, they may be categorized as non-qualifying assets for the REIT asset test.
A significant capital expenditure on a large industrial rooftop array could therefore add measurable value to the non-qualifying side of the balance sheet.
2. The income constraint: trading activity
The income streams generated by the solar systems may be non-qualifying residual business income.
- Selling to the Grid: Revenue from exporting surplus power to the National Grid is a commodity trade. This is non-qualifying residual business income and in the circumstances may be fully taxable.
- Selling to Tenants: This can be more nuanced. Fees for services like cleaning or security can qualify as PRB income if they are truly incidental and ancillary to the property letting. However, if the solar supply is a substantial, separately charged power purchase agreement structured to generate significant commercial profit, it may shift from an ancillary service to a primary energy provision trade and therefore may be classified as non-qualifying residual business profit.
The path forward: structural separation
UK REITs with significant renewable‑energy ambitions should, at an early stage, consider how best to structure both their initial investments in solar and other generating technologies and their ongoing operations to help mitigate these risks.
This article was also authored by Ross Jones, Trainee Solicitor at Womble Bond Dickinson.
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.
