UK REITs: An attractive vehicle for UK property investment

Why a UK REIT?

A real estate investment trust (REIT) is a property investment company which, very broadly, simulates (from a tax perspective) direct investment in UK property, and so avoids the double taxation that can arise when investing through a corporate structure. It also enables UK tax exempt investors to benefit from their own tax status so that they can receive gross of tax returns from indirect investment as they can from direct property investment.

The appeal of the UK REIT continues to grow. Originally the exclusive preserve of the public markets, successive changes to the regime since its inception in 2007 have been designed to allow a broader category of investors to establish REITs, including private equity and institutional capital.

Important changes include:

removal of the 2% conversion charge;
exemption from tax on gains from indirect property disposals;
allowing certain ‘institutional investors’ to hold large stakes in a REIT without it falling foul of the non-close condition, providing the opportunity for captive REITs;
recognition of further exchanges for listing, including TISE which does not have a 'free float' requirement;
three year initial relaxation to the non-close company requirement;
removal of the listing requirement for REITs which are at least 70% owned by ‘institutional investors’ including funds which satisfy a genuine diversity of ownership test;
removal of the requirement for a REIT to own at least three properties, where it holds a single commercial property worth at least £20 million; and
removal of the withholding tax requirement where exempt investors hold their shares indirectly through a partnership.

More recently, further changes have been made by Finance Act 2024 which:

help the REIT satisfy the non-close test where institutional investors hold their interest in the REIT indirectly; and
allow certain life companies to establish group UK REITs.

The increase in the UK corporation tax rate from 19% to 25% from April 2023 has caused investors to look more closely at REITs. In particular, many investors could benefit from a 20% effective rate or less depending upon whether they benefit from treaty rates or exemptions.

Why PwC?

PwC’s REIT team has unrivalled experience in the REIT market. We worked with Government and industry in shaping the original REIT regime introduced in 2007. The team continues to work closely with HMRC on consultations to improve the regime. We advise the majority of the largest and well-established REITs, as well as more recent entrants to the REIT regime and have significant experience of helping clients work through the conversion process to enter the REIT regime.

Key features of a UK REIT

We summarise below, the key features of a UK REIT

Company (or group of companies) carrying on a property rental business
Exempt from corporation tax on both rental income and gains on sales of investment properties (and shares in property investment companies) used in a UK property rental business
Withholding tax (at 20%) on property income distributions
Tax is levied at investor level (subject to the tax status of investors) on distributions of property income and gains

What is a REIT?
Tax status of a REIT
Withholding tax on distributions
Tax status of investors

What is a REIT?

In the UK, a REIT is a company (or group of companies) carrying on a property rental business which meets certain conditions. The use of “trust” in the name is a misnomer and in fact a property investment company which meets the necessary conditions, can elect into the regime by notifying HMRC.

Tax status of a REIT

A REIT is exempt from corporation tax on both rental income and gains on sales of investment properties (and shares in property investment companies) used in a property rental business carried on in the UK.

REITs benefit from a rebasing of underlying property assets when the REIT elects into the regime or when it subsequently acquires a company owning property investments (meaning that the target company is treated as having acquired the property asset for market value at the date the target company joins the REIT, rather than the earlier time when it actually acquired the property). This means that a REIT does not need to seek a discount for any latent capital gain inherent in the target company.

Furthermore, when a REIT sells a company owning investment property, there is once again a market value rebasing of the property asset that the new owner benefits from (although if the company has not been in the REIT regime for at least 10 years, the rebasing of the asset on leaving the REIT is subject to a requirement that the property owning company retains the asset for a period of two years). If the two-year holding period is not satisfied, then the tax base of the property reverts to its original tax base ignoring the rebasing on exit from the REIT regime.

Tax is effectively levied at investor level (subject to the tax status of investors) on their share of rental income which is distributed to them by the REIT as a property income distribution (PID) potentially subject to 20% withholding tax. Distributions of exempt gains are treated in the same way i.e. as PIDs.

Shareholders are generally treated as receiving property income which is subject to corporation tax/income tax at the investor’s marginal tax rate. However, investors who are exempt from UK tax, can reclaim any withholding tax to put them into a position equivalent to investing directly in UK real estate.

Non-UK investors who are not within the charge to corporation tax, including non-resident companies not carrying on a UK property business, or otherwise within the scope of UK corporation tax, will be subject to income tax on PIDs from a UK REIT. In general, the mechanism of tax collection for non-UK shareholders is by the levying of a 20% withholding tax imposed on PIDs (distributions of exempt income and gains) so that non-UK shareholders shouldn’t then have an obligation to file UK tax returns.

Non-UK investors may benefit from a favourable treaty rate under their respective double tax treaty. UK treaties generally limit the rate of withholding tax that the UK can levy to 15%, although some investors, such as pension funds, can often benefit from lower rates which compare favourably to the 25% rate of corporation tax that applies to an ordinary property company from April 2023.

Profits on activities of the REIT other than the property rental business (the ‘residual business’), such as interest income or management services, will be subject to corporation tax in the normal way. Profits from property trading activity are also subject to tax in the normal way, as are profits from property development activity where more than 30% of the value of a property is spent on developing the property which is then sold within three years of completion of the development.

Withholding tax on distributions

As explained above, a UK REIT must distribute 90% of profits from its property rental business but there is no requirement to distribute gains. Dividend distributions out of exempt rental income and exempt gains (if distributed) by the UK REIT are generally subject to a withholding tax of 20%; however, payments can be made gross to UK corporates, UK pension funds, UK charities and to partnerships to the extent that the partners would be entitled to gross payment if they held an interest in the REIT directly.

Most UK double tax treaties provide for a reduced withholding tax rate of 15% for distributions to non-UK tax resident investors. In general, the REIT must withhold 20% on relevant distributions to overseas investors who may then be entitled to claim a refund from HMRC where a treaty rate applies.

Distributions out of other income or gains from the residual business (i.e. outside the REIT ringfence) are treated as ordinary dividends which are not subject to any withholding. Special rules apply to determine out of which profits distributions are made.

Tax status of investors

If the investor is within the charge to corporation tax or income tax, a PID distribution is treated as profits of a UK property business (not a dividend) and is taxed accordingly.

In the case of a non-UK tax resident investor, the PID is treated as a dividend for the purposes of any relevant double tax treaty and it may therefore be possible for the investor to reclaim withholding tax suffered. However, the “holders of excessive rights” rules seek to prevent a corporate investor from holding 10% or more of the REIT and this may limit the possibility of accessing the lower treaty rates which generally only apply where the investor holds 10% or more of the company.

REIT Conditions

There are a number of conditions to satisfy on conversion and on an ongoing basis to preserve REIT status.

the property rental business must represent at least 75% of the REIT’s profits and assets, and include at least one property worth at least £20m or three properties where no one property is worth more than 40% of the total (balance of business and property rental business requirements)
Parent must be UK resident (company requirements)
90% of property income profits must be distributed each year (distribution requirement)
Parent must
- Satisfy the listing requirements or be at least 70% owned by institutional investors; (Listing requirement); and
- be diversely owned (although certain institutional investors are automatically treated as diversely held) (Non-close requirement)
Cannot have excessive gearing and debt finance must be broadly on ordinary commercial terms (Financing requirements)
Corporate shareholders holding 10% or more (Holders of excessive rights) can cause the REIT to suffer a tax charge

Property rental business

The REIT must have a property rental business. Certain types of property business do not qualify e.g. letting to other group members (which do not on-let to non-group members), short term lettings, caravan sites and wayleaves.
The property rental business must involve one property worth at least £20m or three properties where no one property is worth more than 40% of the total. Whether a building counts as one property is defined by reference to whether a property or part of it can be let under a separate lease. A single property which can be multi-tenanted, such as a shopping centre, will generally count as more than one property for the purpose of this test. HMRC also provide the example of a four-storey office block that has its stairwells and common parts designed so that each floor can be occupied by a separate tenant; this would count as four single properties even if, in fact, the whole block is let out to a single tenant.

Balance of business

The profits arising from the (exempt) property rental business during the accounting period must be at least 75% of the company’s/group’s total profits.
The value of the assets involved in the (exempt) property rental business at the beginning of the accounting period must be at least 75% of the total value of assets held by the company/group.
These tests are by reference to international accounting standards rather than tax legislation which can lead to some unintuitive results. For example, a minority interest in a tax transparent property investment joint venture will only count as a ‘good asset’ for these purposes if the REIT can ‘equity account’ under IAS 28, thereby accounting for a share of the profits of the joint venture in the REIT’s profit and loss account.
Where the REIT owns at least 40% of a corporate joint venture which is not a member of the REIT group, the REIT can enter into a joint venture election to treat an appropriate share of the joint venture’s property business as being part of the REIT group. That share of the joint venture is treated as part of the REIT consolidation for the purposes of the balance of business test.
FA 2022 has relaxed the Balance of Business test in certain respects. Firstly, for accounting periods beginning on or after 1 April 2022, profits of the (taxable) residual business resulting from compliance with planning obligations under section 106 of the Town and Country Planning Act 1990 entered into in the course of the property rental business are to be disregarded when performing the Balance of Business profits test and the assets excluded from the Balance of Business assets test. Certain other assets will also be excluded from the Balance of Business asset test where they are held solely in connection with other items which are also excluded from the Balance of Business profits test.
In addition, existing rules that require provision of financial statements to demonstrate that a REIT has met the balance of business tests have been modified. The rules now provide for simplified requirements for group REITs which, if met, remove the need to perform certain calculations and provide full financial statements for each group member.

Company requirements

A REIT can be either a single company REIT or a group REIT. To be a single company REIT, the company would have to be a property investment company; to be a group REIT, the property investment activities must be carried on by members of the group.
The principal company of a group REIT or a single company REIT must be a UK resident company, which is not resident in another jurisdiction at the same time. In principle, non-UK incorporated companies can qualify so long as they are resident in the UK and not elsewhere.
The principal company must not be an Open Ended Investment Company (OEIC). (The equivalent regime for OEICs is the Property Authorised Investment Fund regime although PAIFs are regulated and authorised by the FCA, whereas REITs are not so highly regulated.)
A group REIT consists of a parent company plus all of its 75% subsidiaries, regardless of their tax residence, where the ultimate parent has an economic benefit of more than 50% in each subsidiary. The REIT group is therefore effectively the same group as the capital gains group.
A REIT can only issue one class of ordinary shares. However, it can issue convertible non-voting fixed rate preference shares as well as non-voting fixed rate preference shares and convertible loan stock.

Distribution requirement

90% of the (tax-exempt) income from the property rental business must typically be distributed within 12 months of the end of the accounting period (however neither exempt gains, nor profits from the residual business income have to be distributed). REITs can pay stock dividends (i.e. with the option to issue new shares to shareholders) in lieu of cash dividends, and these are treated as qualifying distributions.
Where a REIT invests in another REIT, 100% of the PID dividends received by the investing REIT must be distributed within 12 months of the end of the accounting period.

Listing requirement

Since REITs were introduced in 2007, it has been a requirement that the REIT must be
- admitted to trading on a recognised stock exchange; and
- either listed on the London Stock Exchange (or foreign equivalent main market exchange which includes The International Stock Exchange in the Channel Islands) or traded on a recognised stock exchange (including AIM).
However, from accounting periods beginning on or after 1 April 2022, the REIT’s shares are not required to be either admitted to trading on a recognised stock exchange, or listed on the LSE (or equivalent) or traded on a recognised stock exchange where:
- Institutional investors hold at least 70% of the ordinary share capital of the REIT. In determining whether the 70% requirement is met, ownership can be traced through companies, partnerships and other types of entities including unit trust schemes and contractual co-ownership schemes; or
- The REIT is owned by a collective investment scheme limited partnership (CIS LP) which satisfies either the ‘genuine diversity of ownership’ condition (which considers whether the fund is marketed to new investors) or the modified non-close condition (i.e. the CIS LP is itself an institutional investor).
For new REITs where the listing conditions continue to apply, there is a grace period of three accounting periods (up to three years) in relation to the additional requirement that shares are listed on the London Stock Exchange (or foreign equivalent main market exchange)/traded on a recognised stock exchange (which includes certain overseas exchanges). If the REIT is not so listed/traded at the end of the third accounting period it is deemed to have left the REIT regime at the end of the second accounting period. However, this grace period does not apply to the basic requirement that a REIT must be admitted to trading on a recognised stock exchange. This condition applies on day 1 of being a REIT.

Non-close requirement

The REIT must not be a ‘close company’ i.e. a company which is under the control of five or fewer ‘participators’. This condition seeks to ensure that REITs are widely held investment vehicles. The term ‘participators’ covers shareholders, directors or other parties (together with related parties) who can exercise control over the majority of the shares, voting rights, income or assets (either through rights held or rights they may be able to obtain). Lenders who are not lending in the ordinary course of business (known as loan creditors) are included when determining who is exercising control.
Shares held directly or indirectly by various institutional investors count towards those shares treated as widely held. The HMRC list of institutional investors includes:
- authorised unit trust schemes and their overseas equivalents;
- UK open-ended investment companies and their overseas equivalents;
- collective investment scheme limited partnerships;
- pension schemes;
- certain insurance businesses;
- certain charities;
- registered housing providers;
- sovereign wealth funds; and
- REITs and their overseas equivalents.
Broadly speaking, collective investment scheme limited partnerships have historically been treated as institutional investors for the purpose of the non-close requirement. However, under changes in law made by FA 2024, for a partnership to continue to be an institutional investor, it will be necessary for the partnership to satisfy either a non-close test or a genuine diversity of ownership test. Authorised unit trusts and OEICs are also subject to this additional test. Grandfathering provisions will apply in certain circumstances where the REIT has previously relied on the original institutional investor definitions.
The definition of “overseas equivalent” of a UK REIT was relaxed by FA 2022 for accounting periods beginning on or after 1 April 2022. This was previously limited to overseas REIT regimes which were equivalent to the UK REIT regime and, for example, where that regime did not have a non-close company requirement, the regime did not qualify. The test now looks at whether the overseas REIT itself, rather than the regime, satisfies the UK tests. Therefore, if as a matter of fact the overseas REIT is widely held, then that test is satisfied.
A REIT is also not a close company if at least 35% of the shares are held by members of the public (defined as individuals, close and non-close companies who own 5% or less of the voting power and those pension funds which are not for the benefit of the REIT’s employees and other investors) and the principal members, together hold less than 85% of the voting power of the REIT’s shares.
If a REIT becomes close then it will lose its REIT status unless it takes corrective action. There is however a three-year grace period on being close for new REITs, allowing a new REIT to be set up with cornerstone investors. If it remains close at the end of three years, it leaves the REIT regime at the end of year three.

Financing requirements

REITs cannot be excessively geared by debt. The REIT must have a profit financing ratio where the profits are at least 1.25x the finance costs. ‘Finance costs’ for the purposes of this test include: interest and amortisation of discounts and premiums on borrowing; the interest element of finance lease payments; and periodic hedging costs and amortisation of related discounts and premiums. For accounting periods ending on or after 1 April 2024, financing costs do not include amounts disallowed under corporation tax principles (e.g. transfer pricing, unallowable purpose, late interest rules etc) with the exception of amounts disallowed under corporate interest restriction rules which continue to be included in the calculation of financing costs.
A tax charge is levied on the REIT where there is excess financing (subject to relief under the hardship provisions).
Corporate interest restrictions also apply, limiting interest deductions to 30% EBITDA.

Holders of excessive rights

In the event that a corporate shareholder were to hold 10% or more of the REIT, they may be entitled to claim beneficial treaty rates that would undermine the REIT regime by negating HMRC’s ability to collect tax through the withholding tax mechanism. Therefore, the regime has been designed to discourage the REIT from allowing its shareholders to aggregate 10% or more of their ownership of the REIT through a corporate vehicle.
A corporate shareholder (or a shareholder treated as a company for treaty purposes), wherever tax resident, who holds 10% or more of the shares or voting rights in a UK REIT, is regarded as a holder of excessive rights.
Where the REIT pays a dividend to a holder of excessive rights (HoER), a penalty tax charge can arise on the REIT, subject to the exceptions referred to below. The charge can only be mitigated where the REIT has taken “reasonable steps” to prevent the payment of such a dividend.
From 1 April 2022 however, the HoER charge has been removed where property income distributions (PIDs) are paid to investors entitled to gross payment e.g. UK registered pension schemes and UK tax resident companies.
In addition, following the FA 2024 changes, a person is also not treated as a HoER if in accordance with double taxation arrangements, the holder is taxed at a particular rate, or not taxed at all, on distributions from a UK REIT, unless the sole reason for that treatment is the size of the holder’s interest in the UK REIT.
Other investors who may be entitled to a repayment of withholding tax on PIDs because of their status (for example, some foreign pension funds or sovereign immune entities) are not excluded from the HoER charge.
UK REITs usually have restrictions in their Articles of Association that prevent distributions from being made to corporate shareholders who hold 10% or more of share capital or voting rights and allow a UK REIT to force shareholders to sell stock if they are in danger of breaching the 10% limit.

Finance Act 2024 changes

As part of the package of proposed changes to tax legislation released on 18 July 2023, the government has renewed its commitment to the REIT regime by making further amendments to the regime which should “enhance the attractiveness of the UK REIT regime”.

One of the changes makes it clearer that the conditions for UK REIT status can be satisfied where the REIT is owned by certain types of institutional investors, including where that ownership is indirect. Another important change affects certain life companies which can now establish group REITs ensuring that they can invest in UK property rich companies without suffering double taxation. See further information.

Our experience

PwC’s REIT team has unrivalled experience in the REIT market. We worked with Government and industry in shaping the original REIT regime introduced in 2007 and the amendments which have followed. We continue to work closely with HMRC’s REIT policy team in relation to improvements to the regime and HMRC’s guidance, and with HMRC’s REIT operational team on existing and proposed new REITs.

Our REIT team has a wealth of experience of advising clients on all aspects of REITs including the establishment of new REITs, REIT conversions, M&A transactions involving REITs, on their ongoing care and maintenance requirements as well as ongoing compliance. Of course, we also have extensive audit credentials in the REIT sector.

Our clients include the majority of the largest and well-established REITs, as well as more recent entrants to the REIT regime. Members of our team have also had significant operational experience working in-house at REITs.

We therefore have an unparalleled insight into the UK REIT market.