2023 Spring Budget Analysis: Real Estate
March 15, 2023
2023 Spring Budget Analysis: Real EstateDownloads
The two key announcements for real estate investors in the 2023 Spring Budget were the unexpected decision for the Government not to implement the proposed reforms to Sovereign Immunity, and the introduction of “capital expensing” allowing a 100 percent first year deduction for capital allowances main pool qualifying expenditure, and a 50 percent deduction for special rate pool expenditure (effectively extending the super-deduction). There were a number of other amendments to existing regimes which were intended to ensure that they better incentivise investment, or work as originally intended.
Cancellation of proposed reforms to Sovereign Immunity
The proposed reforms to Sovereign Immunity, which the Government had been consulting on since July last year, will no longer be implemented. The proposals effectively intended to fully tax Sovereigns and companies owned by Sovereigns including on their rental profits, capital gains, Real Estate Investment Trust (“REIT”) distributions and funds elected as exempt under the Non-Resident Capital Gains (“NRCG”) regime. The Government was also considering whether to make amendments to other regimes (such as Qualifying Asset Holding Company (“QAHC”), REIT, NRCG and Substantial Shareholding Exemption) where the benefits available are dependent upon Sovereigns being regarded as “Qualifying Investors”. These will also no longer be implemented.
This means that for entities benefitting from Sovereign Immunity:
- Tax exempt status on UK income and gains continues to be available;
- They continue to be Qualifying Institutional Investors for purposes of the Substantial Shareholding Exemption on disposal of non-trading companies; and
- They continue to be Qualifying Investors for purposes of determining whether structures of which they (directly or indirectly) own a material proportion qualify into the REIT, QAHC and NRCG Exemption Election regimes. This results in certain structures indirectly owned by Sovereign investors continuing to be able to qualify for these regimes.
As part of this process, it was also expected that there would be greater clarity provided in legislation on the bodies that are entitled to Sovereign Immunity. However, it now appears that this clarity will not be provided given no legislation is being brought forward.
FTI Consulting Comment:
The cancellation of the proposed reforms was an unexpected, but welcomed, reversal - especially given the proposals were put forward when the current Prime Minister was Chancellor of the Exchequer. This will come as encouraging news for Sovereign investors, and also those real estate funds and asset managers with indirect Sovereign investors. With the increase in the headline Corporation Tax rate and wider economic headwinds such as higher interest rates, there are significant challenges for the real estate investment sector. This reversal in policy should help to ensure that both direct and indirect investment into UK real estate from Sovereign investors is not discouraged by an increased tax burden, and remains competitive in the global landscape.
However, not setting out the position on entitlement to Sovereign Immunity more clearly in legislation does seem to be a missed opportunity, but one that we expect industry bodies to pick up with HM Treasury.
Capital Allowances – First Year Allowances
The Chancellor has announced the introduction of “full expensing” for three years from 1 April 2023. The introduction of “full expensing” is essentially a rebranding of the first-year allowances (“FYA”) introduced in Finance Act 2021 within the existing framework in Capital Allowances Act 2001 (“CAA 2001”). A 100 percent FYA will be available for main pool plant and machinery, and a 50 percent FYA will be available for special rate pool plant and machinery, including long-life assets. Currently the rules are expected to apply until 31 March 2026.
Full detail on this and other capital allowances changes can be found on the “Corporation Tax” page. However the key points to note for real estate investors are:
- The FYA must be claimed in the period in which the expenditure is incurred;
- The assets must be new and unused, and not second hand;
- A company may elect to claim normal writing down allowances at 18percent per annum on main pool and 6percent per annum on special rate pool assets; and
- Where FYA is claimed and a company sells the asset, a balancing charge must be brought into account equal to the disposal proceeds. The balancing charge may not arise on disposal if a CAA 2001 s.198 election fixing the disposal proceeds at £1 is made at that time in relation to fixtures where the FYA has been claimed.
FTI Consulting Comment:
The extension of the FYA rules will be welcomed by businesses. However, for real estate investors there are a number of considerations. In particular, the FYA will only apply to new capital expenditure incurred, and not in relation to capital allowances pooled on acquisition of a property (e.g. via a CAA 2001 s.198 election). In addition, the FYA may result in significant losses being generated in the period the expenditure is incurred, and subject to the Corporation Tax loss restriction rules when carried forward.
Modelling the income and tax profile over the ownership period would be important to determine whether it is beneficial for property investors to claim the FYA or to retain capital allowances and claim WDAs as normal.
Genuine Diversity of Ownership (“GDO”) Condition
The Government announced an intention to amend the GDO condition in the REIT, QAHC and Exemption Election regimes to allow individual investment entities to qualify where they form part of a wider fund arrangement and the individual vehicle would otherwise not meet the GDO conditions. These provisions are predominately expected to apply to parallel and feeder fund structures and are intended to apply from Royal Assent to the Spring Finance Bill.
FTI Consulting Comment:
Given the importance of the GDO condition to these regimes and the increased prevalence of more complicated fund structures, the amendment of the GDO condition to ensure that multi-vehicle arrangements (such as feeder and parallel funds) can meet the GDO condition is welcomed.
Changes to the REIT regime
Further changes to the REIT regime (originally announced in December 2022) intended to enhance its attractiveness will be implemented from 1 April 2023. The changes are as follows:
- Removal of the requirement for a REIT to hold a minimum of three properties if it instead holds a single commercial property worth at least £20 million.
- An amendment to the rules for payment of property income distributions to partnerships to allow a property income distribution (“PID”) to be paid partly gross and partly with tax withheld where investors who are entitled to receive dividends gross of withholding tax are partners of the partnership.
- There is an anti-avoidance rule where profits are treated as being trading (and therefore falling outside the REIT’s exempt business)in the event that a property is sold within three years of practical completion of a development and the development expenditure was more than 30 percent of the fair market value of the property. The market value was previously assessed at the point of entry into the regime or acquisition by the REIT. There is now a change in the valuation point at which the fair market value is assessed for determining the 30 percent to better reflect increases in property values prior to development taking place.
FTI Consulting Comment:
These REIT changes will be welcomed by investors, alongside the GDO changes and the REIT changes that were implemented in 2022, which facilitate the setup of captive REITs by qualifying private investors and make single asset REITs simpler to set up. The changes follow significant engagement by the Government with industry stakeholders over a number of years and reflect the Government’s desire to facilitate investment into the UK.
Previously, a single asset would need to be let to three separate tenants, so the simplification of this requirement for larger assets is helpful, and removes odd scenarios where large single let offices and industrial buildings would not qualify to be held in a single asset REIT but a multi-let office would qualify.
The option to allow for a partnership with multiple investors that invests in a REIT to be “looked through” such that the REIT can pay gross the proportion of any PID that related to investors that are entitled to gross payment is also a practical solution to an administrative issue. This minimises the cost and burden for such investors in reclaiming the withholding tax.
The changes to the development anti-avoidance rules allow the valuation basis to better reflect the value of the property before the development takes place. This may then account for an increase in value due to, for example, planning or agreeing to let the property prior to development, or a lengthy income generating holding period before any redevelopment taking place.
Changes to the QAHC regime
The Government announced a number of changes to the QAHC regime which predominately seek to ensure the regime is operating as intended and include measures such as excluding securitisation companies from the regime, amending the anti-fragmentation rule and ensuring that certain corporate entities which are Alternative Investment Funds can be Qualifying Funds under the regime.
However, one key change is allowing for a company to still meet the conditions of the regime even where its investment strategy includes the acquisition of listed securities provided it makes an election to treat distributions from those securities as taxable. Previously, a company would not be able to qualify for the regime if part of its investment strategy was the acquisition of listed securities unless they were being acquired as part of a delisting.
The above changes are in addition to the wider changes to the GDO condition discussed above.
FTI Consulting Comment:
Given the QAHC regime was only introduced in April 2022, we welcome the efforts by the Government to ensure that the regime operates as intended and that the intended companies are able to qualify for the regime. In particular, it is positive to see the willingness of the Government to extend the regime to companies with a strategy of investing in listed securities but with the necessary safeguards to prevent abuse.
Amendments to the Corporate Interest Restriction (“CIR”) rules
Following engagement with stakeholders last year, the Government are introducing changes to the CIR rules in order to address a number of unintended consequences, to ensure the rules operate more appropriately in certain situations and strengthen HMRC’s enforcement powers.
Whilst there are a significant number of changes to the regime with varying commencement dates, key changes include:
- Ensuring a disallowance does not arise purely as a result of a mismatch between tax-interest and group-interest on an appropriation from trading stock to fixed assets;
- Clarifying that the deduction of an income tax loss for a non-resident landlord should not reduce tax-EBITDA,
- Preventing a disallowance from arising due to a mismatch between tax-interest and group-interest on interest accrued prior to commencing a trade and a UK property business (for a non-UK resident company);
- Extending the time period for HMRC to appoint a reporting company to four years from the ending of the accounting period (currently three years);
- Removing the additional time to make group relief and capital allowances claims following a determination by HMRC when a group has failed to file an Interest Restriction Return;
- Amendments to the public infrastructure rules to ensure that a building under construction for use in a property business qualifies for exemption, and to allow certain finance costs payable to third parties via an overseas group company to qualify; and
- Ensuring changes to CIR disallowances are ignored when calculating penalties for inaccuracies in corporation tax returns.
FTI Consulting Comment:
Given the complexity of the CIR provisions and the fact that a number of shortcomings have been identified since the introduction of the rules in April 2017, we welcome the efforts by the Government to amend the rules to remedy unintended consequences and ensure that the rules operate appropriately. In particular, we welcome the efforts from the Government to introduce retrospective amendments for unintended consequences which arose on the transition of non-resident landlords to corporation tax in April 2020.
Conversely, whilst we acknowledge the rationale behind HMRC strengthening their enforcement powers, we consider there is a missed opportunity for the Government to ease the compliance burden on taxpayers. This includes the opportunity to increase the time frame for a group to nominate its own reporting company from one year to two years especially as this was a measure lobbied for by many stakeholders in discussions with HMRC.
Carried interest – elective accruals basis
UK resident fund managers who receive carried interest are usually subject to tax on carry distributions at the time it arises to them. However, the same income or gains can also be subject to tax in another country. This can create issues where the other country taxes the income or gain earlier than the UK, resulting in fund managers paying double tax. From 6 April 2022 (i.e. on a retrospective basis) new legislation will allow individuals to better align their tax liabilities by electing for their carry (on an irrevocable basis) to be taxed in the UK on an accruals basis – this should help prevent issues where double tax relief cannot be claimed.
FTI Consulting Comment:
It is welcome that measures are being introduced to ensure that unintended double tax liabilities do not arise. Impacted individuals will need to think very carefully about making an election given its irrevocable nature and will need to work through the tax consequences that will apply.
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March 15, 2023
Senior Managing Director, Head of EMEA Tax Advisory & Real Estate