Capital allowances may be claimed in a variety of trades and entities. Often overlooked due to its tax status, there is a genuine interaction between REITS and capital allowances as explained below.
Background
Real Estate Investment Trusts (REITS) are tax efficient property investment companies. They were first introduced to the UK in 2007.
The main benefit of having REIT status is profits and gains from the property rental business are exempt from corporation tax.
Profits and gains from any other activities carried on by the REIT remain subject to corporation tax in the normal way. The company will therefore be treated for tax purposes as two different entities – the tax exempt property rental business and the non-tax exempt business.
Conditions for REIT Status
A company must fulfil a number of conditions to qualify for REIT status. Some of the key conditions include:
- The company must be resident only in the UK for tax purposes.
- The property rental business must involve at least three single properties.
- No single property may represent more than 40% of the total value of the properties.
- At least 90% of the profits of the property rental business must be distributed to shareholders annually.
Interaction with Capital Allowances
As property rental income is a qualifying trade for capital allowances purposes, allowances can be utilised to reduce total rental income subject to UK tax. At first glance it would appear that capital allowances are redundant for REITS. This is on the basis that as REITS are not taxpaying, what is the tangible benefit?
There are three notable areas where claiming capital allowances may be of significance:
- Mandatory Distribution of 90% Rental Profits
The REITS distributable profits are calculated under the same UK tax rules subjected to normal UK companies. Therefore the accounting profits will be adjusted to take account of capital allowances. Some REITS will just claim the routine and obvious capital allowances and not bother to engage capital allowances specialists.
However, if the REITS maximise the amount of allowances claimed in a particular year, this will lower the total profits that are mandatory required for distribution to shareholders. It can therefore help REITS to retain more cash in the entity for reinvestment and improve liquidity.
- Interaction with New Fixtures Legislation
By claiming full levels of capital allowances a REIT will be able to pass on more allowances to a future owner. This has become a more important consideration since the changes to fixtures which apply from April 2014.
- Potential Increase for Distribution of Ordinary Dividends
By maximising allowances REITS would now pay less mandatory distributions (in terms of overall quantum). Therefore it has greater flexibility to distribute the excess profits as ordinary dividends.
From a tax perspective this is advantageous to the individual shareholders as dividend tax rates are lower than income tax (which would apply to income received via mandatory distributions).
Although the use of these “shadow allowances” (a term coined by HMRC) does not save any actual tax for REITS, the cash flow benefits mentioned emphasise a value. Furthermore the total allowances available could be significant due to the overall number and type of properties typically held by such entities (mainly offices, hotels and industrial buildings).
Interaction with Other Types of Allowances
- REITS are entitled to claim Enhanced Capital Allowances (ECA) but not able to claim the ECA credit.
- Land Remediation Relief and Land Remediation tax credits are both available.
- The Annual Investment Allowance (AIA) may also be claimed.
REITS & Joint Ventures / Non REITS
Some REITS participate in joint ventures (JV’s) with a single company or group. Provided they have at least a 40% interest in a joint venture company that has a property rental business, the REIT can opt to include its share of the JV’s property rental profits as part of its special tax exempt status.
Normal corporation tax will still apply to JV’s on their non REIT profits. Consequently it is worth talking to capital allowances specialists where this applies.