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Sovereign Wealth Funds invest into U.K. real estate through U.K. REITs

By Elliot Weston

As tax exempt investors, Sovereign Wealth Funds (SWFs) have traditionally sought to invest into U.K. real estate through tax neutral structures. In the past, if a SWF was investing alongside one or two other investors, this would often have meant using a partnership or offshore unit trust. However, U.K. Real Estate Investment Trusts (REITs) are becoming a more attractive option.

We have seen a gradual move from offshore property holding structures to onshore (U.K.) structures, like the REIT, driven partly by international tax changes (BEPS) and the introduction of capital gains tax for non‑U.K. resident investors in U.K. real estate (from April 2019).

The attraction of a REIT is that it is exempt from U.K. corporation tax on U.K. property business profits and gains, provided that it distributes up at least 90% of its net income from its property business. Whilst a non-U.K. resident investor in the REIT would generally be subject to U.K. income tax on such distributions (by way of 20% withholding), a SWF is entitled to sovereign immunity from U.K. tax.

A SWF would typically invest in a “private” REIT, which is held by a small number of institutional investors. A “private” REIT would be listed (usually on The International Stock Exchange), but there is no requirement for the shares to be held by the public.

A REIT must not be controlled by 5 or fewer participators, but there is an exception where those participators include an “institutional investor”, such as a SWF.

A corporate investor holding 10% of a REIT can cause the REIT to suffer a tax charge on distributions to that investor, but HMRC accept that a SWF can hold more than 10% of a U.K. REIT without triggering any tax charge for the REIT.

Since 6 April 2019, U.K. tax is charged on gains made by non-U.K. resident investors on disposals of all types of U.K. property, including where a non-U.K. resident realises a gain on disposal of an interest in a U.K. property-rich collective investment vehicle (such as a REIT). However, a SWF would be exempt from U.K. tax on a disposal of shares in a REIT.

Finally, there is the possibility that stamp duty land tax (at rates of up to 5% for non-residential property) may be introduced on the transfer of units in a U.K. property-rich offshore unit trust. As the transfer of shares in a REIT incorporated in the U.K. attracts stamp duty at only 0.5%, this might be another reason to consider the use of a REIT.

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