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New regulations for Property Authorised Investment Funds
will be introduced from 6 April 2008.
The new regulations provide an alternative to a UK Real Estate Investment
Trust (‘REIT’) and the new AIFs will be open ended vehicles. An AIF that
invests mainly in property and certain related securities will be able to
elect for the Property AIF regime to have effect.
In a Property AIF rental profit and certain other property related income
will be exempt from taxation in the fund. It will normally be distributed to
investors under deduction of tax. Basic rate taxpayers will have no further
tax liability, non-taxpayers and exempt bodies will be able to reclaim this
tax, while higher rate taxpayers and some corporates will have a further tax
liability to pay.
Other taxable income of the Property AIF will also be distributed to
investors under deduction of tax. Investors will similarly be able to either
reclaim the tax or incur a further charge as appropriate.
UK dividends which are currently not taxable in the fund will remain exempt,
as they are for all corporate recipients and will fund dividend payments
carrying a tax credit to investors at present.
To qualify for the new regime, Property AIFs will have to meet certain
conditions including:
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Incorporation as an open-ended investment company (‘OEIC’)
(subject to FSA regulation);
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Carry on a property investment business (amounting
to at least 60% of the business);
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A ‘genuine diversity of ownership’ condition, so
that the fund is not limited or targeted at only a few specified
investments; and
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Limits on the holdings of corporate investors on the
type and amount of loan financing in the fund.
The new regime will not be available to Authorised Unit Trusts (‘AUTs’). The
reason for this is to avoid double tax leakage on payments to non-UK tax
residents. The complexities of the AUT regime, being a trust in form, but a
deemed company for certain tax purposes, could give rise to potential
leakage.
Those trusts in AUT form, who wish to take advantage of the new regime, will
have to convert to OEIC status.
Our view
Whilst capital gains in the current AIF regime are exempt from tax,
property income is currently taxed in the AIF at 20% and when
distributed is treated like a dividend.
This treatment is not a problem for individual investors, who can make
use of the attached tax credit (effectively giving tax rates of 20% or
40% for basic rate tax payers and higher rate tax payers respectively),
it is an issue for tax exempt investors, such as charities and pension
funds, as the tax credit is not refundable to them.
Accordingly, investment in such a fund by exempt investors currently
gives a tax leakage of 20% compared to an alternative investment, such
as a direct property investment or a holding of shares in a REIT. The
effect of this is that such funds have often preferred to invest in tax
neutral offshore structures.
The aim of the new legislation is to reduce the tax distortion and
enable such funds to become attractive to UK exempt investors. In broad
terms, this will be achieved by moving the tax to the investor level.
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