An investment company (sometimes known as a listed fund) is the name given to any company that is listed on a stock exchange and which has the primary purpose of investing in a portfolio of shares or other assets, with the aim of giving investors in such company exposure to the assets in which the company has invested.
Investment trust guide
As a publicly listed entity, investment companies have the ability to access wider and deeper pools of capital than in the private markets alone.
Although structured as a company, an investment company is a type of collective investment fund that does not carry out a commercial enterprise in the way a “normal” company would. Investment companies include investment trusts, real estate investment trusts (or REITs), venture capital trusts and non-UK investment companies. The benefits of all types of investment companies – and not just investment trusts - compared to other types of collective fund include the following:
Introduction
This enables the manager to make longer-term decisions, without having to worry about needing to sell assets when investors sell their shares in the investment company (which is the case with an open-ended structure).
Access to capital markets
Closed ended structure
Boards of directors
As a corporate vehicle, the company requires a board of directors. This provides an additional layer of oversight in relation to the activities of the fund, protecting the interests of investors and providing accountability to shareholders.
Consistent income
Investment companies have the ability to level the amount of income they pay out year to year by reserving income in well performing years to pay out later.
Gearing
The ability of investment companies to borrow money to invest means that they may perform better over the long term (albeit this comes with risks).
Macfarlanes client Supermarket Income REIT (SUPR) is a real estate investment trust providing secure, inflation-protected, long income from grocery property in the UK.
How does an investment trust differ from other investment companies?
In 2017, SUPR launched its IPO as a “blind pool” fund admitted to trading on the SFS, raising £100m. At the time, the SFS was the appropriate market for SUPR because it did not meet the diversification criteria for the Main Market. SUPR is externally managed, with Atrato Capital is its investment adviser (and JTC acting as AIFM). SUPR acquires supermarket property with long, inflation linked leases (it targets a portfolio average of 15 years to expiry or first break) and aims to provide investors with a long-term and secure income stream which is expected grow with inflation. SUPR funds its acquisitions through shareholder equity and bank borrowings. It raises equity at times when it identifies appropriate assets, consistent with its returns profile and deploys the capital raised quickly.
SUPR typically buys assets located in highly populated residential areas, with strong transportation links. A key pillar of its investment strategy is to invest in omnichannel stores. These are larger supermarkets that provide normal in store shopping, but they also operate as last mile online grocery fulfilment centres for home delivery and click and collect. The REIT believes these stores not only benefit from conventional in store grocery sales but are also uniquely positioned to benefit from any increase in online grocery sales.
The majority of its stores are leased to the four largest UK supermarket operators by market share, which are currently Tesco, Sainsbury’s, Asda and Morrisons.
The Macfarlanes team has played a crucial role in the growth of SUPR, both in our many successful equity raises and also performing thorough due diligence on target assets. Their market leading expertise in the REIT space has been invaluable to us.
Rob Abraham
Managing Director, Atrato Group
Since IPO in 2017, the REIT has invested in 67 properties, 41 directly and the balance through a joint venture.
SUPR’s most recent pro forma net assets as at 31 December 2021 (before its most recent equity fundraise in March 2022) stood at £1.1 billion and its market capitalisation is now in excess of £1.5 billion.
In February 2022, it moved to the Main Market, having met the diversification criteria, and has recently joined the FTSE250.
Wider pool of assets
Investment companies are more able to invest in hard-to-reach assets such as private equity, infrastructure and social and environmental impact investments.
Investment trusts
Investment trusts are a form of collective investment fund. The investment trust is typically structured as a UK public limited company. The shares in an investment trust are traded on a stock exchange and the company is managed by an independent board of directors.
1. What is an investment trust?
The investment trust will be an alternative investment fund (AIF) for the purposes of the UK rules on alternative investment fund managers (the AIFM Rules) and will, as a result, need to have an alternative investment fund manager (AIFM). The AIFM is responsible for the AIF’s portfolio management and risk management. The AIFM can be either external (i.e. a third party appointed by the board of the investment trust to be its AIFM) or internal (i.e. the board of the investment trust manages itself as its own AIFM). A UK AIFM (whether external or internal) must be authorised by the FCA under the AIFM Rules. Obtaining the requisite authorisation can take some time, so it can be preferable to appoint an existing authorised AIFM as the investment trust’s external AIFM. The AIFM may appoint an investment adviser to advise in relation to the investment decisions of the AIFM. The investment adviser will also need to have the appropriate FCA authorisation (which could be obtained by becoming an authorised representative of a person that has the necessary regulatory permissions) - though the FCA regime for being authorised as an investment adviser is less onerous than being authorised as an AIFM.
2. What regulatory permissions does an investment trust need to consider?
Independence The board of directors of the investment trust must be able to act independently of its investment manager. Both the chair of the board and a majority of the board (which may include the chair) must be independent. The Listing Rules set out in detail who is not independent (which is broadly persons with a substantive connection to the investment manager). Related party transactions The investment manager and its group will be ‘related parties’ of the investment trust, which means that, among other things, transactions between the investment trust and the investment manager which exceed 5% in the class tests set out in the Annex to Chapter 10 of the Listing Rules (which broadly compare the size of the investment trust against the size of the transaction using various metrics) require shareholder approval.
3. What are the key considerations in relation to an external manager of an investment trust
Yes, investment trusts can be (and frequently are) established as a blind pool funds (i.e. with no assets held or contracted by the investment trust at the point of raising capital from investors). The investment trust’s promoters will need to consider the effect on marketing that having no assets has. Investors may be more willing to invest if the investment trust either has existing assets or has contracted to acquire them – in effect to demonstrate a track record. If the investment trust does not hold any assets and has not contracted to acquire any at the time of launch, its promoters are, in marketing the investment trust, likely to need to demonstrate a “pipeline” of assets into which they can invest.
4. Can an investment trust be a “blind pool” fund?
Investment trusts are able to distribute any surpluses from the realisation of investments as a dividend. However, they will be required to comply with the provisions of UK company law in relation to making such a distribution. An investment trust also benefits from the corporate law regime that enables investment companies to make a distribution out of its accumulated net revenue profits without regard to any capital losses it may have incurred.
7. How are capital profits distributed?
In addition to approval by HMRC, a number of conditions need to be met by a company to be classified as an investment trust. These conditions must also be complied with on an ongoing basis to retain investment trust status and enjoy the full benefits of the investment trust regime. Breaches of the conditions attract consequences (which differ according to the condition breached and the severity of the breach). Conditions under the CTA 2010
6. What are the eligibility conditions?
A company becomes an investment trust by making an application in writing to HMRC. Amongst other things, the application must contain an undertaking (in relation to the first accounting period under the investment trust regime, and all subsequent accounting periods) that the company will meet the conditions set out in Section 1158 Corporation Tax Act 2010 (CTA 2010) and the requirements set out the Investment Trusts (Approved Company) (Tax) Regulations 2011 (the Regulations). Within 28 days of receiving the application, HMRC must give notice accepting the application, rejecting the application or asking for further information. In the latter case, the 28 day clock restarts from the day the further information is provided to HMRC (which must also be provided within 28 days).
5. How does a company become an investment trust?
An investment trust is not required to withhold UK tax when paying a dividend on its ordinary shares (including any dividend designated as an interest distribution under the streaming regime). UK resident individual shareholders who receive dividends from an investment trust that are not designated as interest distributions will generally pay UK income tax on those dividends at dividend rates in the normal way. UK resident individual shareholders who receive dividends from an investment trust that are designated as interest distributions under the streaming regime would be treated for tax purposes as receiving a payment of interest. Such a shareholder would generally be subject to UK income tax at the normal income tax rates (i.e. not at dividend rates). Shareholders within the charge to UK corporation tax that receive dividends from an investment trust (and that are not designated as interest distributions under the streaming regime) will be subject to corporation tax on those dividends unless the dividends qualify for exemption. Dividends paid by an investment trust will generally qualify for exemption (subject to certain conditions). UK corporation tax payers that receive a dividend designated by an investment trust as an interest distribution would be treated for tax purposes as receiving interest under a creditor loan relationship. Accordingly, such a shareholder would be subject to corporation tax in respect of the distribution. Disposals of shares in the investment trust may, depending on the shareholder’s circumstances and subject to any available exemption or relief, give rise to a chargeable gain or allowable loss for the purposes of UK taxation of chargeable gains.
9. What are the UK tax consequences for shareholders in an investment trust?
Although an investment trust is exempt from UK corporation tax on its chargeable gains, an investment trust is generally subject to UK corporation tax on its income in the normal way. However, there is a broad ranging UK corporation tax exemption for dividends which would generally be expected to apply in respect of most dividends an investment trust receives. There is no general UK corporation tax exemption for the receipt of interest. However, investment trusts can take advantage of modified UK tax treatment in respect of their “qualifying interest income”, known as the “streaming” regime. Under this regime, an investment trust may designate all or part of the amount it distributes as dividends as an “interest distribution”, to the extent that it has “qualifying interest income” for the accounting period. If an investment trust designates a dividend it pays as an interest distribution, UK resident shareholders would (broadly speaking) be taxed as if the dividend received were a payment of interest and the investment trust can deduct the amount of the interest distribution from its income in calculating its taxable profit for the relevant accounting period.
8. What is the key tax consequence for a company being an investment trust?
Cross-holdings No more than 10%, in aggregate, of the value of the total assets of the investment trust may be invested in other listed closed ended investment funds. This restriction does not apply to investments in closed-ended investment funds which themselves have published investment policies to invest no more than 15% of their total assets in other listed closed ended investment funds.
10. Can an investment trust invest substantially all of its assets in another fund?
No. Subject to compliance with the listing rules, an investment trust is not limited in the share capital that it issues to investors. In particular, investment trusts have historically used C shares and ZDPs to raise capital. C Shares C (Conversion) shares help an investment trust grow in a way that protects the interests of existing ordinary shareholders. C shares and the proceeds are held in a separate pool and invested in a portfolio of assets. C shares allow the cost of a C share issue to be borne by the C shareholders and for the proceeds of the issue to be held separately until they are invested so they do not affect the returns of the existing shareholders. After a certain period, or when the pool of new money is fully invested, the two portfolios are merged and the C shares are exchanged for ordinary shares. The ability of an investment trust to issue C shares is normally included in the articles of the association of an investment trust when it is launched. ZDPs (zero dividend preference share) A ZDP is a type of share which entitles holders to a fixed capital return on a specified date in the future. Although a typical ZDP is transferrable and will be admitted to trading, a ZDP does not carry dividend rights and is not typically classified as equity share capital (i.e. it is a debt-like instrument). A ZDP enables an investment trust to find alternative sources of capital other than from existing equity investors. An investment trust which has outstanding ZDPs in issuance is known as a split capital investment trust.
11. Can an investment trust only issue ordinary shares?
The UK market that offers the greatest liquidity (including because admission to it is a requirement for inclusion in the FTSE indices) is the London Stock Exchange’s Main Market. The rules of the Main Market are, however, more onerous than other markets. A comparison of the key eligibility requirements and the key ongoing obligations for the London Stock Exchange’s Main Market and Specialist Fund Segment is set out below.
12. To what market should an investment trust’s shares be admitted?
A summary: which must follow a prescribed format and be a fair summary of the prospectus as a whole. Risk factors: which will be tailored to the particular investment trust. A business description: this typically comprises (among other things) an introduction, the history of and background to the business, an overview of the business, including investment objective, investment policy, investment strategy, investment restrictions, valuation policy, and a comprehensive and meaningful portfolio analysis. Details of the directors, management (including track record) and corporate governance. Historical financial information. Capitalisation and indebtedness tables. Taxation summaries for the issuer and shareholders. Additional information: containing miscellaneous details required by the Prospectus Regulation Rules, such as material contracts, share capital history and director remuneration.
14. What are the principal contents requirements of a prospectus for an investment trust?
The disclosure document and verification:
13. What are the principal workstreams for admission to trading?
If you would like further information or specific advice please contact:
Macfarlanes LLP 20 Cursitor Street London EC4A 1LT T +44 (0)20 7831 9222 | F +44 (0)20 7831 9607 | DX 138 Chancery Lane | macfarlanes.com
This content is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained. Macfarlanes LLP is a limited liability partnership registered in England with number OC334406. Its registered office and principal place of business are at 20 Cursitor Street, London EC4A 1LT. The firm is not authorised under the Financial Services and Markets Act 2000, but is able in certain circumstances to offer a limited range of investment services to clients because it is authorised and regulated by the Solicitors Regulation Authority. It can provide these investment services if they are an incidental part of the professional services it has been engaged to provide.
Mark Slade Senior counsel DD +44 (0)20 7849 2269 mark.slade@macfarlanes.com
Richard Burrows Partner DD +44 (0)20 7849 2564 richard.burrows@macfarlanes.com
Jeremy Moncrieff Partner DD +44 (0)20 7849 2476 jeremy.moncrieff@macfarlanes.com
Lora Froud Partner DD +44 (0)20 7849 2409 lora.froud@macfarlanes.com
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Condition A: all, or substantially all, of the business of the company consists of investing its funds in shares, land or other assets with the aim of spreading investment risk and giving members of the company the benefit of the results of the management of its funds. Condition B: each class of shares making up the company’s ordinary share capital is admitted to trading on a regulated market (or is admitted within 60 days of the application to HMRC). Note that a “regulated market” for the purposes of Condition B means: - a UK regulated market (which includes the Main Market of the London Stock Exchange, but not AIM) - an EU regulated market - a Gibraltar regulated market Condition C: the company is not a venture capital trust or a UK real estate investment trust.
The non-close company requirement: the company must not be a close company (i.e. a company which is under the control of five or fewer “participators”, which includes shareholders or certain loan creditors, or any number of participators who are directors) at any time in an accounting period. There is a quoted company exception to the classification of a close company where, broadly, at least 35% of the voting shares are held by the general public and such shares have been subject to trading (and listed) on a recognised stock exchange in the prior 12 months. The income distribution requirement: an investment trust must not retain an amount which is greater that 15% of its income for the accounting period in question, and the relevant distribution must be distributed before the filing date for the company’s tax return for the period. There is no obligation to make a distribution: - if the amount that the investment trust would be required to distributed would be less than £30,000; - to the extent the company is company is required by law to retain the income.
Under the Regulations (Chapter 3 Requirements)
Yes, but some restrictions apply. The Listing Rules provide for further restrictions. Master fund investment policy If the investment trust principally invests its funds (directly or indirectly) in another company that invests in a portfolio of investments (a master fund), the investment trust must ensure that:
the master fund’s investment policy is consistent with the investment trust’s published investment policy and provide for spreading investment risk; and the master fund in fact invests and managers its investments in a way that is consistent with the investment trust’s published investment policy and spreads investment risk.
Eligibility: an investment trust seeking admission to the Main Market would typically submit an eligibility letter to the Financial Conduct Authority (FCA) at the same time as submitting the prospectus for first review. The eligibility letter can be submitted earlier, but doing so is likely to delay the process. Given the limited eligibility requirements for the Specialist Fund Segment, the eligibility process is more informal on that market. Due diligence: if the investment trust is listing with existing assets in place, legal and financial due diligence will be carried out by the investment trust’s lawyers and reporting accountants. Significant input will be needed from the investment trust /its promoters to respond to document request lists and follow-up questions. Accounts: if the investment trust has financial history, it will need to prepare accounts for the last three years (or the period of its operations if shorter) in accordance with IFRS. Those accounts will need to be reported on by the investment trust’s reporting accountants. Working capital: in its disclosure document, the investment trust will be required to state that it has sufficient working capital for the next twelve months. In order to support this statement, an investment trust /its promoters will prepare a working capital model showing cashflow and expenditure projections (typically over a longer period than the 12 month period), including a base case and a downside case with sensitivities applied. The working capital model will be reviewed in detail by the investment trust’s reporting accountants and its sponsor/ nominated adviser. Contractual arrangements: the investment trust will need to enter into contractual arrangements with its service providers and advisers. If the investment trust is externally managed, the management contract is the critical contract and will be scrutinised by the sponsor/nominated adviser and its lawyers. If the investment trust is internally managed, it may wish to put employee incentives in place. Governance: the investment trust will need a board of directors (typically wholly non-executive if the investment trust is externally managed). The length of the recruitment process for finding directors that have the requisite experience and skills and fit with the corporate governance requirements for an investment trust should not be underestimated. Careful thought also needs to be given to the composition of, and terms of reference for, board committees. In addition, the directors will need time to familiarise themselves with the investment trust’s operation and be informed of their responsibilities and liabilities as directors of the investment trust. Financial position and prospects procedures: it will be very important for the board of the investment trust to have accurate and timely information on the investment trust’s operations and finances so that decisions can be made on a timely basis as to whether any public announcements are required. An investment trust will therefore prepare a detailed memorandum on financial position and prospects procedures (usually using a template provided by the reporting accountants), which will then be reviewed in detail by the investment trust’s reporting accountants and its sponsor/nominated adviser.
The principal disclosure document for an investment trust whose shares are to be admitted to either the Main Market or the Specialist Fund Segment is a prospectus. A prospectus will be subject to the review of the FCA. A prospectus typically takes 6-8 weeks from first submission to clear comments from the FCA. Given the risk of liability for the investment trust and its directors for false or misleading statements in the disclosure document, the disclosure document is typically subjected to a verification exercise which seeks to identify evidence supporting the truth of each statement made in the disclosure document. Investment trusts also typically take out prospectus insurance with an insurance broker. Marketing and fundraising: assuming that the investment trust wishes to raise new money on admission and/or existing shareholders in the investment trust want to sell shares on admission, the investment trust/its promoters will typically conduct a “roadshow” for prospective investors using a marketing presentation, which is consistent with the contents of the disclosure document (and which will also be verified).
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What is a REIT?
A REIT is a company which has a special HMRC approved tax status. It is not a trust. A REIT Group is a group of companies where each member of the group has approved tax status. The ultimate parent of a REIT Group is known as the principal company.
REIT overview
Tax issues
Structuring and legal issues
Listing considerations
Other issues
How does a company or group become a REIT?
A company becomes a REIT by giving notice in writing to HMRC (there is no prescribed form) of the future date on which the REIT intends to become a REIT. The notice must contain a statement that certain qualifying conditions are reasonably expected to be met in relation to the REIT in its first accounting period after becoming a REIT.
What are the principal qualifying conditions?
A number of conditions need to be met by a company, or group, to enter the REIT regime. These conditions must also be complied with on an on-going basis to retain REIT status and enjoy the full benefits of the REIT regime. Breaches of the conditions attract tax penalties and/or consequences (which differ according to the condition breached and the severity of the breach) such as removal from the REIT regime. The main conditions are summarised below: (A) Company conditions The conditions below must be satisfied in respect of the principal company of a REIT Group (or by a single company REIT).
To the extent permitted by law, the principal company of a REIT Group must distribute to shareholders, on or before the filing date for its tax return for the relevant accounting period, at least 90% of the income profits of the UK property rental business of the REIT Group.
(B) Property rental business conditions
(C) Distribution condition
HMRC may require a REIT to exit the REIT regime if:
(E) Breach of REIT conditions
The principal company of a REIT Group must not be party to any loan in respect of which the lender is entitled to interest exceeding a reasonable commercial return on the consideration lent or where the interest depends to any extent on the results of any of its business or on the value of any of its assets. If the ratio of a REIT Group’s income profits (before capital allowances) in respect of its property rental business to the financing costs incurred in respect of its UK property rental business is less than 5:4 for an accounting period, then a tax charge will arise.
(D) Borrowing restrictions conditions
(i) the shares forming the principal company’s ordinary share capital are admitted to trading on a recognised stock exchange. This allows the shares in a REIT to be admitted to a wide variety of markets. The most obvious markets in the UK are the Main Market, the Specialist Fund Segment and AIM (each a market of the London Stock Exchange). A technical listing on the International Stock Exchange is also possible if liquidity is not a concern; or (ii) at least 70% of the company’s ordinary share capital is owned directly or indirectly by one or more institutional investors. “Institutional investors” generally includes the trustee or manager of an authorised unit trust (or overseas equivalent) or a pension scheme, an insurance company, a charity, a limited partnership which is a collective investment scheme, a registered social landlord, an open-ended investment company, a person with sovereign immunity, a UK REIT and the non-UK equivalent of a UK REIT. For the purposes of this 70% ownership test, a limited partnership which is a collective investment scheme must also satisfy the “genuine diversity of ownership test” (GDO) to be treated as an institutional investor. In broad terms, for the GDO to be satisfied, the fund documentation of the partnership must state its target investors, that it will be widely available and that it will be marketed in an appropriate manner to reach its target investors. Further, the terms and conditions of the partnership should not be a deterrent to such investors, its manager must act in accordance with the statements in the fund documentation mentioned above, and any potential investor within one of the intended categories must be able to approach the manager to obtain information about the partnership and invest in it.
Tax residence: the principal company must be resident in the UK and not resident anywhere else for tax purposes.
Not a close company: except in the first three years following entry into the REIT regime, the principal company must not be a close company other than by virtue of having a participator who is an institutional investor.
A close company is, broadly, a company under the control of five or fewer participators or of participators who are directors.
At least three properties: throughout each accounting period, the property rental business of the REIT Group must involve at least three properties.
Concentration cap: throughout each accounting period, no one property may represent more than 40% of the total value of all properties involved in the property rental business.
Property rental business income profits: the income profits arising from the property rental business must represent at least 75% of the REIT Group’s total income profits for each accounting period.
Property rental business assets: at the beginning of each accounting period, the value of the assets in the property rental business must represent at least 75% of the total value of the assets of the REIT Group.
Owner occupied property excluded: the letting of property that would fall to be treated as “owner-occupied” in accordance with generally accepted accounting practice (GAAP) does not generally qualify as a property rental business. “Owner-occupied” is defined for GAAP purposes as property held by the owner for use in the production or supply (by the owner or a member of its group, in relation to consolidated accounts) of goods or services or for administrative purposes.
Disposals within three years of substantial development: the tax benefits of the REIT regime will not apply to profits realised on a disposal of a property by a member of the REIT Group in the course of a trade. This includes circumstances where (i) the property has been developed since it was acquired by the company; (ii) the cost of development exceeds 30% of the fair value of the property (determined in accordance with International Accounting Standards) at the later of acquisition and entry into the REIT regime, and (iii) disposal takes place within three years of completion of the development.
Other excluded classes: there are certain classes of income that are excluded from the REIT regime including (among others) income from the operation of a caravan site and rent in respect of the siting of pipelines for oil or gas, mobile phone masts or wind turbines.
Single class of ordinary shares: all the principal company’s shares must either be ordinary shares or non-voting restricted preference shares (broadly, fixed rate preference shares which are either not convertible or only convertible into shares in the principal company). Further, the principal company must only have one class of ordinary share in issue.
Not an OEIC: the principal company must not be an open-ended investment company.
Ownership condition: either
it regards a breach of the conditions relating to the REIT regime (including in relation to the UK property rental business), or an attempt to obtain a tax advantage, as sufficiently serious;
the REIT Group has committed a certain number of breaches of the REIT conditions in a specified period; or
HMRC has given members of the REIT Group two or more notices in relation to the obtaining of a tax advantage within a ten-year period.
REIT status is also lost automatically if:
the conditions for REIT status relating to share capital or the entering into loans with non-commercial returns are not met;
the principal company ceases to be UK resident for tax purposes (or becomes dual-resident);
the principal company becomes an open-ended investment company; or
in certain circumstances, where the principal company ceases to fulfil the close company conditions.
Are there any other key tax consequences of being a REIT?
The principal company of a REIT Group will become subject to an additional tax charge if it pays a dividend to, or in respect of, a holder of excessive rights. A holder of excessive rights is, broadly, any shareholder with a 10% or greater holding which is a body corporate (or which is deemed to be a body corporate). However, a person that would otherwise be a holder of excessive rights is not treated as such where the principal company reasonably believes that the recipient falls within certain excluded categories such as a charity, the scheme administrator of a registered pension scheme or a UK resident company. The additional tax charge is calculated by reference to the whole dividend paid to a holder of excessive rights, and not just by reference to the proportion that exceeds the 10% threshold. The tax charge will not be incurred if the principal company has taken reasonable steps to avoid paying dividends to such a shareholder. To demonstrate that it has taken such reasonable steps, a principal company typically includes in its articles of association provisions allowing it to identify holders of excessive rights, withhold dividends from them, disenfranchise them and, ultimately, arrange for their shares to be sold.
Who can be included in the REIT Group?
All members of a group of companies (including non-UK tax resident companies) can be members of a REIT Group. A REIT Group consists of the parent company (which must be a UK tax resident company) and companies in which (directly or indirectly) the parent company owns 75% of the ordinary share capital. The subsidiaries must also be “effective 51% subsidiaries” (broadly speaking, the parent is beneficially entitled to more than 50% of the company’s distributable profits and will be entitled to more than 50% of its assets on winding up).
What is the key tax consequences of being a REIT?
The main tax benefit of being within the REIT Regime is a UK tax exemption for the REIT Group on the profits of its property rental business and on the disposal of interests or rights in certain UK property rich vehicles (broadly, a vehicle is UK property rich if at least 75% of its gross asset value is derived from rights over or interests in UK real estate).
What are the tax consequences for shareholders in the REIT?
Property Income Distribution (PID)
A PID refers to distributions from the principal company of a REIT Group out of the tax-exempt profits of the REIT Group. UK tax resident shareholders will be taxed on PIDs as if those dividends were profits of a UK property business. An individual shareholder who is subject to income tax at the basic rate will be liable to pay income tax on the PIDs at a rate of 20%, higher rate taxpayers at a rate of 40% and additional rate taxpayers at a rate of 45%. If the REIT Group has other sources of profit, it may pay dividends out of those (non-property business) profits and they will be taxed as dividends in the normal way (i.e. at up to 39.35%) for UK tax resident individuals. Non-UK tax resident shareholders who receive a PID will generally be chargeable to UK income tax on the PID as profit of a UK property business and this tax will generally be collected by way of a 20% withholding tax (see further below).
Disposal of shares in a REIT
Taxable UK tax resident shareholders will generally be subject to tax in respect of any gain arising on the disposal of shares in the principal company of a REIT Group. Taxable non-UK shareholders will also generally be subject to UK tax on gains arising on the disposal of shares in the principal company of a REIT Group. In common with the approach to investors in offshore collective property funds, shareholders will be within this non-resident tax charge regardless of the size of their shareholding. These rules provide for a “rebasing” to April 2019, so that only gains accruing after that date are taxed.
Is a REIT required to withhold tax on payments of PIDs?
Subject to certain exceptions summarised below, the principal company of a REIT Group is required to withhold income tax at 20% from its PIDs. Individual UK resident shareholders may, depending on their circumstances, either be liable to further tax on the PID at the applicable marginal rate or be entitled to claim repayment of some or all the tax withheld on the PID. Tax is not required to be withheld at source from a PID where the principal company of a REIT Group reasonably believes that:
the person beneficially entitled to the PID is a company resident for tax purposes in the UK; or
the PID is paid to the scheme administrator of a registered pension scheme, or the sub-scheme administrator of certain sub-schemes or the account manager of an ISA and that the PID will be applied for the purposes of the relevant scheme or account.
For non-UK tax resident shareholders, it is not possible to rely on a double tax treaty to pay PIDs free of withholding tax, but such shareholders may be able claim repayment of the tax withheld (depending on the terms of the relevant double tax treaty).
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(i) the shares forming the principal company’s ordinary share capital are admitted to trading on a recognised stock exchange. This allows the shares in a REIT to be admitted to a wide variety of markets. The most obvious markets in the UK are the Main Market, the Specialist Fund Segment and AIM (each a market of the London Stock Exchange). A technical listing on the International Stock Exchange is also possible if liquidity is not a concern; or (ii)at least 70% of the company’s ordinary share capital is owned directly or indirectly by one or more institutional investors. “Institutional investors” generally includes the trustee or manager of an authorised unit trust scheme (or overseas equivalent) or a pension scheme, an insurance company, a charity, a limited partnership which is a collective investment scheme, a registered social landlord, an open-ended investment company (or overseas equivalent), a person with sovereign immunity, a UK REIT and the non-UK equivalent of a UK REIT. For the purposes of this 70% ownership test, a limited partnership which is a collective investment scheme must also satisfy the “genuine diversity of ownership” (GDO) test to be treated as an institutional investor From Royal Assent to the Finance Bill 2023-24 as currently drafted certain of the investors above will be required to satisfy either the GDO test or a modified version of the close company test in order to qualify as an institutional investor. In addition, a co-ownership authorised contractual scheme will be an institutional investor provided it meets the GDO condition or non-close condition. In broad terms, for the GDO test to be satisfied, the fund documentation of the fund arrangements must state the investors it is targeting, that it will be widely available and that it will be marketed in an appropriate manner to reach its target investors. Further, the terms and conditions of the arrangements should not be a deterrent to such investors, its manager must act in accordance with the statements in the fund documentation mentioned above, and any potential investor within one of the intended categories must be able to approach the manager to obtain information about the fund and invest in it.
Not a close company: except in the first three years following entry into the REIT regime, the principal company must not be a close company other than by virtue of having a participator who is an institutional investor. After Royal Assent to the Finance Bill 2023-24 this condition is due to include indirect participation by an institutional investor through intermediate holding companies (and this will be treated as having always been the case).
Property assets minimum threshold: throughout each accounting period, the property rental business of the REIT Group must involve:
Disposals within three years of substantial development: the tax benefits of the REIT regime will not apply to profits realised on a disposal of a property by a member of the REIT Group in the course of a trade. This includes circumstances where (i) the property has been developed since it was acquired by the company; (ii) the cost of development exceeds 30% of the fair value of the property (broadly determined in accordance with International Accounting Standards), and (iii) disposal takes place within three years of completion of the development.
The principal company of a REIT Group will become subject to an additional tax charge if it pays a dividend to, or in respect of, a holder of excessive rights. A holder of excessive rights is, broadly, any shareholder with a 10% or greater holding which is a body corporate (or which is deemed to be a body corporate). However, a person that would otherwise be a holder of excessive rights is not treated as such where the principal company reasonably believes that the recipient falls within certain excluded categories such as a charity, the scheme administrator of a registered pension scheme or a UK resident company or a partnership to the extent its partners fall within the excluded categories. With effect from Royal Assent to the Finance Bill 2023–24 the excluded categories for this purpose are due to include a non-UK investor entitled to relief or exemption from UK withholding tax on PIDs under a double tax treaty for a reason other than the size of its shareholding. The additional tax charge is calculated by reference to the whole dividend paid to a holder of excessive rights, and not just by reference to the proportion that exceeds the 10% threshold. The tax charge will not be incurred if the principal company has taken reasonable steps to avoid paying dividends to such a shareholder. To demonstrate that it has taken such reasonable steps, a principal company typically includes in its articles of association provisions allowing it to identify holders of excessive rights, withhold dividends from them, disenfranchise them and, ultimately, arrange for their shares to be sold.
What is the key tax consequence of being a REIT?
at least three properties where no one property represents more than 40% of the total value of all properties involved in the property rental business; or
at least one property which is a commercial unit with a value of at least £20 million.
the person beneficially entitled to the PID falls within a category of investors entitled to gross payment (such as a company resident for tax purposes in the UK); or
the PID is paid to the scheme administrator of a certain pension scheme, or the sub-scheme administrator or the account manager of a child trust fund or ISA and that the PID will be applied for the purposes of the relevant scheme or account.
Where the payment is to a partnership with eligible investors as partners the principal company may not be required to withhold tax at source on the payment of a PID to the partnership to the extent of such eligible investors’ share of the partnership profits. For non-UK tax resident shareholders, it is not possible to rely on a double tax treaty to pay PIDs free of withholding tax, but such shareholders may be able claim repayment of the tax withheld (depending on the terms of the relevant double tax treaty).
Can the REIT be an overseas entity or have overseas subsidiaries? The principal company of a REIT Group can be an overseas entity (e.g. a Jersey or Guernsey company) as long as it is solely UK tax resident. A REIT Group is not prohibited from having overseas subsidiaries but the tax consequences of doing so should be considered carefully. Can a REIT hold overseas property or non-real estate assets? Yes. A REIT can also hold non-real estate assets, provided that investing in such assets is within the scope of the REIT’s published investment policy. Such assets will not be treated as forming part of the property rental business. Can a REIT be externally managed? Yes, a REIT can either be internally or externally managed. If a REIT is externally managed, a REIT will enter into a among other things, provides for a management fee, a performance fee (if any) and termination rights. There are two primary consequences of external management under the following Listing Rules. Independence The board of directors of the REIT must be able to act independently of its investment manager. Both the chairman of the board and a majority of the board (which may include the chairman) must be independent. The Listing Rules set out in detail who is not independent (which is broadly persons with a substantive connection to the investment manager). Related party transactions The investment manager and its group will be ‘related parties’ of the REIT, which means that, among other things, (subject to certain exceptions and unless the REIT is admitted to trading on AIM) transactions between the REIT group and the investment manager which exceed 5% in the class tests set out in the Annex to Chapter 10 of the Listing Rules (which broadly compare the size of the REIT group against the size of the transaction using various metrics) require shareholder approval. Depending on whether the REIT is listed (and on which market), VAT can be chargeable on the fee paid to an external adviser. However, with careful structuring it is possible to minimise any net VAT leakage to the REIT. Can a REIT be a “blind pool” fund? Yes, REITs can be (and frequently are) established as a blind-pool funds (i.e. with no real estate assets held or contracted). However, the “REIT” will not be able to formally become a REIT (and obtain the tax benefits of so doing) until it meets the REIT qualifying conditions (including the property assets minimum threshold condition described above). The REIT’s promoters will need to consider the effect on marketing that having no properties has. Investors may be more willing to invest if the REIT either has existing assets or has contracted to acquire properties – in effect to demonstrate a track record. If the REIT either already holds or has contracted to acquire properties, it will need to include a valuation report on those properties in the disclosure document (see question 19 below). If the REIT does not hold any properties and has not contracted to acquire any at the time of launch, its promoters are, in marketing the REIT, likely to need to demonstrate a “pipeline” of investments. Can a REIT invest substantially all of its assets in another fund? Yes but some restrictions apply. The REIT will first need to ensure that doing so does not make it lose REIT status (see question 4 above). The Listing Rules provide for two further restrictions. Master fund investment policy If the REIT principally invests its funds (directly or indirectly) in another company that invests in a portfolio of investments (a master fund), the REIT must ensure that:
the master fund’s investment policy are consistent with the REIT’s published investment policy and provide for spreading investment risk; and
the master fund in fact invests and managers its investments in a way that is consistent with the REIT’s published investment policy and spreads investment risk.
Cross-holdings No more than 10%, in aggregate, of the value of the total assets of the REIT may be invested in other listed closed-ended investment funds. This restriction does not apply to investments in closed-ended investment funds which themselves have published investment policies to invest no more than 15% of their total assets in other listed closed-ended investment funds. What is a private REIT? A private REIT is a REIT that is not widely held or marketed. Private REITs have historically taken advantage of markets such as the International Stock Exchange, which do not require REITs to have a “free float” and which do not have disclosure standards as onerous as those on other markets. Going forward, depending on the intended investor base, private REITs alternatively may be able to rely on the 70% institutional investor ownership condition referred to in question 4 above. Those establishing a private REIT will, however, need to think carefully about how the REIT is held in the context of other REIT qualifying conditions (such as the requirement for the REIT not to be a close company). What regulatory permissions do a REIT/its promoters need to consider? The REIT will be an alternative investment fund (AIF) for the purposes of the UK rules on alternative investment fund managers (the AIFM Rules) and will, as a result, need to have an alternative investment fund manager (AIFM). The AIFM is responsible for the AIF’s portfolio management and risk management. The AIFM can be either external (i.e. a third party appointed by the REIT to be its AIFM) or internal (i.e. the REIT manages itself as its own AIFM). A UK AIFM (whether external or internal) must be authorised by the FCA under the AIFM Rules. Obtaining the requisite authorisation can take some time, so it can be preferable to appoint an existing authorised AIFM as the REIT’s external AIFM. See question 12 above for more on appointing an external AIFM.
To what market should a REIT’s shares be admitted? The UK market that offers the greatest liquidity (including because admission to it is a requirement for inclusion in the FTSE indices) is the London Stock Exchange’s Main Market. The rules of the Main Market are, however, more onerous than other markets. A comparison of the key eligibility requirements and the key ongoing obligations for each of the London Stock Exchange’s Main Market, AIM Market and Specialist Fund Segment is set out below.
Eligibility: a REIT seeking admission to the Main Market would typically submit an eligibility letter to the Financial Conduct Authority (FCA) at the same time as submitting the prospectus for first review. The eligibility letter can be submitted earlier, but doing so is likely to delay the process. The AIM Market requires an early consultation with the AIM team and, as such, eligibility will be addressed at an early stage. Given the limited eligibility requirements for the Specialist Fund Segment, the eligibility process is more informal on that market.
What are the principal workstreams for admission to trading?
*REITs can also be admitted to Chapter 6 (commercial company) but for simplicity, only Chapter 15 is considered in this guide.
Due diligence: if the REIT has an existing business, legal and financial due diligence will be carried out by the REIT’s lawyers and reporting accountants. Significant input will be needed from the REIT/its promoters to respond to document request lists and follow-up questions.
Accounts: if the REIT has financial history, it will need to prepare accounts for the last three years (or the period of its operations if shorter) in accordance with IFRS. Those accounts will need to be reported on by the REIT’s reporting accountants.
Working capital: in its disclosure document, the REIT will be required to state that it has sufficient working capital for the next twelve months. In order to support this statement, a REIT/its promoters will prepare a working capital model showing cashflow and expenditure projections (typically over a longer period than the 12 month period), including a base case and a downside case with sensitivities applied. The working capital model will be reviewed in detail by the REIT’s reporting accountants and its sponsor/nominated adviser.
Contractual arrangements: the REIT will need to enter into contractual arrangements with its service providers and advisers. If the REIT is externally managed, the management contract is the critical contract and will be scrutinised by the sponsor/nominated adviser and its lawyers. If the REIT is internally managed, it may wish to put employee incentives in place.
Valuation report: if the REIT has existing properties or has contracted to acquire properties, it will need to obtain a third party valuation report in respect of those properties. The valuation report is typically prepared in accordance with the RICS “red book”.
Governance: the REIT will need a board of directors (typically wholly non-executive if the REIT is externally managed). The length of the recruitment process for finding directors that have the requisite experience and skills and fit with the corporate governance requirements for a REIT should not be underestimated. Careful thought also needs to be given to the composition of, and terms of reference for, board committees. In addition, the directors will need time to familiarise themselves with the REIT’s operation and be informed of their responsibilities and liabilities as directors of the REIT.
Financial position and prospects procedures: it will be very important for the board of the REIT to have accurate and timely information on the REIT’s operations and finances so that decisions can be made on a timely basis as to whether any public announcements are required. A REIT will therefore prepare a detailed memorandum on financial position and prospects procedures (usually using a template provided by the reporting accountants), which will then be reviewed in detail by the REIT’s reporting accountants and its sponsor/nominated adviser.
The disclosure document and verification.
The principal disclosure document for a REIT whose shares are to be admitted to either the Main Market or the Specialist Fund Segment is a prospectus. See question 19 below for details of the principal contents requirements for a prospectus. If the REIT’s shares are to be admitted to trading on the AIM Market, the principal disclosure document is an AIM admission document which, while broadly similar in terms of content to a prospectus, does not need to be vetted by the regulator prior to publication. A prospectus will be subject to the review of the FCA. A prospectus typically takes 6-8 weeks from first submission to clear comments from the FCA. There is no such review process for an AIM admission document but the nominated adviser will need to be satisfied that it contains the prescribed contents. Given the risk of liability for the REIT and its directors for false or misleading statements in the disclosure document, the disclosure document is typically subjected to a verification exercise which seeks to identify evidence supporting the truth of each statement made in the disclosure document. REITs also typically take out prospectus insurance with an insurance broker.
Marketing and fundraising: assuming that the REIT wishes to raise new money on admission and/or existing shareholders in the REIT want to sell shares on admission, the REIT/its promoters will typically conduct a “roadshow” for prospective investors using a marketing presentation, which is consistent with the contents of the disclosure document (and which will also be verified).
What are the principal contents requirements of a prospectus for a REIT? A prospectus for a REIT would typically include:
A summary, which must follow a prescribed format and be a fair summary of the prospectus as a whole. Risk factors: which will be tailored to the particular operations of the REIT. A business description: this typically comprises (among other things) an introduction, the history of and background to the business, an overview of the business, including investment objective, investment policy, investment strategy, investment restrictions, valuation policy, and a comprehensive and meaningful portfolio analysis*. Details of the directors, management (including track record) and corporate governance. A property valuation report (see question 18 for more details).* Historical financial information and (if necessary e.g. because the REIT has contracted to acquire properties) pro forma financial information.* Capitalisation and indebtedness tables. An operating and financial review (OFR): being a narrative description of the REIT’s financial condition, operating results and capital resources in relation to the period covered by historical financial information.* Taxation summaries for the issuer and shareholders. Additional information: containing miscellaneous details required by the Prospectus Regulation Rules, such as material contracts, share capital history and director remuneration.
* Not relevant for blind pool funds.
What principal third party service providers and advisers does a REIT need in connection with admission? The UK market that offers the greatest liquidity (including because admission to it is a requirement for inclusion in the FTSE indices) is the London Stock Exchange’s Main Market. The rules of the Main Market are, however, more onerous than other markets. A comparison of the key eligibility requirements and the key ongoing obligations for each of the London Stock Exchange’s Main Market, AIM Market and Specialist Fund Segment is set out below.
Investment manager/investment adviser: if the REIT is to be externally managed, it will need an investment manager to, among other things, perform the function of an Alternative Investment Fund Manager (AIFM) under the AIFM Rules. If the promoter of the REIT is not already authorised as an AIFM, it may take a significant amount of time to obtain an AIFM licence. In those circumstances, REITs often appoint an existing AIFM (there are a number of “out-of-the-box” AIFM providers in the market) as their AIFMs (whether temporarily or permanently), with the promoter acting as investment adviser. Administrator/company secretary: externally managed REITs will typically need an administrator and company secretary to perform certain accounting, administration and secretarial services. Sponsor/nominated adviser: a sponsor’s primary responsibility is to confirm to the FCA that a REIT has satisfied all of the requirements for listing. It will also provide advice on the listing rules and corporate finance advice including on timetable, structure and marketing. A nominated adviser performs a similar function in relation to the AIM Market. Broker: the role of the broker (there may be more than one) is to procure subscribers and/or purchasers for shares in the offering and to assist in the management of communications and information flow to and from shareholders. The broker may be the same entity as the sponsor/nominated adviser, although some REITs prefer the sponsor/nominated adviser to be independent. Lawyers: the REIT’s lawyers are typically responsible for, among other things, producing a legal due diligence report on the REIT, drafting the disclosure document (with input from others), advising on an appropriate structure for the REIT group (including from a tax perspective), drafting and negotiating all legal documentation and performing a verification exercise on the disclosure document and marketing presentation. Reporting accountants: the REIT’s reporting accountants are typically responsible for, among other things, producing a financial due diligence report on the REIT, reporting on the REIT’s historic financial information, reviewing the REIT’s working capital position and its financial position and prospects procedures. Debt providers: REITs typically employ some gearing and so it is usual for a REIT to have one or more debt facilities. See question 4 for restrictions on borrowing by REITs. Registrar: the registrar will maintain the share register of the REIT. Receiving agent: if the REIT raises money through an offer for subscription, the receiving agent manages receipt of subscription forms. Typically, the receiving agent operates in the same organisation as the registrar. Depository: to comply with the AIFM Rules, a depositary will need to be appointed to perform certain functions (e.g. cash flow monitoring and verification of the REIT’s ownership of its property assets), although a lighter-touch regime may apply to REITs that are overseas entities, such as Jersey or Guernsey companies. Valuer: the valuer produces the valuation report referred to in question 18 above. PR advisers: REITs typically appoint PR advisers to manage the process of public communications in connection with admission. Insurance broker and underwriter: a REIT will typically take out both directors and officers liability insurance and public offering of securities insurance.
What corporate governance standards apply to a REIT? REITS typically report against the Association of Investment Companies (AIC) Code of Corporate Governance (the AIC Code), as it is specifically tailored to closed-ended investment companies. Reporting against the AIC Code satisfies any requirement to report against the UK Corporate Governance Code. How long does it take to launch a REIT? The time taken to launch a REIT will depend on a number of factors, including the complexity of existing business and the offering but a REIT is typically capable of being launched within four to six months of starting work.
Nick Barnes Partner DD +44 (0)20 7849 2914 nick.barnes@macfarlanes.com
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