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By Ben Stupples
The U.K.’s property sector has received a tax boost through the government’s latest plans to limit the amount of interest that real estate companies can deduct from their taxable profits.
Real estate investment companies—such as British Land PLC, Hammerson plc, and Land Securities Group Plc—will be partly exempt from limiting the interest that they can deduct from their taxable profits on investments they make in certain public infrastructure assets, according to Jan. 26 draft legislation.
Published by Her Majesty’s Revenue and Customs, the draft rules to limit the interest deductions comes in response to the OECD’s 15-action project to combat tax avoidance from multinational companies, and include a wider definition of qualifying investments.
Multinational companies previously reduced their corporate taxes by deducting excessive amounts of interest—usually derived from debt financing, such as bonds—against their taxable profits.
Action 4 of the Organization for Economic Co-operation and Development’s base erosion and profit shifting project aims to combat this tax practice by limiting the interest companies can make based on a fixed ratio on their earnings before interest, taxes, depreciation and amortization.
Andrew Stewart, a London-based transfer pricing senior manager at business advisory firm BDO, said HMRC’s new definition of qualifying public infrastructure exempted from the interest deductibility rules was wider than he had originally expected.
“It’s good news for the property sector,” he told Bloomberg BNA in a Jan. 26 telephone interview. “Any U.K.-based real estate investment company has potential to fall inside the rules, and any third party has the ability to come within the exemption” through the exclusion of third-party loans.
Since the original Dec. 5 draft legislation for the U.K.'s 2017 Finance Bill, Her Majesty’s Treasury has been under pressure to change the definition of public infrastructure eligible for exclusion from the government’s new interest deductibility laws, according to Ken Almand, a London-based partner and head of transfer pricing at global accountancy and consultancy firm RSM.
“The original proposal from the Treasury was very narrow, and there were companies brought into the rules that thought they were clearly investing in projects that were for the public benefit,” he told Bloomberg BNA in a Jan. 26 telephone interview, citing building bridges as one example.
“There has to be a get out” clause “for certain industries” that mostly finance their investments through debt, he added in relation to Action 4 which seeks to prevent companies exploiting tax rules to shift their profits to low-tax jurisdictions.
“For some companies, there’s no case to make if they don’t get the right interest deductions.”
The Public Benefit Infrastructure Exemption, as it’s officially known, aims to protect investment that has a public benefit. The measure will exempt interest expense for qualifying companies on funds invested in long-term infrastructure projects for public benefit, according to a Dec. 5 policy paper.
To qualify for the exemption, companies will have to meet specific criteria in the draft legislation.
Any public infrastructure has—must have had, or is likely to have—an expected economic life of at least 10 years and be recognized on the balance sheet of a group company subject to corporation tax.
In general, the exemptions do not include interest payable to shareholders or other related parties.
Debt financing through loans and bonds is an important part of the U.K.’s real estate sector, which makes up 5.4 percent of the U.K.’s economy, according to data from the British Property Foundation.
Respectively, Land Securities, British Land and Hammerson are the U.K.’s three largest real estate investment trusts by market capitalization, according to data compiled by Bloomberg BNA.
In total, the companies have made 39 bond issuances to help fund their business operations, valued at a total of 11 billion pounds. London-based Hammerson alone, which also invests in real estate across France and Germany, has a 1.3 billion revolving line of credit due for repayment this year.
Public infrastructure that will be eligible for exclusion under the new interest deductibility laws include health or educational buildings, training bases for any of the U.K.’s armed forces or any police force, or any court of prison buildings, according to HMRC’s Jan. 26 draft legislation.
The restrictions will only apply to companies deducting interest payments of more than 2 million ($2 .5 million) a year. Above that threshold, a fixed ratio rule will limit multinational companies claiming interest payments of more than 30 percent of their EBITDA, while a group ratio rule for larger multinationals will also allow higher net interest deductions based on their global leverage.
The OECD recommended that countries introduce separate legislation in their own jurisdictions for banks and insurers as they generally receive net interest income rather than net interest expense.
Yet Her Majesty’s Treasury said Dec. 5 the general rules will apply to the U.K.’s financial services.
“I’ve spoken to a few banks recently and they’ve been struggling through what came out from the Treasury back in December,” Wayne Weaver, a London-based tax partner at Deloitte U.K., who specializes in financial services groups, told Bloomberg BNA in a Jan. 26 telephone interview.
“It’s a harder piece of work to go through the numbers for complex groups with overseas operations and other activities, like asset management or investment banking,” he added in reference to how the U.K.’s banking sector will cope with adapting to the general interest deductibility laws.
On Jan. 26, in addition to the interest deductibility laws, HMRC published draft legislation on tax relief for companies’ carried-forward losses and the taxation of the U.K.’s non-domiciled residents.
The changes to carried-forward losses give companies greater flexibility to set them against either their total profits in later periods, or in the form of group relief in a later period.
They also limit the amount of profit against which carried-forward losses can be set, with companies not able carry forward more than 50 percent of the company’s total profits for that period.
By 2021, the U.K. expects to have gained 4 billion pounds through the new interest restriction laws.
Rosalind Rowe, an honorary member of the U.K.'s Royal Institution of Chartered Surveyors, said in response to the U.K.'s interest deductibility draft legislation that real estate investment trusts, or REITs, like Land Securities and British Land are “important investors” across the U.K.'s property industry
It is worth noting that REITs “have been subject to an interest restriction from Day 1; most have low levels of gearing on long term debt,” she said in a Jan. 27 emailed statement. “Therefore it is appropriate that the rental business of a REIT should not be subject to any further tax adjustments relating to interest expense.”
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