Finance Bill

This group of amendments relates to real estate investment trusts, or REITs, which were introduced with effect from 1 January 2007. Their introduction was, in part, a response to Kate Barker's review of housing supply and the need to promote greater efficiency and flexibility in the UK property investment market. Two and a half years after their introduction, it is possible to make some evaluation of the effectiveness of the new REIT regime. It is clear that large property groups have obtained REIT status, but there have been no new REITs, and in particular none covering residential property. It would be fair to say that the economic climate has not been ideal for the creation of new REITs, but there is clearly a debate to be had on whether the fact that REITs covering residential property have not come into effect is down to the economic problems or defects in the tax system. Since we debated the matter in Committee, the House of Lords Select Committee on Economic Affairs has commented, in its report on the Finance Bill, that REITs""have failed to live up to expectations" ." Paragraph 245 of that report states:""It is difficult to conclude that this partial failure is wholly due to the economic circumstances and not also in part to structural defects in the system. Moreover there has been little attempt to respond flexibly or significantly in their design to the difficult economic context."" The group of amendments that we are considering is an attempt to encourage the Government to respond flexibly and significantly. Indeed, the Government have made some progress on that front. In Committee, I raised possible ways of providing some flexibility in design, based on proposals made by the British Property Federation. Since that date, the House of Lords Select Committee has recommended that the Government""look again with greater sympathy at the proposals by the representative bodies."" To assist, we have today tabled four amendments, which, as I say, are based on the British Property Federation proposals. We are pleased to see that in one case the Government have followed suit, at least partially, and tabled an amendment seeking to address one of the concerns that we identified. Broadly, we seek in our amendments to address two issues. The first issue relates to the current requirement that REITs distribute 90 per cent. or more of property income, because in the current economic circumstances it is very helpful if companies can retain cash. Credit is clearly difficult to access, and companies need to build up balance sheets—in particular, to keep banks lending to them. If and when the property market picks up, a REIT with sufficient cash might be able to make several acquisitions. Amendment 17 seeks to address the issue of a mandatory distribution of 90 per cent., which has to be done in one year, by deferring it for four years. It would be only a temporary measure, and any profits arising in accounting periods ending after 31 March 2010 would be subject to the current distribution rules, but it would provide REITs with flexibility. Amendment 18 would provide for distributions to be paid by new shares rather than by cash, and there should not be a revenue implication: shareholders receiving a stock dividend, which is a distribution for these purposes, would be automatically subject to tax, as they would be with a normal property income distribution in cash. We therefore press the Government to look sympathetically at the amendment. Amendment 16 is a less radical proposal, but it addresses the same area and would retain the 90 per cent. test. Any breach of it would not result in the risk of expulsion from the REIT regime, as that would be expensive for the REIT, but would involve corporation tax being paid on the undistributed profits. The argument that the Government tend to make against all such proposals is that there is an issue of investor protection, but when institutions are looking for investors to invest in a REIT, there is strong commercial pressure to make use of such provisions only when necessary. It is a commercial judgment that, one might strongly argue, could be left to the REITs rather than to the regulations, so we would be grateful for the Government's response to those points. The second issue relates to the profit-financing cost ratio. Property income distributions are subject to a withholding tax of 20 per cent., unless the recipient is a UK charity, pension fund or corporate. Payments of interest by a REIT, however, may not be subject to withholding tax, and there is therefore the clear possibility of a REIT distributing income through interest payments as an avoidance measure. The profit-financing cost ratio is an attempt to address that. It is an anti-avoidance provision aimed at preventing REIT investors from structuring their investment as a loan. Broadly, the PFCR rule provides that the amount of a REIT's tax-exempt profits must be at least 1.25 times the size of the financing costs that are related to the REIT's tax-exempt business. There are, however, a couple of problems with that. First, a REIT might hedge market value movements in a debt with a derivative contract. The PFCR rule does not take into account any profit on debt, but it does take into account a matching loss on the derivative. The loss is counted as a financing cost so the REIT might breach the ratio as a consequence of market movements. Secondly, the aggregate of all movements in a derivative contract is deferred until closing out occurs, and that could lead to a distortion of the ratio in one particular year. Amendment 15 seeks to address those specific problems. As I mentioned earlier, Government amendment 47 addresses the issue of the profit-financing cost ratio by allowing HMRC to waive rules in particular circumstances—when a REIT is in severe financial difficulties, the circumstances arose unexpectedly and the company could not reasonably have taken avoidance action. I have communicated with the British Property Federation, which welcomes movement on the issue but is concerned that the particular circumstances that I have mentioned are somewhat restrictive, difficult to interpret and vague. As a consequence, Government amendment 47 may not be effective enough in addressing what both sides of the House agree is a potential problem. I would welcome comments from the Minister on that, because we think that amendment 15 would provide REITs with greater certainty and clarity and address the specific problems raised by the British Property Federation, rather than having the apparently broader flexibility involved in HMRC's waiving the ratio, although in restricted circumstances that would be difficult for the REIT to understand. The Minister may well be able to provide guidance and clarity on the issue; as it stands, however, we are not sure that Government amendment 47 is as successful as amendment 15.