The BEPS impact on real estate: moving from traditional funds to REIT structures
In a world of melting tax receipts and mobile profits, real estate offers tax authorities a rare commodity - a tax base that can’t move. Nonetheless, the effective tax rates on real estate income is low in most jurisdictions through tempting tax benefits with Real Estate Investment Trust (REIT) regimes. However, the tide is starting to turn. These issues and subsequent tax implications were outlined and discussed at the Taxand Global Conference in Milan.
With the support of the G20, the OECD have over the last two years focused on BEPS, a programme of global tax legislative change to combat tax evasion and avoidance.
Real estate has become a global asset class where investors can have multiple assets across jurisdictions. Initially real estate investments did not come under the scope of the BEPS changes. However, the OECD has now woken up to real estate and begun to encompass collective funds, although the tax issues surrounding REITs have not yet been fully dealt with.
There are many practical implications for traditional real estate fund structures. One of these key areas is, of course, ‘substance’ and particularly the use of registered office headquarters in tax-favourable jurisdictions as these merely ‘brass plate’ companies will no longer be accepted. One of the ways the OECD plans to combat the use of these structures is through increasing transparency, particularly around transfer pricing.
For funds with holding companies in multiple jurisdictions, increased reporting requirements are expected to be implemented, making funds responsible for filing one report of their global structure, which would automatically be passed to local tax authorities. Funds will also be expected to prove their substance, through staff numbers and breadth of their operations to permit them having a low-tax jurisdiction as their holding company base.
Tax treaty abuse prevention is also a major area of the BEPS programme which could affect real estate investors. This is aimed at companies who use conduit companies and low-taxed foreign branches to artificially shift income. Companies operating across multiple jurisdictions will come under scrutiny due to their use of investment vehicles to collect money across different countries to invest in properties located in other jurisdictions.
BEPS will not stop here, it will also neutralise the effects of hybrid mismatch arrangements which currently can give rise to double deduction of expenses, or double non-taxation of income.
With restrictions on traditional fund models, REIT regimes are becoming more widespread for “core” assets and allow favourable taxation of real estate pools for investors. REIT schemes can provide certain tax benefits including exemptions for income and capital gains and ‘BEPS-aware’ investors are now looking at the implementation of REIT structures, as well as changing the structures of real estate investments.
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With BEPS on the horizon, investors should consider:
- While many of the details regarding the implementation of BEPS on real estate funds is yet to be seen, real estate tax is changing and investors need to be aware of the coming changes and adapt their structures to be both tax efficient and compliant
- REIT-type vehicles offer an interesting alternative in many countries and may become the new normal for structured real estate investment
- The valuation dynamics as well as different ETRs may drive further real estate spin offs from operational groups
- Finally, notwithstanding all the difficulties and complexity, there are still opportunities to be found
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