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European REITs Still Attractive, Tax-efficient Property Investment
Over the past few years, collective investment vehicles for real estate have become more and more popular. The diversification of real estate risk is an increasing need for investors and in this context, the Real Estate Investment Trust (REIT) is an important topic. As in the US and Asia, many European nations have introduced REITs. However, REITs have lost part of their importance in the last couple of years as a result of global market turmoil. In many cases investors used up tax losses so no further benefits accrued from a change to REIT status. However, with at least a temporary recovery in markets, real estate investors are increasingly active and the REIT has once again become a hot topic. Taxand's global real estate tax team assumes that substantial volumes will be invested in REIT structures in the near future. Taxand considers the importance of REITs to the Real Estate industry and discusses the top jurisdictions in Europe where they are most effective.
Depending on local law, the REIT is normally established as a corporation. It needs to fulfill several conditions regarding the type and number of real estate investments, listing on a Stock Exchange (eg France and UK, but not the Netherlands), free float of shares, minimum share capital and the need to annually distribute profits etc. One thing REITs have in common is that they do not pay income tax on real estate income or capital gains. The concept is to avoid double taxation of the real estate profits at both the REIT and investor level. However, as a consequence, the entry into REIT status will normally trigger an exit taxation; for example, in France, the REIT regime triggers taxation of all unrealised capital gains on assets transferred to the REIT at a rate of 19%. In the UK an entry charge of 2% on the market value of REIT assets is levied. However, such exit taxes are significantly below ordinary corporate income tax rates meaning that the change to a REIT regime does not lead to full taxation of the pre-existing non realised capital gains and remains an attractive proposition. Contrary to the UK and France, Italy does not levy any exit tax upon a move to the REIT status.
Profit distributions made by the REIT to its investors may be subject to withholding tax (eg UK 20%, France and Germany 25%, the Netherlands 15%) or exempt. Due to the fact that REITs normally need to distribute the majority of annual profits from rental income and property gains, withholding tax is an important aspect of a tax efficient set up. However, reductions or exemptions from withholding taxes are often granted under a double taxation treaty where REIT dividends are paid to foreign investors. This can lead to complete and worldwide tax exemption of real estate income. According to the above, the following should be borne in mind when setting up a REIT:
- Weigh up the payment of the entrance charge and the burden from regulatory issues (listing requirements) against tax exemption of future capital gains and income
- Ensuring all requirements are met and can feasibly be met in the future to continue to benefit from the REIT regime eg in France termination of the REIT regime within 10 years after election triggers significant penalties
- Make sure that limitations regarding shareholding and free float rules are acceptable
- Annual distribution requirements will hinder reinvestment of REIT profits
- Ensuring the investor tax profile matches the benefits offered by the REIT regime
In our experience, the top REIT regimes in Europe are the French SIIC or the Dutch FBI. In addition, Belgium and Italy are important REIT countries. The UK REIT also has the potential to become very attractive in the future. Historically, however, it has not often been used by investors which is why the UK government is now considering whether some REIT qualification can be relaxed. Amongst others, the abolition of the entry charge has been discussed, as has the relaxation of ownership rules for institutional investors and listing requirements. The implementation of such changes would certainly be good news for UK investors. Legal and tax efficient structures for collective real estate investments may also be offered by non-REIT countries like Switzerland and Luxembourg, and these countries are important alternative jurisdictions for efficient real estate investments.
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First published on Property Investor Weekly, on 7 November 2011