Clause 38 - Real estate investment trusts: UK REITs which invest in other UK REITs

Finance Bill – in a Public Bill Committee am 2:45 pm ar 4 Mehefin 2013.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Question proposed, That the clause stand part of the Bill.

Photo of David Crausby David Crausby Llafur, Bolton North East

With this it will be convenient to consider schedule 18 stand part.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

The clause relates to something that hon. Members will be excited to debate: REITs. I know that many of them get lots of letters about real estate investment trusts.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am not surprised that the hon. Member for Chelsea and Fulham receives correspondence about them because they are very important investment vehicles and have changed the investment scene relating to property and the taxation of those financial instruments. REITs are securities that sell like a share on stock exchanges and invest in real estate directly through property or mortgages. As of September 2012, there were 34 countries with REIT-like arrangements in place. They are tax-advantage vehicles to encourage investment in the property sector. The clause and schedule 18 will allow UK REIT income, which is derived from investing in other UK REITs, to be treated as income of its tax-exempt property rental business.

On the face of it, this is a relatively sensible piece of housekeeping in relation to the cash flow and investment profiles of real estate investment trusts. If a REIT releases cash on the sale of a property but has yet to identify suitable subsequent property investment or is holding excess cash, it currently has few choices but to place the cash on short-term interest-bearing deposit, which obviously does not have a vastly impressive return, especially at the moment. Many argue that REITs could make better returns on such cash if they were allowed to invest short-term in other REITs. That would promote greater liquidity in the property market and attract additional investment income, particularly into the built environment. So far, so good.

However, I want to raise a couple of points with the Minister while we are on this provision. The first is a rather standard question. What is the effect of the policy on Exchequer revenues? It will have an impact more broadly on tax treatments. I do not know whether HMRC has done any modelling on how the arrangement might affect yields. I would be grateful if the Minister could let us know.

A more substantive question is what these real estate investment trust vehicles are investing in. I understand that by and large they are in commercial property arrangements. There are some circumstances in which residential property REITs exist. What impact do REIT arrangements have on the residential property market and its price? There is concern in some quarters about the Government looking at the demand side of the equation but not much at the supply side of the housing market.

If there are trades and transactions taking place in the residential property sector, there could be an impact on price inflation. Has the Treasury analysed the general impact of REITs on property prices in the residential sector? Does the Minister believe there is any supply-side benefit from the REIT arrangements in place? Will he also clarify whether there is any overlap between Help to Buy arrangements and investment in real estate investment trusts?

We have already debated whether Help to Buy would exclude those remortgaging to release equity for onward purchase of a second or third home. I am not particularly averse to that happening, but for the fact that tax subsidy raises lots of eyebrows. People would ask why the taxpayer should subsidise that sort of activity.

Photo of Brooks Newmark Brooks Newmark Ceidwadwyr, Braintree

The hon. Gentleman is making some interesting points. Does he not agree that historically the REIT market is an efficient  way to raise capital for individuals who want to make investments in real estate? I think that it provides the liquidity that is sometimes lacking.

I do not want to make his arguments for him, but I am going to now. There is a point about the transparency of the pools of REITs. As we have seen with other derivative instruments, the lack of transparency created the problems of 2008. I hope that he would want to make a point about the importance of ensuring that these pools of mortgages are transparent, showing the assets that they have beneath them.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am very grateful to the hon. Gentleman for his refreshing and welcome non-party point. He is correct that some of the securitisation of the sub-prime housing market, particularly in the United States, was very much part of the cause of the crash that left us with financial difficulties in this country. It would be useful if the Minister were able to assure us that for REITs, which generally have been a welcome vehicle for certain types of investment, there are no longer unintended consequences of opacity in terms of what is happening, so that investors know what they are getting into when they buy into real estate investment trusts.

I shall be grateful if the Minister confirms that Help to Buy does not in any way give direct or indirect advantage to those who are investing in property through a real estate investment trust. In other words, can he confirm that there is an exclusion in the Help to Buy provisions that does not impinge on investing in property through REITs? I assume that that must be the case, but it is important that the Minister clarifies that.

Photo of Ian Mearns Ian Mearns Llafur, Gateshead 3:00, 4 Mehefin 2013

My hon. Friend will remember that when baskets of what are known as liar loans were sold on the international markets they were given triple A credit ratings by the credit rating agencies. One must query the judgment and the investigative powers of the credit rating agencies and the legitimacy of the opinions that they give.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

That is something that we have to safeguard against. I do not think it is necessarily a facet of the REIT market, because it is something that previous Administrations also introduced and helped to support. But it is always worthwhile to guard against these things, and to make sure that people check the transparency of the arrangements.

The other question that I want to ask the Minister is about social housing and support for affordable housing construction. My understanding is that the Government originally consulted on the idea of using REITs as a vehicle for supporting social housing investment. However, for various reasons, they decided not to take that forward, so there was not a REIT vehicle arrangement to help what many of us think ought to be the priority. Of all the elements of the residential market that we need to start boosting, the social housing dimensions need the most support. Will the Minister explain why REIT investment routes have been blocked for social housing investment? What is the rationale for that, and is it something that he will take the opportunity to review again on another occasion? Those are the points that I have for the Minister on the clause.

Photo of David Gauke David Gauke The Exchequer Secretary

Clause 38 and schedule 18 make improvements to the real estate investment trust—REIT—regime by allowing a UK REIT to treat income from another UK REIT as income of its tax exempt property rental business. That change will generate positive benefits for both the REIT industry and wider Government objectives, such as stimulating growth and tax simplification. It will help support the REIT business environment and help remove potential barriers to further future investment activity.

Let me provide the Committee with some background. REITs are a tax-exempt vehicle introduced to encourage investment in the property sector. Subject to certain conditions, REITs are exempt from corporation tax on property income, but their shareholders are fully taxed on the distributions or dividends received from a REIT.

Since their launch in 2007, 24 UK REITs have been created with a total market capitalisation of over £28 billion. Currently, if a REIT invests in another REIT then it is taxed on the distribution it receives in the same way as the end investor. However, it is only an intermediary between the lower-tier REIT and the end investor. That means that both the upper-tier REIT and the end investor suffer from tax on investment in the same underlying property.

The existing double tax charge on REITs investing in REITs is economically inefficient, and reduces the profits that a property can offer. Therefore, following Budget 2012 the Government undertook a consultation to consider the tax treatment of REITs investing in REITs, and 15 written responses were received. There was consensus that amending the tax treatment of REITs investing in REITs would generate positive benefits for both the REIT industry and wider Government objectives. Deloitte commented:

“It will allow REITs to run their businesses more flexibly and facilitate further investment into the UK property sector…The change may spawn a number of new substantial REITs”.

The Government have, therefore, decided to legislate on the matter. Clause 38 and schedule 18 will relax the REIT rules by allowing REITs to treat income from other REITs in the same way as income from property. Such income will be exempt from corporation tax on the condition that the upper-tier REIT distributes all the income from the lower-tier REIT to its investors. The tax on the property income distribution collected at the shareholder’s level will, therefore, be protected. The measure will have effect for accounting periods beginning on and after Royal Assent. Amending the tax treatment of income from REITs investing in REITs will allow REITs to split their portfolios into separate asset classes, which will facilitate greater investment in the property markets.

During the consultation, respondents proposed including REITs in the definition of “institutional investor”. We have listened to interested parties, and we announced at Budget 2013 that the Government would informally consult on the matter with the industry this year. HMRC is also informally consulting on one technical matter that may enhance the working of the schedule regarding the definition of tax-exempt income.

Photo of Brooks Newmark Brooks Newmark Ceidwadwyr, Braintree

I am trying to understand the thrust of the clause. Is it a way of preventing double taxation by a REIT investing in a REIT, or is it a device to help  facilitate capital flows in the property market to encourage people to invest in REITs? Is it one or the other, or is it really a bit of both?

Photo of David Gauke David Gauke The Exchequer Secretary

My hon. Friend and I both served on the Bill Committee of the Finance Act 2006, in which REITs were introduced, and he and I spent many a happy hour debating them. The clause is designed to avoid double taxation to ensure that a REIT that invests in a REIT does not find that tax is being paid at two points. The provision should help the expansion of REITs and remove a barrier to growth. I hope that provides my hon. Friend with some clarification.

I turn to the points raised by the hon. Member for Nottingham East. He asked about cost. As the tax information and impact note states, the provision will have a negligible impact on the Exchequer. It removes a barrier that has prevented REITs from investing in REITs, which has generally not happened because it has been an inefficient structure. As a result, the cost of the change to the Exchequer will be negligible.

The hon. Gentleman asked about the relationship between REITs and the Help to Buy scheme. Those are two separate policies. Help to Buy aims to help families get on to the property ladder or to ascend it and REITs are essentially property investment vehicles, so they are in rather different places. Residential REITs are not yet a reality, but one is about to enter the market. There is nothing to prevent REITs from investing in residential property, but currently returns are not high enough to attract investors.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

Simply on the Help to Buy point, if a residential REIT decided to purchase 100 residential units beneath the £600,000 threshold in the Help to Buy scheme, would it qualify for loan assistance from the Government?

Photo of David Gauke David Gauke The Exchequer Secretary

No, it would be separate, because the Help to Buy regime is designed for people who are looking to reside in the property that they purchased, whereas the REITs regime is for those who are making a property investment as opposed to wanting to reside in the property that is purchased.

The hon. Gentleman asked about the creation of social housing REITs. He is right to say that we looked at that. Responses to the consultation suggest that the need for further changes to the REIT regime to support social housing REITs was seen as not particularly pressing. For some stakeholders, the changes to the REITs regime in the Finance Act 2012 were already sufficient to enable them to set up a social housing REIT.

Other interested parties currently not considering establishing a social housing REIT were concerned that housing at social rents alone would be unable to generate sufficient returns to attract investors. For those parties, further additional changes to the REIT regime, such as the removal of the listing requirement, would be unlikely to make any difference to their thinking. Essentially, we did not believe that the various ideas that we looked at to encourage social housing REITs would be effective.

The hon. Member for Nottingham East asked about the impact of REITs on house prices. We cannot yet assess the impact on house prices as there are not yet  any substantial residential REITs on the market, so the answer is that they have not had an impact on house prices.

I hope that my answers are helpful to the Committee. The provision is a useful way to tidy up the REIT regime. I agree with the remarks made by my hon. Friend the Member for Braintree and by the hon. Member for Nottingham East: REITs are a useful addition to the UK system and can facilitate property investment. We are considering a relatively minor measure that can assist in that objective.

Question put and agreed to.

Clause 38 accordingly ordered to stand part of the Bill.

Schedule 18 agreed to.