Channel Islands Drifitng Away?

July 8th, 2015

A number of offshore property funds have converted to UK REITS in the last year. This was not the first of these types of fund to come onshore, so we thought we would take this opportunity to explain why the lure of the Channel Islands is fading.

The first thing to note is that pure Guernsey property companies are still subject to UK tax (at 20%) on rental income arising in the UK, although they are not subject to capital gains tax, nor any Guernsey tax. As the companies are generally geared (ie they use borrowing to increase the size of their portfolios), in the past they have been able to offset interest payable against their UK rental income, with the result that the actual UK tax paid has often been small or even non-existent.

Changes to borrowing (including lower interest rates on re-financed debt) have meant the threat of an increased UK tax bill for two of the companies that have converted. For example, F&C UK Real Estate Investments said in its circular on conversion that staying put meant ‘…it is anticipated that [the] income tax charge will increase in the future as a result of the refinancing of the Group’s intra-group loans over time’.

The clearest comment came from Schroder Real Estate Investment Trust (formerly Invista Foundation Property Trust) which said ‘The income tax charge borne by the Group for the period ended 31 March 2014 was £153,000. For the year ended 31 March 2015, it is estimated that the income tax charge borne by the Group will increase to £198,000…based on current practice, the Company’s tax advisors estimate that UK income tax payable is likely to increase to between £1,450,000 and £1,700,000 per annum’.

In the case of the third conversion, Standard Life Investments Property Income Trust, the company was running out of tax losses: ‘The Group currently has brought forward taxable losses to offset against [£5m net] taxable income. However, once these losses are fully utilised it is expected that the Group will suffer UK income tax on its net taxable income’.

Conversion to a REIT has the following consequences for all three companies:

  • They become UK resident for tax purposes. That does not mean they have moved their incorporation base from Guernsey, but it does mean board meetings must take place in the UK (where the fund management has always resided).
  • The REIT regime means that the companies have no UK tax to pay on their rental income or capital gains, so long as they comply with the REIT rules.
  • Distributions of rental income made by the companies cease to be foreign dividends, complete with a 10% tax credit and instead become property income distributions (PIDs). With certain exceptions, mainly for exempt investors, PIDs are paid with 20% income tax deducted at source. So far converting companies have kept their distribution rates unchanged, which effectively means a 20% income cut for taxpaying investors, but makes no difference for tax-exempt investors (eg pension funds and ISA managers).
  • As a UK REIT, there may be greater liquidity and investor demand for the fund. Some institutional investors will consider investment in UK REITs, but not offshore property funds.

The move onshore has been helped by the July 2012 abolition of the previous 2% asset value charge on conversion. However, for taxpaying retail investors, it is not necessarily welcome news.