Real estate infrastructure exemption 'not comprehensive solution' says expert

Out-Law News | 27 Jan 2017 | 4:12 pm | 3 min. read

An exemption for property rental projects from the new restriction on tax relief for interest deductions "is welcome and will benefit some real estate investment projects, but is not a comprehensive solution" a real estate tax expert has said.

John Christian of Pinsent Masons, the law firm behind, was commenting as the government published further draft legislation to be included in this year's Finance Bill.

“The extension of the public infrastructure exemption to property rental businesses is a great improvement on the initial proposals and will benefit some real estate investment projects .It is not a comprehensive solution for property investors though as features of some investment structures, such as a non-resident borrower, parent company guarantees and development activities can prevent the exemption applying," he said.

A new 'fixed ratio' rule is being introduced from April to limit the tax relief available for companies in respect of interest payments. Tax relief for interest will be limited to 30% of profits chargeable to corporation tax, excluding interest, capital allowances, tax amortisation and relief for losses. There will be a de minimis allowance for groups of £2 million a year.

Draft legislation published this week sets out details of a 'public benefit infrastructure exemption' designed to take infrastructure projects and certain real estate projects, out of the interest deduction restriction. To qualify, a company’s income and assets must be referable to activities related to 'public infrastructure assets', have comparable levels of debt to other group companies undertaking similar activities, be fully taxable in the UK and the company must make an election.

Any building may be a 'qualifying infrastructure asset' if it is part of a UK property business and intended to be let on  a 'short-term basis' to persons who are not related parties. 'Short-term basis' means having an effective duration of less than 50 years and not being considered a structured finance arrangement.

In addition any physical asset may be 'public infrastructure asset' if it meets a 'public benefit test'. That is, the asset is procured by a relevant public body or its use is or could be regulated by an infrastructure authority.  This includes bodies regulating airports, harbours, utility companies, the environment, roads and rail.

Interest on loans will only be excluded from the group's interest restriction calculation if paid to a lender which is not a 'related party' and if the lender's recourse is limited to the income and assets of, or the shares in a qualifying infrastructure company. Guarantees, indemnities or other financial assistance will be ignored, but only if provided by a relevant public body or a person not related to the company.  John Christian said that parent company guarantees were sometimes required by third party lenders and would prevent interest being excluded under the new rules.

The new rules will apply to existing borrowing as well as to loans taken out after 1 April. However, there is a limited 'grandfathering' provision which will enable the exemption to apply for some projects where the loan was agreed before 12 May 2016 even though the interest is paid to a related party. The 'grandfathering' provisions will be limited to cases in which 80% of the qualifying company's expected income has been 'materially fixed' for 10 years or more by long-term contracts with, or procured by, public bodies or their wholly owned subsidiaries and so will not apply to property rental projects.

"The lack of grandfathering of existing projects without a public sector counterparty is expected, but disappointing and the financial basis of some of these projects will be affected," said Christian.

When the government first announced the new rules, the proposed exemption for infrastructure was very narrow and did not include real estate companies. Last year the British Property Federation (BPF) said that the proposals in their original form, could cost the real estate industry an additional £660 million a year, representing approximately 9,000 jobs in the construction sector.

In December last year a government response to a consultation on the proposals said that a public benefit infrastructure exemption would be introduced, but gave very few details.

An interest restriction was one of the recommendations made by the Organisation for Economic Co-Operation and Development (OECD) as part of its base erosion and profit shifting (BEPS) project to prevent tax avoidance by multinationals.

The new interest deduction rules will include a group ratio rule based on the net interest to EBITDA ratio for the worldwide group. This is intended to help groups with high external gearing for genuine commercial purposes. The draft clauses published this week include further details of how the group ratio rule will apply.

“The compliance burden under the new regime will be significant- there are over 100 pages of draft legislation- which will add to transactional and ongoing costs for an investment as well as any financial impact of interest restriction," Christian said.