New tax regulations dealing with the issue of BEPS (Base Erosion and Profit Shifting) may have a disproportionate impact on the real estate development sector as they are implemented in the UK. The concept of BEPS originates from the OECD and the G20 nations. The intention is to deal with the topical issue of Multinational Enterprises (MNEs) exploiting gaps and mismatches between different countries’ tax systems. However, a consequence (probably unintended) of the implementation of these arrangements may be to make some real estate projects unviable.
The issue for the real estate sector is that the OECD considers that interest on debt is a high risk area which can facilitate 'profit shifting’. As a result, when implementing the BEPS recommendations, the OECD recommends that countries should restrict the tax deductibility of interest to between 10%-30% of earnings. Whilst debt secured against real estate in the UK may pose a relatively low ‘BEPS’ risk, it may be difficult to tailor the rules to exclude this kind of financing arrangement from the ambit of the OECD’s recommendations. Ministers must decide how flexibly to interpret the OECD’s recommendations without the risk of creating avoidance opportunities. We are expecting the UK to announce its intention to implement the recommendation on interest deductibility in the Budget tomorrow, with a subsequent consultation which will more clearly outline the government’s intentions.
As the real estate sector is so capital intensive, there is real concern that restricting the tax deductibility of debt will increase its overall cost to companies in the sector. This is likely to reduce the amount of debt capital that the sector can deploy and will make it more expensive for real estate companies to fund themselves through borrowing. This will adversely impact on the level of investment in built environment development projects and regeneration.
It will therefore be important for companies operating in the real estate sector, particularly developers and investors, to respond to any consultation – putting the issue into a real estate context and explaining which sort of developments that would be put at risk by the proposed interest deductibility restrictions. Developments in regional cities (particularly mixed use or residential developments) will be particularly powerful examples to note in any consultation response. Also it will be important to note in any consultation response any projections for numbers of potential jobs, residential units, business rates yield etc. from developments which would be put in jeopardy as a result of the proposed restrictions.