REITs are investment companies that hold rental properties. One of their biggest advantages is their tax effective nature as Irish corporation tax is not payable on the income or gains from the property rental business of the REIT.
On 13 February 2013, the Minister for Finance presented the Finance Bill 2013 (the Bill) to Dáil Eireann, which included provisions for the establishment of Real Estate Investment Trusts (REITs) in Ireland.
REITs allow for a diversification of risk and investment through shared ownership of a portfolio of different properties. The flexible nature of REITs allow for investment to be accessible to both retail and institutional investors.
Features of a REIT
The Bill outlines the conditions a company must follow to become a REIT. A REIT must satisfy the conditions below:
- It must be a company incorporated under the Companies Acts.
- It must be resident in Ireland
- It must have its shares listed on the main market of a recognised stock exchange in a Member State*.
- It cannot be a "close company” under the control of five or fewer participators*,
- It must meet the following conditions by the end of the relevant accounting period:
- At least 75% of the aggregate income of the REIT to derive from property rental business;
- The REIT to conduct rental business with at least three properties with the market value of no one property exceeding 40% of total market value of all the rental properties*;
- The REIT to maintain a ratio of at least 1.25:1 in respect of property income to property finance costs; and
- It distributes at least 85% of its property income to its shareholders.
*The features marked with an asterisk are subject to a three year grace period.
REITs will be required to list on a main market on an exchange in a Member State of the EU. It is envisaged that the new Irish Stock Exchange Listing Rules currently being prepared for the REIT structure will broadly follow the UK Listing Rules. The new Listing Rules are due to be released shortly, but it is expected they will be similar to the rules for trading companies rather than those for investment funds.
The requirement for the listing to be on a main market will result in more stringent conditions being imposed, compared with admission to listing on a smaller market such as GEM in Ireland. This could restrict REITs to larger entities. Smaller, alternative exchanges generally have less burdensome requirements thus reducing costs. It remains to be seen whether this will have an impact upon the take up of the REITs structure.
The REIT will not have to list on an exchange for a period of three years. It would seem that the REIT will be largely unregulated for the duration of this three year grace period.
REITs compared with Qualifying Investor Funds (QIFs)
Property QIFs are increasingly being used as tax effective structures for holding Irish property for international investors. It will be interesting to see how QIFs and REITs compare as competing products. The main differences between the two types of funds appear to be that (i) REITs are accessible for both retail and institutional investors whereas QIFs are only open to larger investors who pass the qualifying investor test and can afford the minimum subscription of €100,000 and (ii) REITs have borrowing limits, whereas QIFs do not.
QIFs are subject to Central Bank of Ireland regulation whereas REITs are not. However the listing requirement will have regulatory implications for REITs.
It is clear that QIFs are Alternative Investment Funds and so do fall within the scope of the Alternative Investment Fund Managers Directive. However, each REIT will need to be considered on a case by case basis to determine whether it falls within the scope of the Directive or not. Some REITs established as groups may be able to avail of the holding company exemption.
In order to become a REIT, notice must be given to the Revenue Commissioners. The REIT must also file an annual electronic return with the Revenue Commissioners. This is similar to the regime which already exists for Irish s.110 securitisation vehicles.
One of the most beneficial aspects of a REIT is the avoidance of double taxation on property rental profits. No corporation tax is charged on profits of a REIT’s property rental business or chargeable gains from disposing of assets from the property rental business. The profits are only taxed when distributed to the shareholders.
However it is important to note that this applies ONLY to property rental income and not profits from other aspects of a REIT's business. Where an asset is acquired for property rental, and where that property is developed at a cost exceeding 30% of market value and sold within three years, profits from the sale shall be chargeable to corporation tax.
The Bill contains procedures for Capital Gains Tax to be chargeable when an existing company becomes a REIT. When a company becomes a REIT, it will be deemed to have sold and then reacquired its assets at market value.
A dividend withholding tax of 20% is imposed on property income dividends. There are exemptions available for certain pension funds, insurance companies, exempt persons or non-residents under tax treaties.
Comparison with UK REITs
Unsurprisingly, the Irish regime largely follows the existing UK model. One divergence from the UK position is the level of income that must be distributed to shareholders; 90% in the UK and US whereas the figure is 85% in Ireland. It is also encouraging to see that the Irish model has addressed some of the difficulties which the original UK regime encountered. This is seen specifically in the provision to give REITs a three year grace period to satisfy certain conditions.
However, one difference with the UK rules is that Irish REITs are required to be listed on a main market, as opposed to the UK where smaller exchanges such as AIM are permitted.
REITs are a welcome addition to the property fund structures available in Ireland and will hopefully encourage investment managers to consider the REIT model in their future plans.