THE MOVEMENT OF ASIAN CAPITAL INTO UK INFRASTRUCTURE PROJECTS
On 20 March 2014, DLA Piper (together with Deloitte) presented at a seminar hosted by UK Trade and Investment (UKTI) in Hong Kong on the subject of investment in UK infrastructure. The location of the seminar was no accident— UK infrastructure investment is a hot topic in Asia and it is no surprise that the seminar was attended by a host of Hong Kong and Chinese investors. Investment ties between Asia and the UK have been strengthening for some time, and infrastructure, which implicitly includes real estate, is a key sector of inward foreign direct investment (FDI) for the UK.As Asian investors become wealthier and more sophisticated, the UK Government has specifically targeted these entities to contribute to the rejuvenation of the UK’s ailing infrastructure system.
In this article, we outline recent growth in Asian (and particularly Chinese) investment in the UK and some recent significant investments by Asian entities. We look at the reasons why the UK has targeted Asia as a source of FDI, and why Asian investors see the UK as an attractive destination for their funds. Finally, we examine some of the basic legal and tax issues that may affect foreign investors in UK infrastructure.
UK infrastructure and foreign direct investment
The UK is traditionally one of the top destinations in the world for FDI. In an increasingly competitive global FDI environment, statistics revealed that the UK was the number one European destination for FDI in 2012/13. Energy and infrastructure investments accounted for a relatively large proportion of investment projects attracted by the UK in 2012/13, with 16 per cent falling into the category. UKTI has recently focused on attracting FDI into UK infrastructure, and counted 2012/13 as a successful year—it facilitated £1.9 billion of FDI into major infrastructure and regeneration projects.
Asian investment in the UK is strong. In 2012/13, Japan, India and China were among the top 10 investors in the UK. An Ernst & Young survey of more than 100 Asian companies showed that 41 per cent considered the UK to be in their top three FDI destinations in Europe in 2012.Table 1, see right, shows some examples of the major UK projects in which Asian companies have invested in recent years.
Beijing Construction Engineering Group (BCEG) acquired a 20% stake in Airport City Manchester, the company behind Manchester’s £800 million Airport City development. In March this year, Airport City Manchester announced it will visit Beijing, Shanghai and Shenzhen with the aim of attracting more Chinese investors to the project.
Osaka Gas and Sumitomo Corporation acquired Sutton and East Surrey Water.
China Investment Corporation acquired a 10% stake in Heathrow Airport.
Hitachi Ltd acquired Horizon Nuclear Power.
Hitachi Rail Europe acquired a 40% stake in Agility Trains.
State Administration of Foreign Exchange (China) purchased a 10% stake in Veolia Water UK.
China Investment Corporation purchased an 8.68% stake in Thames Water’s parent company, Kemble Water.
Japanese company Marubeni Corporation added to its UK portfolio with investments in the Gunfleet Sands and Walney 1 OFTO wind farms.
Itochu Corporation acquired a 20% stake in Tyne & Wear Waste PFI.
Table 1: Examples of recent investments by Asian Companies
In addition to the above, Cheung Kong Infrastructure Holdings Ltd, the largest publicly listed infrastructure company in Hong Kong, has been building up its UK infrastructure portfolio since 2010. It now holds stakes in many infrastructure projects and companies in the UK, including 100 per cent stakes in UK Power Networks Holdings Limited (formerly EDF Energy plc),Wales & West Utilities and Northumbrian Water Group, and smaller stakes in Seabank Power Ltd, Northern Gas Networks and Southern Water. This infrastructure sits alongside existing holdings of Hutchison Whampoa, such as the Port of Felixstowe, the UK’s largest and busiest container port.
Recent political and regulatory events, such as China and the UK signing a currency swap agreement, the Chancellor of Exchequer announcing that Chinese companies will be allowed up to a 100 per cent stake in new UK nuclear power plants, and the establishment of a UK–China infrastructure task force, show that there is a serious political will for investment ties between the UK and Asia to strengthen further. Some of the infrastructure investment opportunities in the UK which UKTI is currently targeting include:
energy investment opportunities—according to UKTI’s Inward Investment Report 2012/13, there are investment opportunities in “offshore wind, carbon capture and storage (required for new coal thermal power plants), combined heat and power, waste-to-energy, and nuclear and marine technologies”;
the Thames Water Tideway Tunnel—Thames Water is set to formally advertise for investors for this proposed £4.2 billion project in May;
the High Speed 2 (HS2) rail project—the UK Government plans to build a high speed rail link between London and Birmingham initially, and then extend the link to Manchester and Leeds; and
communications infrastructure opportunities— the UK Government has committed to the roll-out of infrastructure to provide the best superfast broadband network in Europe by 2015. There are also opportunities in mobile data technology.
Why has the UK targeted Asia as a source of FDI?
The UK Government has long acknowledged that UK infrastructure must be upgraded and brought up to date to keep pace with the UK’s increasing population and to stimulate economic growth. Each year the UK Government publishes its National Infrastructure Plan, which identifies key projects— and hence investment opportunities. In recent years, the UK Government has begun targeting Asian, and particularly Chinese, firms and institutions as potential investors in the UK’s infrastructure projects. Asia is particularly attractive as a source of FDI because:
rapid economic growth and expansion in Asia has led to governments and private companies having the capacity to acquire and manage overseas assets;
China’s economic growth means that it will not maintain its status as a low-cost manufacturing powerhouse forever, and it will therefore need to find other ways to maintain its economic growth—one of these being FDI; and
China has expertise and experience that the UK can benefit and learn from. For example, China has recently constructed its own domestic high speed rail network, prompting the UK Government to look to it for guidance in constructing the HS2 network (despite China’s reputation in this area being tarnished by a fatal crash in 2011 in the Zhejiang province and the 2012 collapse of a section of rail line).
Why are Asian investors looking to the UK?
The reasons why Asian investors may choose to invest in the UK, and in particular in UK infrastructure, are many and varied. In a general sense, the following traits (amongst others) make the UK an attractive destination for FDI:
Lifestyle and cultural aspects—Asian investors view the UK as having a good quality of life and stable social climate. Furthermore, wealthy Asian parents often send their children to UK schools and universities, and there are long-standing Hong Kong and Chinese immigrant communities in the UK’s major cities;
Potential of the existing infrastructure network— including technological, telecommunications, transport and logistics infrastructure;
Political and legal stability— the UK is traditionally politically stable and its legal system is transparent. Foreign investment in UK infrastructure is supported by all major UK political parties, which means that Asian investors can count on the existence of a positive investment environment even in the event of a change of government; and
Attractive corporate taxation.
The corporate tax point is an important one. Despite increasing pressure on the UK Government to raise taxes on investors into UK residential real estate (which has resulted in higher stamp duty land tax rates for investors in high-value residential property, as well as moves to increase capital gains tax for foreign investors into residential property), the need to create an advantageous tax environment for foreign investors in UK infrastructure is widely accepted. As a result of this and the UK Government’s drive to increase the attractiveness of the UK as a destination for FDI, the UK’s regulatory environment has become much more accommodating for foreign investors in recent years. In particular, over the past decade, the UK tax system has been reformed to encourage more foreign investors to enter the market, including:
the introduction in 2009 of a complete exemption from tax on dividends in almost all circumstances;
a series of cuts to corporation tax which will make it the lowest in the G20 by 2015; and
the coming into force of the new China–UK double tax agreement in December 2013.
Of course, investment will always be a primarily financial decision based on a risk/ return profile. Infrastructure, particularly in the case of an existing asset, has the benefit of being a low-risk investment with reliable returns, and it is relatively insulated from inflation. Infrastructure’s risk/return profile is often suited towards pension funds and sovereign wealth funds (SWFs), because these kinds of investors typically look for slowly maturing assets. This is aligned with the types of investors Asia has been producing over the last 15 years. Since the Asian financial crisis in the late 1990s, fiscal and/ or export policy in some countries in the region resulted in the accumulation of surplus foreign exchange reserves. This had two consequences that are significant for current purposes—the emergence of Asian SWFs, and the rapid growth of outward FDI from the region.
China’s economic rise has also been significant in increasing the attractiveness of Asia as a source of FDI. Chinese businesses are looking to expand globally as China’s role in manufacturing changes. For several reasons, including rising factor costs and manufacturing sector volatility, China’s viability as a low-cost manufacturing centre has declined in recent years. This has had two important consequences.
Many in China are looking to maintain economic growth in other ways, for example, by increasing FDI; and
moving up the value chain has also become a priority for China.
In order to move up the value chain, China needs to increase its technical knowledge. The UK is renowned for being forward-thinking and investing in research and development, and partnering with experienced innovators allows Chinese investors to learn whilst making a return on their projects. Additionally, in highly regulated areas such as nuclear technology, being involved in projects located in strict regulatory environments such as the UK lends Chinese firms credibility, increasing the likelihood that they will be able to export their technology elsewhere.
Whilst existing infrastructure assets represent low-risk investment with reliable returns, the promotion and delivery of new assets offer additional opportunities to investors, where the UK planning system—relatively recently overhauled—provides enhanced certainty to investor promoters. In this sense the UK (and England in particular) benefits from transparent and consistent policy, which provides confidence for promoters. Important facets of this include:
the publication of the National Infrastructure Plan and National Policy Statements for specific infrastructure types such as power projects and ports, which have legal weight in decision-making on the very largest infrastructure projects;
a statutorily regulated decision-making process under the Planning Act 2008 in England, which requires a decision, even on the very largest projects, within one year of the examination of the case for the project;
the availability of powers of compulsory acquisition of land for suitable projects promoted by private sector entities;
transparency as to mitigation and infrastructure payments under statutory formulas such as section 106 of the Town and Country Planning Act 1990 or the Community Infrastructure Levy; and
a reduction in the scope and timescale for legal challenges of planning decisions that has been introduced this year.
Whilst the above provide certainty as to outcome, there are also means of entering the market alongside existing public and private sector bodies who can act as promoters of projects. These include advertised competitive tenders for works procured by public sector bodies and utilities— typically to be found in the Official Journal of the European Union. The procurement regime is attractive to procuring bodies and foreign investors in that overseas capital, experience of delivery and resources can be brought to bear in relation to such procurements, albeit that the competitive dialogue process underlying the procurements can be legalistic and resource- intensive in itself. It is notable that the UK regime is not biased towards domestic entities.
Investing in UK infrastructure: basic tax issues
As with any investment, tax will be a major consideration when calculating likely returns and deciding on an appropriate structure. Tax on investments in the UK occurs at three stages: acquisition, income and disposal.
Stamp duty land tax (SDLT) will apply on acquisition, and will vary depending on the asset price. The rate for purchases of commercial real estate over £500,000 is 4 per cent. Purchasing commercial property via an offshore corporate or unit trust wrapper is an option to mitigate SDLT.
Value added tax (VAT) will also apply on acquisition at the rate of 20 per cent of the purchase price for commercial properties. To keep VAT to a minimum, investors should consider registering for VAT and opting to tax, which will usually mean that VAT is recoverable. If the purchase of property can be considered a “transfer of business as a going concern” (which would usually occur where income producing assets are transferred), the transaction will be VAT-free.
Several taxes will apply during the period the investment is held, including:
income tax, at 20–23 per cent of rents generated;
UK withholding tax, at 20 per cent on each rental payment; and
UK withholding tax on interest, at 20 per cent (subject to treaty relief and exemptions).
Capital Gains Tax (CGT) may apply if the acquisition vehicle is a UK resident for tax purposes. To avoid CGT, the acquisition vehicle should be managed and controlled offshore.
The future of Asian investment in UK infrastructure
After examining recent investments by Asian entities and the current UK–Asia investment climate, it seems clear that Asian investment in UK infrastructure is likely to grow over the coming years and an increase in infrastructure investment should have exciting benefits for both Asian investors and the UK public.