New Clause 9 — Real Estate Investment Trusts

Orders of the Day — Finance Bill – in the House of Commons at 5:37 pm on 6 July 2005.

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'(1) The ICTA 1988 is amended, by inserting after section 842A—

Real Estate Investment Trusts

(1) The Treasury shall, by regulations, to be laid prior to 31st October 2005—

(a) make provision about the treatment of Real Estate Investment Trusts for the purposes of any enactment relating to the taxation or Stamp Duty Land Tax, and may make provisions for separate sub-funds of such trusts;

(b) impose requirements on a company as to the conditions that need to be met for a company to be a Real Estate Investment Trust for an accounting period;

(c) provide for the modification of any enactment relating to taxation in its application in relation to—

(i) Real Estate Investment Trusts,

(ii) shareholders in Real Estate Investment Trusts; or

(iii) transactions involving Real Estate Investment Trusts;

(d) make provision for transitional arrangements for companies incorporated before 1st January 2006 that become Real Estate Investment Trusts on or after the 1st January 2006.".

(2) Regulations under this section shall not increase the tax to which a Real Estate Investment Trust or an investor in such a Trust would be liable except for those regulations.

(3) This section shall come into effect the month after the passing of this Act.'.—[Mr. Spring.]

Brought up, and read the First time.

Photo of Richard Spring Richard Spring Shadow Minister, Treasury

I beg to move, That the clause be read a Second time.

New clause 9 would compel the Government to introduce tax legislation to facilitate the introduction of real estate investment trusts as a collective investment vehicle for property in the United Kingdom. The Government have been good at announcing the introduction of REITs, but have so far failed to deliver the goods. As a result, investment has gone offshore.

It should be noted that despite several announcements by the Government of tax legislation to give effect to REITs, such legislation does not appear in the Bill. That is due to problems involving the current method of taxation of overseas landlords, whereby rents payable to them are subject to a 22 per cent. withholding tax except when the landlord has the prior agreement of the Inland Revenue. The worry is that a REIT will effectively escape such a tax when paying a distribution to the overseas landlord. However, many other countries have REITs and have appropriate tax regimes for them.

There is genuine concern that the current position is causing the property fund industry to locate elsewhere. There are now £3 billion-worth of listed property trusts in Guernsey that might otherwise be in the United Kingdom: that has been confirmed by Merrill Lynch investment managers. The quoted property investment trust market has increased from approximately £0.3 billion in 1998 to nearly £3 billion now, going from effectively 0 per cent. to 10 per cent. of UK listed real estate by market value. However, the market value of onshore trusts has remained nearly constant. Virtually all quoted property has gone offshore.

In the United States, REITs are a commonly held investment vehicle. Japan launched them in 2001, France in 2003, and Germany is considering introducing them. It would be preferable if we could introduce a regime before Germany. Companies are effectively developing equivalent structures elsewhere. A major insurer established such a vehicle in Guernsey, complaining that it would have liked at least to have the option of making it a UK vehicle.

In the US, REITs now own no less than $220 billion worth of real estate, of which $35 billion is residential. They have to distribute 90 per cent. of their income, and tend to have far greater and more consistent dividend yields than conventional shares. Given the ageing profile of the British population, that will be important, as pension funds have more retirees than future pensioners making contributions, and seek to move from having assets with potential growth to having income-producing assets.

REITs tend to have different cycles from the bond and equity markets. They therefore make for prudent investment by individuals, pension funds and life assurance companies wishing to reduce risk by maintaining a diversified portfolio. REITs also tend to trade at near asset value, whereas current UK property groups tend to trade at a discount to net asset value, often of between 10 and 15 per cent.

The longer it takes the UK to establish such a vehicle, the lower the tax take will be as more and more vehicles go offshore, and the bigger will be the loss to the UK economy. Perhaps one of the Government's concerns about REITs is that they produce high levels of income, and might be unwelcome competition for the other forms of income-producing investment that investors could consider: for example, the increasing amount of Government debt that the Treasury issues to finance the Exchequer.

If we turn to the history of REITs, the Budget of 2003 included announcements to improve the flexibility and efficiency of the commercial property market. The pre-Budget report of 2003 announced the consultation paper to be produced in the Budget of 2004, following on from the Budget of 2003. In the Budget of 2004, a consultation document was launched promoting more flexible investment in property, and seeking views on how a new property investment fund—a UK version of the successful US REITs—might be structured to meet the Government's objectives of further enhancing the liquidity of property investment, providing greater access to retail investors and encouraging expansion in the private rented sector. Of course, we have now come to the Budget of 2005.

Accountants and actuaries often identify as one of the characteristics of the Government that Treasury announcements are made without adequate supporting information on which they can make judgments, and often express anxiety publicly about the impact of Treasury announcements that are made without the supporting detail, given all the pressures that result on business and business decisions. It is curious that we have the reverse situation here—the Government have made four announcements about REITs, but no specific date for introducing such vehicles has been brought forward.

The British Property Federation is of the view that there will be no net tax leakage for implementing a REIT regime. The US experience is that REITs pay significant taxes other than corporate tax, such as business rates, stamp duty land tax and VAT, before any shareholder-level taxes. US REITs are widely held, and it should be noted that the US has rules to prevent overseas owners from controlling REITs to avoid US tax. As I shall indicate, Canadian research shows that such vehicles should produce a slight increase in tax yields in the longer term. We are therefore concerned by the Chancellor's reluctance to bear the possible short-term fall in tax revenues—the determining reason why the Government refuse to introduce REIT legislation—which is further discouraging capital investment from the United Kingdom.

The US plans to get around concerns about US owners abusing the rules by having concentration limits. Withholding taxes, which were 30 per cent., generally had the habit of blocking and deterring foreign investment that would otherwise be welcome. In the late 1990s, the US Treasury reduced the high withholding taxes on REIT dividends. That applied to all newly negotiated treaties in which withholding taxes were lowered for investments below a certain threshold, typically to 15 per cent. As a consequence, the level of overseas investment in US REITs substantially increased.

It should also be noted that external investors in UK property normally shelter their 22 per cent. tax charge under the current overseas landlord regime, typically by gearing up their investments. A 15 per cent. withholding tax rate would probably levy more tax than the 22 per cent. as the withholding could not be reduced by an overseas investor gearing up to buy shares in the REIT, especially given that REITs have tended to produce considerable income.

The Canadian Institute of Retail Funds and Canadian Institute of Public and Private Real Estate Companies also undertook a very detailed and scientific study of similar issues around withholding taxes for REITs. It concluded that there would be an immediate reduction in tax yields, being the corporation tax forgone on dividends and capital gains, net of the tax collected through withholding. When taking into account that most of the value would generally be deferred to tax residents who would pay tax on their REIT shares and dividends, however, the result was a net increase in tax yields. Overall, therefore, the REIT vehicle would result, at best estimate, in a small increase in tax yields in the long term.

On a wholly dispassionate point, it is difficult for people to retain a satisfactory return on their investments in dividend terms because interest rates throughout the world today are very low, and in many instances lower than in this country. Individuals go into REITs as a form of investment to capture yield. For example, the US experience shows that the average REIT yield in dividend terms is 5.13 per cent., whereas the Standard and Poor 500 stock index yield is 1.8 per cent. It is difficult for people to get a satisfactory return, and this is certainly one way of doing it.

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The National Association of Real Estate Investment Trusts in the United States recommends the following, based on the US experience, all of which we could reasonably include in UK tax law. The first recommendation is not to have a quoted requirement for REITs; the second is to permit gearing to reduce the level of withholding tax and distributions payable by REITs, with the sensible suggestion that we should have "safe harbour" levels for effectively tax-deductible debt—a principle worth considering throughout UK tax law.

Photo of Geoffrey Clifton-Brown Geoffrey Clifton-Brown Opposition Deputy Chief Whip (Commons)

Will my hon. Friend not also press the Government on the following fact? If there were a greater market in commercial property—undoubtedly there would be a more flexible market if REITs were introduced—the Government would also gain more in tax through increased business activity generated thereby, because leases would be granted more flexibly.

Photo of Richard Spring Richard Spring Shadow Minister, Treasury

I entirely agree. Indeed, in submissions made to the Treasury by the British Property Federation, those exact points have been spelled out.

We are fortunate in this country to have a hugely successful and internationally recognised financial services industry, with a skills and knowledge base that is incomparably successful by international standards. We can be grateful that it exists, because as we all recognise, our manufacturing capabilities do not match our success in the financial services industry—and REITs represent an area of investment that the investment community wants to see on the statute book.

The Government have accepted in principle that this is the right thing to do, but for reasons that are difficult to understand, they have been unable to come to a firm conclusion. I simply say to the Paymaster General that there is no substantive disagreement on the principle, but we must accept that at this stage we need to fix a date for the introduction of REITs. That is exactly what the new clause is all about, and I hope that the Minister's response will clarify how we can move the process forward as rapidly as possible.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I have three questions to ask the hon. Gentleman. As background, he cited the figures and the research from Canada, but as the House will know, Canada is 32 times the size of the United Kingdom and has twice as much house building per capita per annum as this country does. What evidence does he have of the effect that REITs would have on house prices in this country, the availability of houses for home owners to buy, and the levels of rents, both commercial and domestic?

Photo of Susan Kramer Susan Kramer Shadow Minister, Treasury, Shadow Spokesperson (Business, Innovation and Skills), Liberal Democrat Spokesperson (Business, Innovation and Skills)

Despite the comments of Rob Marris, REITs are a largely non-controversial issue; indeed, there is consensus across the House that they are a desirable instrument. For the ordinary consumer—the retail investor—REITs are important because they are easy low-cost mechanisms for entering and exiting the property market. They would allow people to diversify their investment portfolios, which is what we want, to enable people to manage risk better within their investments.

For the Government, there is a desire to achieve a closer alignment between the taxation of direct and indirect property investments. I fully recognise that there are issues that the Government must tackle—such as definition, legal issues, issues of withholding and foreign investors, and the ring-fencing of ownership and management versus the actual activities that take place on property. Surely, as we look around the globe, not least at Australia and the USA, there are plenty of examples of how all those issues have been tackled. The new clause is, from the perspective of the Liberal Democrats, essentially a wake-up call. It is about saying to the Government that they should please get a spur into Treasury officials, of whom we see so many in and out of the Box day after day, and get something sorted so that REITs can be made properly available to people in the UK.

Photo of Ivan Lewis Ivan Lewis The Economic Secretary to the Treasury

May I first welcome the new attachment of the Opposition parties to the concept of REITs? It was, in fact, this Government who introduced the potential benefits of a REIT system and we never heard any proposal to that effect from Opposition parties.

New clause 9 follows a simple pattern. Opposition Members have said that they want to focus the Government's mind on making more rapid progress in solving the problems associated with REITs. The problem with the new clause is that it invites the Government to introduce regulations before 31 October, irrespective of whether, before that date, we have resolved all the difficulties and concerns that hon. Members have accepted as authentic and legitimate. How can a particular date be specified for a set of proposals when there is no way of being certain that it is possible to resolve the outstanding problems relating to them? Doing so would be entirely irresponsible.

What we have said throughout is that it is our objective and desire, if we can resolve the problems, to introduce proposals for the next Finance Bill—and that remains our position, but we cannot guarantee it. If, in the course of our discussion and consideration of the issues, it continues to become apparent that the principles necessary to underpin a REIT scheme cannot be secured, we will have to take that into account before taking any final decisions. The message about the need to make rapid progress on REITs is, frankly, one that the Opposition have no need to keep telling the Government.

Photo of Edward Balls Edward Balls Labour, Normanton

I fully accept the Minister's point that REITs were originally a Treasury proposal rather than one suggested by Opposition Front Benchers. Given the earlier comments of Conservative Front-Bench Members about the importance of having simplicity and stability in the tax system, does my hon. Friend find it rather strange to hear them arguing that we should rush ahead with legislation before we have had enough time to sort out the technical details? Surely it is in the interests of stability and transparency that we get the legislation right before we put proposals before the House.

Photo of Ivan Lewis Ivan Lewis The Economic Secretary to the Treasury

I entirely agree with my hon. Friend that consistency is not a trademark of the Opposition, as we have seen throughout our debate on the Finance Bill. Conservative Members are telling interested parties outside that they are aware of the importance of REITs, but the Government have already made that clear on several occasions. We have also placed on the record, in the context of the Budget and the Finance Bill, our belief in the importance of REITs and the fact that we support them in principle. We have also acknowledged that, if at all possible, we need to make speedy progress with them.

As I have said, the problem with the new clause is that it confines the necessary debate, discussions and consideration of the genuine difficulties that we face in reaching a decision to a period before the end of October this year. It is easy for the Opposition to propose such amendments, but it would be entirely irresponsible for the Government to accept a time scale that we have no way of being absolutely certain of meeting.

There is no need for Opposition Members to continue to reiterate that we all support the concept of REITs in principle. Nor is there any need for those Members to tell us that it needs to be done as quickly as possible. We differ in that we are not prepared to compromise on the fundamental principles that we have outlined time and again. We have talked about the desirability of REITs, but also about some of the genuine obstacles and barriers to achieving them.

I say to those who have a genuine interest in putting a sensible and credible REITs framework in place that the credible thing to do is to work with the Treasury and the Government to ensure that the obstacles and difficulties are resolved. If that happens, we can put REITs on the statute book very quickly. On that basis, I ask Mr. Spring to withdraw the motion.

Photo of Richard Spring Richard Spring Shadow Minister, Treasury

It is a real joy to have the presence of Rob Marris. Something was lacking in our proceedings until, as I came to the Dispatch Box, there he was; the whole atmosphere in the Chamber suddenly lifted. I am delighted to see him, but I should point out that his questions could more appropriately have been put to his own Front Benchers, who have had a number of years in which to resolve these issues. I cited the experience of the United States in respect of residential, rather than commercial, investment, and gave the hon. Gentleman the relevant figures. So the experience of the United States has been specified and spelled out, and I dare say that it might be comparable in this country.

I should point out to the Economic Secretary that he doth protest too much. The idea seems to be that our suggestion is appalling, irresponsible and gratuitously offensive. The argument is that we are suggesting that this process, about which we have heard in three successive Budgets, should suddenly become terribly quick, and that it is quite wrong to deal with it rapidly. The Government have had a number of years in which to consider this issue. There have been representations from the investment community—[Interruption.] I thank the Economic Secretary for that sedentary intervention. I am not sure whether I heard him correctly, but he seemed to suggest that he wants us to participate in this process. We would be more than delighted to do so, and so would the investment community. Perhaps we could then persuade him to reach some form of conclusion.

The idea is that 31 October is in some way a blood-curdling date, but all that the inclusion of such a date is designed to do, as the Economic Secretary well knows, is to bring this issue to a rapid conclusion. As he will know from the industry, because this issue has not been resolved, money is going offshore instead of coming into this country. However, it has been resolved perfectly satisfactorily in a number of foreign jurisdictions. I should point out that it is not a case of officials doing an outstanding job and the Treasury being at fault; it is Ministers themselves who are procrastinating and who cannot get their act together. [Interruption.] The same point applies to Ed Balls.

We have tabled this new clause in order to raise this issue yet again. I am afraid that those out there who are watching this particular Government performance will be extremely disappointed by the Economic Secretary's response. We do not wish to press the matter any further, other than to make the perfectly valid point that it should be brought to a proper conclusion. I hope that it will be dealt with very rapidly, and that we can stop the endless procrastination that is so damaging for our businesses. That said, I beg to ask leave to withdraw the motion.

Motion and clause, by leave, withdrawn.