Enterprise, everywhere

Having sought to stabilise the economy with his autumn statement, Jeremy Hunt’s first budget in March 2023 was all about growth and his four pillars of industrial strategy: enterprise, employment, education and everywhere. Recognising that a competitive corporate tax system is essential for encouraging investment and innovation, the chancellor announced a series of tax measures to create a culture of enterprise and spread opportunity everywhere. Some of these proposals are directly real estate related while others may also affect the real estate sector.

In this briefing we consider the tax proposals announced at spring budget 2023 that will have an impact on the real estate sector.

Enterprise

The spring budget purportedly delivers a range of enterprise-boosting tax measures to attract the most productive companies to set up, invest and grow in the UK. Some of these measures, although not aimed directly at real estate, will still impact on it, such as the increase in the main rate of corporation tax, and others, such as reforms to the real estate investment trust (REIT) rules, are aimed at directly bolstering investment in real estate. 

Corporation tax

Despite calls from all sides to abandon the imminent hike in corporation tax, no such announcement was forthcoming. Nor was the ‘roadmap’ to a possible lower rate in the future set out that some had predicted (although much was made of the fact that the UK will still have the lowest rate of corporate tax in the G7). 

The main rate has therefore risen to 25% from 1 April on profits over £250,000, with the previous 19% rate applying to profits of £50,000 or less. Businesses with profits between £50,000 and £250,000 will be taxed at the main rate but may claim marginal relief. This increase in the corporation tax rate is obviously not such an enterprise boosting measure but to offset this the chancellor also announced some more beneficial changes. 

Capital allowances

Although full expensing had been mooted as an option to replace the super-deduction when it expired at the end of March, it was still somewhat surprising when Jeremy Hunt announced the introduction of a three-year 100% first year allowance for main rate assets (in addition to a three-year extension of the temporary 50% first year allowance for special rate assets introduced in 2021). This means that for every pound spent on main rate plant and machinery, the same amount can be deducted from taxable profits (and 50 pence in the pound as spent on special rate plant and machinery continuing to be deductible against taxable profits as previously). For those in the real estate sector the ability to write off the full cost of expenditure on main rate plant and machinery will be helpful compared to the previous writing down rates of 18% for general plant and machinery and 6% for special rate assets. 

At first glance, the super-deduction 2.0 appears less generous than its 130% relief predecessor but being able to write off the full cost of expenditure for the next three years does offer some comfort against the increase in corporation tax as outlined above. The government is also at pains to emphasise that it provides the joint most generous capital allowances regime in the OECD, and its promise to put the relief on a permanent footing as soon as ‘economically responsible’ is no doubt intended to encourage continued capital investment. Whether businesses are prepared to commit to such expenditure in the current economic climate remains to be seen, although the three-year time period will assist those who are taking a longer-term view in relation to the timing of investment expenditure.

REIT rules

Since the REIT rules were introduced in the UK in 2006, investment in REITs has increased and large institutional investors are increasingly investing in them. The government has recognised that certain rules have become outdated or create unnecessary costs or administrative burdens. By alleviating some of these constraints the intention is to enhance the attractiveness of the UK REIT regime for real estate investment. 

Some initial changes to the REIT rules were introduced last year, in particular now allowing ‘private’ REITs. Previously, to qualify as a REIT a company had to be trading on a recognised stock exchange, but from 1 April 2022 this condition was removed where at least 70% of the company’s ordinary share capital is held by one or more institutional investors. 

The detail has now been published in the so-called Edinburgh Reforms to the REIT rules which introduce three welcome changes with effect from 1 April 2023 to:

1. Remove the requirement for a REIT to hold a minimum of three properties where it holds a single commercial property worth £20m or more.
2. Amend the ‘three-year development rule’ that deems a disposal of property within three years of being significantly developed as being outside the tax-exempt property rental business. This means that the valuation used when calculating what constitutes a significant development better reflects increases in property values and is not impacted by inflation. The valuation will now be the highest of the fair value of the property (as determined in accordance with international accounting standards) on entry into the REIT regime, at the time of acquisition of the property or at the beginning of the accounting period in which the development commenced. 
3. Allow for property income distributions (PIDs) paid to partnerships to be paid partly gross and partly subject to withholding tax. This will be welcomed in mixed partnerships where a partner is entitled to gross payments. 

Qualifying asset holding company (QAHC) regime

The QAHC regime was introduced in April 2022 to further establish the UK as an attractive place to set up asset-holding companies. The QAHC regime has potential application to ownership of non-UK properties (but not to UK property assets or UK property-rich companies) and the rules are now being amended to allow a greater number of diversely held fund structures to be eligible for the regime. By doing this the government will be hoping that it will lead to an increased take up of the QAHC regime, which confers UK tax exemption on disposals of certain eligible asset classes (including shareholdings where the substantial shareholding exemption would not otherwise apply to exempt capital gains from UK corporation tax). 

Related to the QAHC regime legislation a further change is being introduced to amend the genuine diversity of ownership condition for the purposes of QAHC, REIT and non-resident capital gains tax (CGT) rules. Now, where an entity forms part of multi-vehicle arrangements, the genuine diversity of ownership condition can be treated as satisfied if it is met in relation to the multi-vehicle arrangements as a whole (even if the individual entity would not satisfy the test for genuine diversity of ownership when it is considered on its own). 

Sovereign immunity

Hidden in the detail of the budget was a very welcome additional announcement that the sovereign wealth exemption from direct taxation will remain, which will be a relief to UK real estate funds. This means that a sovereign wealth investor (as previously constituted) will continue to be exempt from UK tax on non-resident CGT on real estate disposals and on rental income, and also from tax on PIDs from a UK REIT. 

Non-UK charities

Prior to 15 March 2023, charities located in the UK, EU or EEA could qualify for charitable tax reliefs in the UK including from stamp duty land tax (SDLT) and the annual tax on enveloped dwellings. However, with effect from the day of the budget, non-UK charities will not be able to claim UK charitable tax reliefs unless such non-UK charities had asserted eligibility for such charitable tax reliefs to HMRC by Budget day.

Everywhere?

Having originally been launched in Kwasi Kwarteng’s ill-fated growth plan of September 2022, refocused investment zones now form part of Jeremy Hunt’s ‘levelling up’ agenda with the aim of delivering benefits of economic growth everywhere.

Investment zones

Although not a particularly innovative idea for stimulating investment, given their similarities to freeports, the government plans to establish 12 investment zones across the UK in which ‘special tax sites’ are designated. Potential investment zones include Liverpool, South and West Yorkshire and the East and West Midlands. Targeting growth in sectors such as digital technologies and life sciences, these ‘high-potential knowledge-intensive growth clusters’ will offer a package of tax benefits including:

• SDLT relief for purchases of land or buildings acquired for qualifying commercial purposes and used for such purposes for up to three years;
• Enhanced capital allowances for companies incurring qualifying expenditure on new plant and machinery primarily for use in a special tax site;
• Enhanced structures and buildings allowances of 10% per year for 10 years for qualifying expenditure on non-residential structures and buildings situated in special tax sites (structures and buildings allowance is usually at a rate of 3% per annum); and
• National insurance contribution (NICs) relief for employers with physical premises in a special tax site on earnings of new employees who spend 60% or more of their working time there (this rate can be applied on the earnings of all new hires up to £25,000 per year for three years).

A real estate business in these areas will benefit from the SDLT relief along with the enhanced allowances and also a relief from business rates. However, whilst an interesting development, relatively small sums have been ear-marked for each zone (£80m per zone, spread over five years), which may limit their effectiveness. Funding is expected to commence in the financial year 2024/2025. 

All at once?

Given that the spring budget marks the fourth fiscal event in six months, we could be forgiven for thinking that all might be quiet on the tax front for the foreseeable future. However, with the UK economy remaining precarious and a general election in the offing in 2024, it is anticipated that it will only be a matter of time before further tax changes are on the table. The government appears committed to making the UK a place where real estate investment is encouraged, as evidenced by its improvements to the REIT rules and confirmation that there will be no changes to the sovereign immunity regime, so there may be further measures that impact the real estate sector to come.