I Overview

i Investment vehicles in real estate

A variety of vehicles are used for investment in UK real estate, including partnerships, unit trusts and companies. The choice of entities will, as for investment in other jurisdictions, depend largely on the identity and tax status of the investors. For indirect investment, historically investors have had a choice between an onshore exempt regulated vehicle, such as a real estate investment trust (REIT), and an offshore or transparent one, such as a Jersey unit trust or a partnership, with both delivering tax neutrality for investors. The position has become more complex since 2019 with the extension of capital gains tax to non-resident investors in UK real estate, but it is still possible to structure indirect investment in a tax-efficient way for investors through a broad range of vehicles.

The UK levies a tax, known as stamp duty land tax (SDLT), on the transfer of English properties, of around 5 per cent on the acquisition of commercial real estate. This tax does not apply to the acquisition of vehicles holding real estate. This has meant that investors will often hold real estate assets in individual vehicles, with a view to maximising their gain on a disposal, with purchasers typically offering a higher purchase price where they can acquire the vehicle and save SDLT. An investor will often, therefore, use holding vehicles that are tax neutral for as broad a range of investors as possible to increase the options on exit.

There may be non-tax reasons for holding assets in holding vehicles as well, most obviously where debt finance is used and the lender requires a ring-fenced security package.

The transfer tax referred to above applies to the direct acquisition of real estate and also to the acquisition of an interest in a partnership whose main activity is investing in real estate. For this reason, it is uncommon for real estate to be held directly in a partnership, which would otherwise be a tax efficient vehicle because of its transparent status for direct tax purposes. Real estate joint ventures using partnerships are more typically structured as partnerships holding assets via corporate holding vehicles for this reason.

UK pension funds are exempt from UK tax on gains and income from real estate investments, so where they participate in a joint venture their preference will often be to use tax transparent entities as the joint venture and holding vehicles, to ensure there is no tax payable at the level of the joint venture. The use of Channel Islands unit trusts to hold real estate investments is widespread as these vehicles deliver the desired transparency for exempt investors and the transfer of units is not subject to transfer taxes.

ii Property taxes

Income from UK real estate is taxable regardless of the location of the owner. Previously, gains realised on the disposal of UK real estate were only subject to tax where the owner was resident in the UK. However, the territorial scope of UK capital gains tax has been extended, in line with most other jurisdictions, so that with effect from April 2019 gains realised on direct and indirect disposals of UK real estate are subject to UK capital gains tax. Exemptions from tax on gains and income from real estate are available to certain pension funds and charities.

The UK also levies a transfer tax on the acquisition of real estate, with separate regimes applying to properties in England, Northern Ireland, Wales and Scotland. The value added tax (VAT) regime also applies to supplies of UK real estate.

II Asset Deal versus Share Deal

i Legal and corporate tax framework

The taxation of income from UK real estate is governed by the core UK corporation and income tax legislation. Non-UK resident investors have historically been subject to the income tax regime, with the corporation tax rules applying only to UK incorporated and UK resident companies.

Although the rates of taxation under the income and corporation tax regimes differ, the core principles governing the computation of taxable income are largely the same for all types of investor. One key exception to this has been that measures introduced to implement Actions 2 and 4 of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting Project are contained within the corporation tax regime and do not currently apply to income tax payers. In April 2020, corporation tax on income was extended to all corporate non-UK resident investors in real estate, at which point the regime for UK and non-UK corporate investors was to a large extent be harmonised.

The rates for tax on capital gains also differ, with one rate applying to companies and another to individuals, but the same legislation governing the computation of chargeable gains applies to all tax payers.

The indirect tax rules are contained in the UK's domestic VAT legislation and various statutes that cover transfer taxes. Certain taxing rights have been devolved to the Welsh and Scottish governments, including transfer taxes, resulting in different regimes applying to the acquisition of real estate in these three regions. Although the rates vary, in broad terms the Scottish and Welsh regimes have largely been modelled on the English one and the legislative framework is similar in all three regions. Following the departure of the UK from the EU on 31 January 2020, the UK entered into a transitional period until 31 December 2020. At this point, subject to any extension of the transitional period, the UK will leave the EU VAT regime. Nevertheless, it is expected that much of the domestic VAT legislation governing supplies of real estate will be retained.

ii Investment in real estate

Tax on acquisition

Stamp duty land tax

Transfer tax is payable on the acquisition of a direct interest in real estate in the UK. Historically this tax was stamp duty and applied to English, Scottish, Welsh and Northern Irish properties. Stamp duty was a somewhat antiquated tax, and stamp duty mitigation was relatively straightforward and very common in commercial real estate transactions. The UK government responded to this by introducing a new transfer tax for real estate, SDLT, in 2003. In recent years, the power to levy a transfer tax has been devolved to the local Welsh and Scottish governments, and now these two regions have their own transfer tax: land transaction tax (LTT) in Wales, and land and buildings transaction tax (LBTT) in Scotland, with SDLT now applying only in England and Northern Ireland. Although the Scottish and Welsh regimes are independent, they are based closely on the original SDLT regime, with the main difference often being in the rates. The top rate for acquisitions of commercial property in England, Northern Ireland and Scotland is currently 5 per cent, and in Wales 6 per cent.

SDLT2 applies to all acquisitions of UK real estate, with the relevant rates applying in a 'slice' system to the consideration provided. For English and Northern Irish commercial property, the first £150,000 of the consideration is chargeable at zero per cent, the next £100,000 is chargeable at 2 per cent and the remaining balance is chargeable at 5 per cent. So, for example, if the consideration is £100 million, the SDLT charge will be just under £5 million.

SDLT is payable on consideration in all forms provided for the acquisition, including the assumption or discharge of debt or other liabilities, and the provision of consideration 'in kind', for example development works or another land interest. There are various reliefs, for example for charities and certain transactions (such as the lease element in a sale and leaseback) but none of these are likely to be applicable on the straightforward purchase of a commercial property by an investor.

Where VAT is payable on the purchase price for property, SDLT is payable on the VAT-inclusive price and cannot be recovered. The acquisition of commercial property is often not subject to VAT under the rules for transfers of going concerns and the main benefit to a purchaser of obtaining this treatment is the SDLT saving.


The supply of land in the UK is exempt from VAT unless the seller has 'opted to tax' the property. In most cases, the owners of commercial property will 'opt to tax' their property. This means that any supplies they make with the property, including lettings to tenants and sales to purchasers, will be subject to VAT (at a current rate of 20 per cent), and the owners can recover VAT incurred on costs related to the lettings and sale.

Where a seller has opted to tax a commercial property, the sale will not be subject to VAT provided that the sale meets the conditions to be the 'transfer of a going concern' (TOGC). Where a sale is a TOGC, it is not treated as a supply for VAT purposes, and no VAT is payable on the purchase price even though the seller has opted to tax the property. The conditions for TOGC treatment are as follows.

The seller must use the property for the purposes of a business and the buyer must intend to carry on the same kind of business with it. Where a property is sold subject to a lease to an unrelated occupational tenant and that lease will remain in place after completion, the property will usually meet the 'business' test for these purposes.

Where the seller is VAT registered, the buyer must be registered or as a result of the transaction be liable to be VAT registered. If the purchaser entity is not VAT registered by the time of the supply of the property (which for VAT purposes will usually occur on completion), it will nevertheless be liable to be registered for VAT where it is a non-UK entity if it expects to make taxable supplies of any value in the following 30 days. For these purposes, where a non-UK entity acquires a property that is let, the UK tax authority (HMRC) treats the buyer as making taxable supplies within 30 days of acquisition (even if no rent is actually payable by the tenant in that period). Therefore, a newly established non-UK holding vehicle should meet the VAT-registration condition where the property is let.

Where the seller has opted to tax the property, the buyer must also opt to tax the property and notify the option to tax to the UK tax authority on or before completion of the sale (the date can be earlier in some circumstances where a deposit is payable). Opting to tax a property is a straightforward process and involves completing the relevant form and submitting it to HMRC. For new entities that are registering for VAT, the option to tax notification is usually submitted at the same time as the application for registration.

The buyer must also confirm to the seller that a certain anti-avoidance provision in the legislation does not apply to it.3 Under this provision, a person's option to tax can be disapplied in certain circumstances, including where a property is let to a related party of the landlord, and at least 80 per cent of the tenant's business activities carried on at the property are not taxable for the purposes of VAT. Provided that the occupational tenants of a property are not connected to the buyer and there are no arrangements for tenants to contribute towards any works undertaken by the landlord at the property, this confirmation can be given and TOGC treatment will be available.

As a result of registering for VAT and opting to tax the property, the buyer entity will in the future charge VAT to its tenants on their rent, and will be entitled to recover the VAT it incurs on property management fees and its other property-related costs. The buyer will be required to file VAT returns with the tax authority on a quarterly basis. Each quarter, the buyer will account for the VAT charged by it to its tenants on their rent, net of the VAT incurred on expenses of its business.

Holding period

Tax on rental income

Non-resident individuals investing in UK real estate are currently subject to UK income tax on their rental profits, with the top rate currently 45 per cent.

Prior to April 2020, non-resident corporate investors in UK real estate were also subject to UK income tax on their rental profits. The basic rate, 20 per cent, applied to corporates. Since 6 April 2020, non-resident corporate owners of UK real estate have been subject to UK corporation tax, rather than income tax. The main differences in the two regimes are that the corporation tax rate is currently slightly lower than the income tax rate, at 19 per cent, and the corporation tax regime has more anti-avoidance provisions that could limit the tax relief available in respect of any related-party financing.

An investor's taxable rental profits will be calculated in accordance with generally accepted accounting practice, subject to any specific tax rules. It should be noted that under accounting rules, profit recognition will not always reflect the amount of rental income received in a period. For example, where a lease contains a rent-free period, accounting rules require the rent payable to be recognised over the term of the lease (including the period in which no rent is received).

Non-resident landlord scheme

The UK operates a tax withholding system for non-resident investors in real estate, known as the Non-Resident Landlord Scheme (NRLS). Under this scheme, tenants and letting agents of real estate owned by non-UK residents are required to deduct income tax at the basic rate (20 per cent) from payments of rent to their landlords, unless they have received a direction from the UK tax authority to pay rent gross. Non-resident landlords can apply for permission to receive rent gross and this is almost always granted to newly established entities. Where no direction to pay rent gross has been given, the tax withheld by tenants or letting agents is credited against the landlord's liability to account for tax on their rental profits.

Although non-resident corporate landlords are now within the UK corporation tax regime in respect of their UK property rental income, the NRLS will continue to apply to them.

Rental income: tax deductions

Deductions against an investor's taxable income (under both the income tax and corporation tax regimes) will be available for the items set out below.


Costs of a revenue nature incurred for the purposes of the property rental business, such as management fees, will be deductible against the company's taxable rental profits.

Finance costs

Investors can also claim deductions in respect of interest and other finance costs incurred for the purposes of acquiring the property. There are various rules that restrict the amount of tax relief on interest costs, particularly where the financing is provided by a related party.

Rental income: limitations on tax deductions
Transfer pricing

Under the transfer pricing regime, where the interest rate or quantum of related-party lending is not on arm's-length terms, interest in excess of what would have been payable in an arm's-length loan is not deductible.

Corporate interest restriction

The corporate interest restriction (CIR) rules can also limit the amount of tax deductions available. The CIR is part of the corporation (rather than income) tax regime and so has applied to non-resident corporate investors since April 2020. These rules apply where a corporate group's UK interest expense exceeds £2 million per year. For these purposes, a group will include a parent company and all its consolidated subsidiaries. If the annual interest payable by a group to third-party lenders and on any shareholder debt is no more than £2 million, the CIR regime will not apply.

If a group's annual interest expense is higher than £2 million, the CIR regime will apply. The rules are complex but in broad terms, a group that is subject to the regime can elect for one of two 'barriers' to apply to it. The first is the 'fixed-ratio rule', under which a group can obtain deductions for interest expense up to 30 per cent of its UK tax earnings before interest, tax, depreciation and amortisation (EBITDA) (effectively the operating profit from the property). The other barrier is the 'group ratio' under which the group can deduct a percentage equal to the proportion its external borrowing bears to the group's EBITDA. This barrier enables some groups whose third-party borrowing costs exceed 30 per cent of their UK taxable EBITDA to obtain relief for a higher percentage. A group can choose which barrier to use each period. Both barriers are subject to a 'debt cap', which effectively prevents groups from loading up their UK subsidiaries with debt.

Under the group ratio, related-party debt is disregarded when calculating the group's external borrowing. The effect for holding structures is likely to be that relief for shareholder debt will only be available under the CIR to the extent that annual interest under any third-party financing is less than 30 per cent of EBITDA.

There is an exemption from the CIR that applies to certain companies that let real estate and meet various conditions. The exemption extends only to interest payable to non-related parties, and so effectively ensures that qualifying companies can claim interest deductions in respect of all their bank debt, regardless of the outcome of the fixed ratio and group ratio rules. This exemption could be helpful in years when the buyer group's EBITDA is very low, for example during a period of refurbishment.


The corporation tax regime also contains a set of rules designed to counteract tax advantages relating to hybrid arrangements. These rules can work to deny deductions for interest on related-party loans where the payer is subject to UK tax and the payee is not. This includes where the entities are ultimately funded by hybrid instruments, including instruments that are treated as debt in the jurisdiction of one party to the instrument and equity in the jurisdiction of another party.


As noted above, non-resident individuals are subject to UK income tax on rental income received from directly held UK real estate, or real estate held through a transparent vehicle such as a partnership, at the rates applicable to UK-resident individuals. Individuals will remain subject to the income tax regime following the extension of the corporation tax regime to non-resident property owning companies in April 2020. As such, they will not be subject to the corporate interest restriction or hybrid rules in respect of the funding of their investments.

Withholding tax

UK withholding tax applies to the payment of 'UK source' interest on loans with a term of more than one year. A number of factors are relevant when determining whether interest has a UK source, including the residence of the debtor, the location of any security provided for the debt and the governing law of the loan contract. Interest on a bank loan is generally considered to have a UK source if it is secured on UK real estate, so the interest paid by most investors in UK real estate to their lenders will fall within the withholding regime. There are some important exceptions: no withholding tax is payable if the lender in question is a UK bank or company, or a non-UK entity lending through a UK establishment (e.g., a non-UK bank lending through its London branch). Further, if the lender is based outside the UK in a jurisdiction that has a double tax treaty with the UK, the treaty may reduce the rate of withholding tax that is payable (often to zero per cent).

Although case law4 has caused some uncertainty over what constitutes UK source interest, it is still generally held that where a non-UK resident entity pays interest to a non-UK lender, the loan is not secured on assets located in the UK, the interest is paid to and from accounts outside the UK, and the loan is governed by the law of a non-UK jurisdiction, the interest is not UK-source, even though it may be funded by payment of rents by tenants of a UK property. On this basis, it is usually possible to ensure that interest on shareholder debt used to finance real estate investments is not UK source and remains outside the scope of withholding tax.

Capital allowances

An investor within the charge to UK tax that carries on a qualifying activity (such as a property rental business) can claim capital allowances on qualifying expenditure incurred on fixtures that are 'plant and machinery' that it uses for the purposes of carrying on that activity (e.g., lifts, fire alarms). Capital allowances are a form of tax relief for the depreciation of these assets, with available allowances reducing the relevant company's taxable income for the period in which they are claimed.

Qualifying assets are divided into two groups: plant and machinery in the 'main rate pool'; and long-life assets and integral features in the 'special rate pool'. The rate of written down allowance in the pools is 18 per cent and 6 per cent per year respectively, each calculated on a reducing balance basis. The balance of allowances available to a company each year is known as its 'tax written down value'. A company can elect in each period whether to claim any available allowances.

For example, if a company has incurred £10,000 on qualifying assets in the main rate pool, in the first year the company can deduct £1,800 (18 per cent × £10,000) from its taxable rental profits. The tax written down value in the second year is £8,200 (£10,000 less £1,800 claimed in the first year). In the second year, the company can claim £1,470 (18 per cent × £8,200), and so on in future periods.

When fixtures are transferred on the sale of a property, it is possible to transfer the available allowances to the transferee, by the entry into of an election (a Section 198 election), under which the parties elect to treat the part of the sale price attributable to the fixtures as equal to the tax written down value of the fixtures at the time of transfer. The same election can be used to ensure that the seller retains the benefit of any remaining allowances.

An investor within the charge to UK tax that carries on a qualifying activity (such as a property rental business) can also claim capital allowances on qualifying expenditure incurred on the construction or acquisition of a structure or building first used for non-residential purposes. Construction must have started on or after 29 October 2018 and the qualifying expenditure must also be incurred on or after that date.

These allowances, referred to as structures and buildings allowances (SBAs), are claimed at a flat rate of 3 per cent annually over a period of up to 33.3 years. Broadly, investors purchasing unused structures or buildings from developers may claim SBAs on acquisition costs. If the structure or building has already been brought into use, the investor may claim SBAs on the developer's construction costs (treated as qualifying capital expenditure incurred by the investor). Separately, investors may also claim SBAs on renovation costs provided the relevant building or structure was first used for non-residential purposes and continues to be so used. Unlike allowances on plant and machinery, any SBAs claimed are added to the amount of the sales proceeds when calculating an investor's taxable gain on a disposal of the property.

Tax on exit

Capital gains

Until recently, disposals of UK commercial real estate by non-UK resident investors were not subject to UK capital gains tax, giving non-UK investors a material advantage over their domestic peers. With effect from April 2019, the UK capital gains regime was extended to cover gains realised by non-residents on both direct disposals of UK real estate and indirect disposals. This represented a major shift in the UK tax landscape, but it has aligned the UK with most other common investment jurisdictions. Certain classes of investor are exempt from UK capital gains tax, namely certain pension funds and charities, and sovereign entities, but all other non-UK investors are prima facie within the scope of UK tax on their UK real estate gains.

The rates are the same as for UK resident investors in commercial real estate, namely 19 per cent for corporates and a top rate of 20 per cent for individuals. Where the non-resident investor held the property prior to April 2019, the taxable gain will be calculated by reference to the market value of the property on 5 April 2019, unless the investor elects otherwise. So for investors whose properties are standing at a loss at that date, it will be in their interests to elect to use their original cost rather than the April 2019 value when computing their taxable gain.

Indirect disposals are disposals of shares or interests in a 'property rich' vehicle. For these purposes a company is property rich if at least 75 per cent of the gross market value of its assets derives from UK real estate. Value is traced through layered structures, so that a company will be property rich if its sole asset is a shareholding in a subsidiary that holds real estate. There are anti-avoidance rules aimed at the artificial manipulation of a company's balance sheet designed to prevent a company from being property rich.

In some cases, gains on indirect disposals will only be taxed where the person making the disposal owns at least 25 per cent of the vehicle in question, or has owned 25 per cent during the two-year period prior to the disposal. Any interests held by an investor's related parties are aggregated for these purposes. This 25 per cent threshold does not apply, however, in most cases where the asset in question is held in a 'collective investment vehicle'. A 'collective investment vehicle' is broadly defined and will include most joint venture and fund entities, as well as real estate investment trusts (REITs). The effect of these rules is that in most co-investment cases, all investors will be subject to UK capital gains tax on a disposal, however small their interest.

There are two exemptions available to non-resident investors making indirect disposals where the property in question is used in a trade. These exemptions will be valuable to investors in property-rich businesses such as hotels and care homes.

Substantial shareholding exemption

The substantial shareholding exemption (SSE) is part of the main UK capital gains tax framework and applicable to UK and non-UK tax payers. It is available to corporate sellers only, on the sale of shares in companies that are trading. There are various conditions that must be satisfied: in broad terms the main conditions are that the seller must have held at least 10 per cent of the ordinary share capital of the investee company for a period of 12 months, and the investee company or group must have been trading for 12 months. The investee company will generally be treated as trading if at least 80 per cent of its activities are trading in nature.

The SSE will also be available in some circumstances on the disposal of a property-rich company, where the company is not trading. Where at least 80 per cent of the company making a disposal is held by certain categories of investors, the SSE is available on the sale by that company of any subsidiaries of the company (whether trading or non-trading), and where between 25 and 80 per cent of the seller company is held by qualifying investors, a proportionate amount of its gain will be exempt from tax, reflecting the proportion of these investors' ownership. Qualifying investors for these purposes are broadly institutional investors that are exempt from UK capital gains tax, including certain pension funds, charities and sovereign immune entities. The extension of the SSE to vehicles held by these entities provides an efficient route for investment in real estate by these investors.

Trading exemption

This exemption is similar to the SSE, although as an exemption that only applies to non-residents on indirect disposals of property-rich entities, the conditions are more specific to the property in question. The investee's property must be used for the purposes of a trade that the company has carried on for at least a year prior to the disposal, with no more than 10 per cent of the company's real estate (by market value) being used for non-trading purposes. Unlike the SSE, there is no minimum holding period for this exemption, and it is available to all non-resident investors, including individuals.

Treaties and anti-forestalling

Most double tax treaties to which the UK is a party permit the UK to tax non-residents on both direct disposals of UK real estate and disposals of vehicles that are UK property rich (with some treaties containing exceptions for indirect disposals, for example where the vehicle in question is regularly traded). A small number of treaties do not allow the UK to tax gains on indirect disposals, the most prominent of these being the UK–Luxembourg treaty. The domestic rules contain an anti-avoidance measure preventing new structures being set up in Luxembourg to take advantage of this treaty protection, and the UK–Luxembourg treaty is in the process of renegotiation. However, until the treaty is amended, structures using Luxembourg holding vehicles that were established before the extension of UK capital gains tax was announced in November 2017 should be able to benefit from treaty protection, with the result that gains from indirect disposals of real estate investments will not be taxed in the UK.

Regime for funds

A particular concern when the extension of capital gains tax to non-resident investors was announced arose in relation to the application of the new regime to fund and co-investment vehicles, which commonly use non-UK holding vehicles for their real estate investments. UK pension funds and other investors that are exempt from UK capital gains tax hold a large proportion of their UK real estate investments through these structures. A particularly popular vehicle is a unit trust based in the Channel Islands (Jersey or Guernsey) or the Isle of Man. These vehicles involve a corporate trustee based in the relevant jurisdiction holding the assets on behalf of the investors, whose interests consist of units, with each unit entitling its holder to a proportionate amount of the asset's income and gains. These vehicles are particularly popular as they can be structured in a way that makes them transparent for UK income tax purposes. For UK capital gains tax purposes, they are treated as companies. Provided they were properly managed outside the UK, these unit trusts would (prior to April 2019) have been outside the scope of UK capital gains tax. This means that tax-exempt investors such as pension funds can receive their share of the fund's income without any tax at the level of the unit trust, and similarly any gains realised by the sale of the asset would have been returned to the investors without tax at fund level.

Without special rules, these vehicles, and others commonly used in real estate fund and joint venture structures such as non-UK companies, would have become subject to tax on gains, leading to tax-exempt investors suffering tax at fund level where they would not if they held assets directly. Transfers of these vehicles do not attract SDLT and so a sale would typically be structured as the sale of the unit trust rather than the real estate asset. However, with these vehicles now within the scope of UK capital gains tax, exempt investors could have suffered from sale prices being discounted by buyers for latent gains in the structure. In addition, funds with multiple layers of holding companies and master holding companies could have suffered multiple tax charges on a single gain as it was returned up the structure to investors.

A special regime for funds and joint ventures has been included in the extended capital gains tax rules to address these issues. Funds and joint ventures can enter into elections that have the effect of shifting gains in the holding structure up to the level of investors. This allows tax-exempt investors such as pension funds to receive their share of gains without incurring tax at fund level. This ensures that these investors, as well as non-UK investors who are exempt from UK capital gains tax (certain charities, and sovereign immune entities) can continue to invest in UK real estate via funds and joint ventures without suffering more tax than they would on direct investments.

There are two types of elections for funds: transparency election and exemption election.

Transparency election

This election applies to any collective investment vehicle that is transparent for UK income tax purposes but is treated as opaque for capital gains purposes. The most obvious example, and the main target of this election, is the Channel Islands unit trust referred to above. These entities can elect to be transparent for UK capital gains tax purposes, and where they do so the investors in the vehicle will be treated as if they hold the underlying real estate directly. This means that investors who are exempt will not be taxed on disposals by the vehicle and as the vehicle is transparent there will be no latent gain in the vehicle that could lead buyers to discount price on an acquisition of the vehicle.

Consequently a sale structured as the sale of the units in a unit trust will still be available in most cases as a tax-efficient exit route. The parties are in the same position from a capital gains position as they would have been on a direct sale of the asset and the buyer benefits from an SDLT saving because the acquisition of units is not subject to SDLT.

Exemption election

This election applies to non-UK vehicles that are opaque for capital gains tax purposes (most obviously companies). Vehicles that meet the relevant conditions are exempt from capital gains tax. Gains realised by the structure are subject to tax when they are distributed to investors or when the fund ceases to qualify for exemption. The tests to be met by a fund wishing to benefit from this exemption election are complicated, but in broad terms it is open to structures that meet either a widely held or a widely marketed test. The structure in question must have a non-UK holding entity and be property rich. In certain circumstances, a fund that is held as to more than 25 per cent by investors resident in a jurisdiction with a double tax treaty preventing the UK taxing indirect real estate disposals will not be entitled to make the election.

Where a fund has elected to be exempt, any gains it or any of its subsidiaries realise will be exempt, as will its share of gains of any joint venture in which it holds at least 40 per cent. A further advantage of the exemption regime is that if the fund disposes of a property-holding subsidiary, that subsidiary obtains a rebasing of its real estate assets, so that its base cost is equal to market value at the time of exit. This means that future buyers will not suffer from any latent gain in the subsidiary.

Funds that meet the conditions and make the exemption election must comply with various reporting obligations, providing information, inter alia, about the tax status of their investors to the UK tax authority.

VAT on exit

A sale of UK commercial real estate will be subject to VAT if the seller has opted to tax it, which will generally be the case (see above). However, provided that at the time of the sale the property has at least one tenant in occupation, it should be possible to structure the sale as a TOGC so that there is no VAT on the price. The VAT incurred on the costs of selling the asset should be recoverable.

A sale of shares in a company (or units in a unit trust) is not subject to UK VAT.

SDLT on exit

On an asset sale, the buyer would be subject to SDLT at the prevailing rates (currently 5 per cent for commercial property) on the consideration provided. Indirect disposals, in the form of the sale of a property holding company or unit trust, are not subject to SDLT. For this reason, UK commercial real estate transactions are commonly structured as the sale of the holding vehicle. The sale of a partnership holding real estate is generally subject to SDLT, and therefore it is unusual for UK commercial real estate investments to be held directly by partnerships, although these are popular vehicles for funds and joint ventures.

III Alternative investment funds

i Introduction – regulatory issues

The definition of an alternative investment fund (AIF) is extremely wide and captures many open-ended and closed-ended listed and unlisted real estate funds that are not undertakings for collective investment in transferable securities (UCITS) and are therefore not governed by the EU UCITS Directive, but fall within the EU Alternative Investment Fund Managers Directive (AIFMD). The only typical non-UCIT real estate ownership structures that are entirely outside the scope of the AIFMD are joint ventures and co-management arrangements for a particular asset where each of the investors co-owns directly the asset under management.

UK REITs are subject to the AIFMD and their tax treatment and regime are dealt with in Section IV. Aside from REITs, in general, collective investment in UK real estate through AIFMD compliant vehicles adopts one of two structural approaches, depending on the number and identity of investors, and whether the model is open or closed ended.

In the case of smaller investor pools, closed-ended investment, and tax-exempt investors, such as pension funds, who might naturally prefer a tax transparent vehicle, the UK limited partnership (LP) is a popular choice. This does come with its own complexity from a regulatory perspective, as the AIFMD does not properly contemplate partnership structures, and the identity of the manager is not always the obvious choice – it may very well be an external manager rather than the general partner.

UK LPs are usually established with a general partner that is a body corporate with a minimal share in the LP. Investors are able to invest into the LP as limited partners. LPs offer the advantage of flexibility in drafting the partnership deed so that profits can be shared in variable ways.

A common fund structure would involve LPs holding offshore companies or unit trusts that hold the real estate asset. As explained above, one benefit of using holding vehicles under a partnership is that transfers of fund assets, and interests in the fund itself, can be achieved without an SDLT cost. Partnerships using non-UK resident holding vehicles can also benefit from an exemption from capital gains tax (see Section II.ii, 'Regime for funds').

For investors looking for an open-ended investment, the regime for property authorised investment funds (PAIFs) presents the most logical alternative. A PAIF is an open-ended investment company with a business portfolio comprising predominantly real estate, shares in UK REITs or non-UK REIT-type entities. It must notify the UK tax authority that it wishes to be subject to the regime and meet certain conditions relating to its ownership, funding and business activities. A PAIF can be newly incorporated or an existing authorised unit trust that converts to a PAIF. The regime has not been widely used to date, in part because of practical difficulties in managing income streams and reporting them to investors.

From a regulatory perspective, managers of PAIFS that are non-UCITS retail schemes and qualified investor schemes are subject to the requirements of the AIFMD.

A more recently established alternative to the PAIF is the authorised contractual scheme (ACS), an authorised collective investment scheme that is tax transparent. The ACS can take one of two forms – limited partnership or contractual co-ownership – and represents a UK equivalent to overseas pooling vehicles such as the Irish common contractual fund. The tax treatment of a limited partnership ACS follows the tax treatment of a limited partnership as set out below. The co-ownership ACS also offers tax neutrality from an investor perspective – investors should not be subject to greater amounts of tax on their investment than they would have if they had invested directly – but with the additional advantage of seeding relief from SDLT on contributions of real estate to the ACS, provided certain conditions are met.

ii Purchase and contribution of real estate assets

Indirect taxes on purchase and contribution

The SDLT and VAT treatment of an acquisition of real estate by an LP or PAIF from a third party are the same as for any other buyer of UK real estate (see Section II). The table below sets out the SDLT and VAT treatment where real estate is contributed to an LP or PAIF by a partner or shareholder.

Note that the acquisition of an interest in the LP itself may be subject to SDLT in certain circumstances (namely where the LP holds real estate assets directly rather than through holding vehicles). Transfers of shares in a PAIF are not chargeable to SDLT.

Contribution to an LP Contribution to a PAIF
these circumstances the LP is effectively regarded as transparent. Broadly, the proportion of the real estate that becomes owned by persons other than the transferor and their connected individuals will be chargeable to SDLT.
A contribution of real estate to an LP will be taxed according to the general VAT rules. If the property is occupied by tenants, the transfer of a going concern rules may apply to render the contribution outside the scope of VAT.
On conversion of a unit trust to a PAIF, full relief is available from SDLT.
Seeding relief may be available for the initial transfer of properties into a PAIF.
A contribution of real estate to a PAIF will be taxed according to the general VAT rules. If the property is occupied by tenants, the transfer of a going concern rules may apply to render the contribution outside the scope of VAT.

Direct taxes for the seller and contributor

The seller of commercial real estate will be subject to UK capital gains tax on any gain, including where the seller contributes the asset to the fund vehicle in exchange for an interest in the vehicle. However the extent to which a gain is realised on a contribution will differ depending on the vehicle:

Contribution to an LP Contribution to a PAIF
As the LP is tax transparent, the contributor is treated as disposing of a proportionate share in the real estate only (the proportion to which the other partners are entitled).
While the contribution of an asset to an LP by a partner is a disposal, the general case is that the contributing partner is not treated as realising a gain.
Where the contributing partner is connected with the other partners otherwise than by reason of being in partnership, the asset has been revalued in the accounts, or there has been a payment outside the LP accounts for the transaction, different rules apply and it is likely that a gain will be realised.
A PAIF is an open-ended investment company that has separate legal personality and is treated as opaque for tax purposes. Therefore, a contribution by an investor to a PAIF necessarily involves a change of beneficial ownership and the investor will realise a gain in accordance with the rules described above.

Tax regime of the investment vehicle

Income and capital gains taxes
The LP is treated as transparent for direct tax purposes – there is no tax at the level of the LP. The partners are subject to tax in accordance with their own circumstances on their proportionate share of the profits of the partnership. The PAIF's property investment business is treated as a separate 'ring-fenced' business.
The income from that business is exempt from corporation tax, along with dividend income (to the extent it qualifies for exemption), and distributions from UK REITs or their overseas equivalents. The PAIF's other income is subject to corporation tax at 20%.
If the PAIF is a QIS then its property income must be at least 125% of its property financing costs (if not, the deficit is charged to tax).
The PAIF is exempt from tax on chargeable gains.

The VAT treatment of these vehicles is the same as for other investment entities (see Section II, 'VAT') and they will generally be able to recover VAT incurred on property-related costs.

An LP will generally be registered for VAT in the name of its general partner. The general partner is treated for VAT purposes as making any supplies the LP makes with the property, and can charge and recover VAT accordingly. The usual VAT rules for property apply equally to a PAIF.
If the PAIF has opted to tax the property it holds, it will be a taxable person for VAT purposes and entitled to recover input VAT in relation to those properties.
Withholding taxes
No withholding tax is levied on distributions made by the LP.
Dividends and interest income received by the LP may suffer withholding tax depending on the underlying territory making the payment.
The LP cannot generally access double tax treaties. However, investors may be able to access the treaties applicable to underlying subsidiary entities.
A PAIF may make property income distributions, dividend distributions, or interest distributions. Under Financial Conduct Authority rules, PAIFs must (broadly) distribute all their income to investors.
Income received in respect of the PAIF's ring-fenced tax-exempt property investment business must be distributed as property income. Taxable income (e.g., interest) in respect of any business activities falling outside the ring-fence is distributed as interest. The balance, of non-taxable income (e.g., broadly, dividends) is distributed as a dividend.Unless an exemption applies, PAIFs are required to withhold income tax at 20% from a property distribution (credit is given for tax withheld). A PAIF must pay property income distributions gross if it believes that, broadly, the recipient is subject to UK corporation tax or an exempt body and would be entitled to receive interest payments on a gross basis. If a PAIF makes a distribution to a company which holds shares representing 10% or more of the NAV of the PAIF, the PAIF is effectively subjected to tax on that proportion of its property income.
The PAIF is not subject to a requirement to withhold tax in relation to interest and dividend distributions.

Tax regime of the investors

Partners in an LP

The partners are subject to tax on their proportionate share of the profits of the partnership and these profits will have the character of the underlying proceeds. Therefore, non-resident investors will be subject to UK tax on both rental income from the LP's real estate assets, and gains from disposals of those assets (see Section II for more detail on the tax treatment of real estate investments).


The tax treatment of non-resident investors in a PAIF on receipt of distributions is set out below. Gains realised on the sale of shares in a PAIF will be subject to UK capital gains tax, including for non-resident investors.

Property income distributions PAIF distributions (interest) PAIF distributions (dividends)
Subject to UK income tax. Most taxpayers will receive distribution net of basic rate income tax. Basic rate taxpayers therefore have no further tax to pay. Higher and additional rate taxpayers will have further tax to pay. PAIF required to withhold UK income tax from distribution. It may be possible for investors to claim relief under a double tax treaty. No deduction of tax at source and the non-resident investor will not incur any further UK tax liability.

IV Real Estate Investment Trusts

i Introduction – legal framework

The UK REIT regime was first introduced in 2007. A company (or group of companies) that satisfies each of the applicable conditions may apply to HMRC for REIT status.

The principal tax benefit for shareholders to investing in UK real estate through a REIT is that the REIT will be exempt from UK corporation tax on any income or gains arising to it from its property rental business. Accordingly, the regime provides a tax-efficient means of holding UK real estate through a corporate structure while mitigating the UK corporation tax payable from that vehicle.

ii Requirements to access and maintain the regime

Qualifying conditions

A company or group must satisfy several qualifying conditions to become a REIT, and additional qualifying conditions must be complied with on an ongoing basis to maintain REIT status. As part of a consultation on the UK's fund regime and the attractiveness for funds of the UK as a jurisdiction in which to base their holding vehicles, announced in March 2020, the UK government is reviewing these conditions.

Company conditions

At present, the company (or, in the case of a group, the principal company of the group) must satisfy the following qualifying company conditions:

  1. Condition A: the company must be tax resident solely in the UK.
  2. Condition B: the company must not be an open-ended investment company.
  3. Condition C: the company's ordinary share capital must be admitted to trading on a 'recognised stock exchange' and listed on the Official List of the London Stock Exchange. A list of recognised stock exchanges is prescribed and published by HMRC, and features a wide variety of markets, including both the Main Market and alternative investments market (AIM) of the London Stock Exchange.
  4. Condition D: after the first three years of having had REIT status, the company must not be a 'close company'. A close company is, broadly, a company under the control of five or fewer participators or of participators who are also directors. Certain exemptions apply where a REIT would be a close company by virtue only of having an investor who is an institutional investor. These rules mean that a company can have REIT status where it is held by a small number of investors, where it is controlled by one or more institutional investors. As a result REITs are sometimes used as joint venture vehicles by these investors.
  5. Condition E: the company must have only one class of ordinary shares.
  6. Condition F: the company must not be party to a loan where the interest is either dependant on the results of its business or is otherwise excessive (or which provides for repayment of an excessive amount).
Property rental business conditions

The company or group must carry on a property rental business that satisfies each of the following conditions:

  1. the business must involve at least three properties; and
  2. no single property may represent more than 40 per cent of the total value of all properties involved in the business (for these purposes, a REIT's property rental business excludes certain prescribed activities and income, such as the letting of property that would fall to be treated as 'owner occupied' in accordance with generally accepted accounting practice).
Distribution condition

A REIT must distribute at least 90 per cent of the net income profits of its property rental business to shareholders on or before the filing date for the REIT's tax return for the relevant accounting period.

Balance of business conditions

The REIT's income profits arising from the property rental business must represent at least 75 per cent of its total income profits.

Additionally, at the beginning of each accounting period, the value of the assets in the REIT's property rental business must represent at least 75 per cent of the value of all its assets.

Entry to the regime

To obtain REIT status, a company must give written notice to HMRC of the future date from which it intends to become a REIT. While there is no prescribed form for such notice, it must contain a statement that the company reasonably expects to meet company conditions A, B, C, E and F throughout its first accounting period after becoming a REIT.

Tax regime of the REIT

Entry tax

Tax consequences of joining the regime include the following:

  1. the tax base cost of assets held by the REIT will be adjusted to market value at the date of entry;
  2. the REIT will be treated as beginning a new accounting period on the date of entry; and
  3. any losses in the property rental business cannot be carried forward and their benefit is effectively lost.

Historically, companies or groups entering the regime were subject to an entry charge broadly equal to 2 per cent of the gross market value of the assets of the property rental business. However, the entry charge was abolished for companies or groups entering the regime on or after 17 July 2012.

Tax exemption regime for income deriving from leasing activity

The income profits of a REIT's property rental business are exempt from UK corporation tax.

When a REIT disposes of any of the assets in its property rental business, any capital gain arising to it will generally be exempt from UK corporation tax. This includes where the disposal is structured as the sale of shares in a UK property-rich subsidiary or the sale of interests in an offshore collective investment vehicle that has not made an election for transparency under the non-resident capital gains tax regime.

However, any residual activities carried on by the REIT remain subject to UK corporation tax as normal. The REIT's property rental business and residual business are each ring-fenced, such that losses arising from the tax-exempt property rental business cannot be set against taxable income or gains arising from the residual business.

Dividends received by a REIT (whether from a UK or overseas subsidiary) are generally treated as being part of the tax-exempt property rental business.

Indirect taxes on acquisition, contribution and disposal of real estate assets

A REIT is subject to SDLT and VAT in the same way as any other investor in UK real estate.

Other tax charges

A REIT will be subject to a tax charge if:

  1. the ratio of its income profits in respect of its property rental business to its financing costs in respect of that business is less than 1.25:1 in an accounting period;
  2. it makes a distribution to a corporate shareholder holding 10 per cent or more of the ordinary shares in the REIT; or
  3. it breaches the distribution condition (to the extent that it falls short of the requisite 90 per cent distribution).

Tax regime of the shareholders

Distributions by a REIT in respect of the income profits and capital gains of its property rental business are referred to as property interest distributions (or PIDs) and are generally treated as UK property income, subject to UK taxation in the hands of shareholders.

Withholding tax at the basic rate of UK income tax (currently 20 per cent) generally applies to PIDs. However, PIDs can be paid gross to the extent that the REIT reasonably believes that the recipient is either subject to UK corporation tax, or exempt from tax (such as a pension fund).

Non-UK tax resident shareholders may be entitled to receive PIDs at a reduced rate of withholding tax under the provisions of an applicable double tax treaty with the UK. The tax charge on distributions to shareholders holding 10 per cent or more of the REIT is designed to mitigate the loss of UK tax, because most treaties allow a reduction in the rate of UK withholding only where the non-resident shareholder holds at least 10 per cent of the relevant company.

Distributions made by a REIT out of the profits of its residual business are taxed as dividends in the hands of its shareholders as normal.

Non-resident shareholders selling their shares in a REIT will be subject to UK capital gains tax on their gains (see above).

Events that determine the forfeiture of the regime

If a REIT ceases to meet any of company conditions A, B, E or F (and, in certain cases, company conditions C and D) in an accounting period, it will automatically lose its REIT status with effect from the end of the previous accounting period.

HMRC may revoke a company or group's REIT status where that REIT breaches any of the property rental business, balance of business or distribution conditions with sufficient severity or frequency. However, the regime includes complex rules which, in specific circumstances, can apply to disregard minor or infrequent breaches of certain conditions.

Additionally, the REIT regime contains a principal anti-avoidance rule under which HMRC may counteract any tax advantage which a UK REIT has tried to obtain for itself or another person. HMRC may revoke REIT status where the REIT breaches this rule multiple times.

V International and cross-border tax aspects

The UK has a broad network of double tax treaties, focus on which has increased in light of the recent extension of UK capital gains tax to non-resident investors in real estate. As noted above, most treaties permit the UK to tax gains on both direct and indirect disposals, with the most notable exception being the Luxembourg treaty, which does not permit the UK to tax gains of Luxembourg entities from the sale of UK property-rich vehicles. Given the large number of UK and European real estate investments structured through Luxembourg holding vehicles, the UK government is understandably keen to amend this treaty to permit the UK to tax indirect disposals.

The domestic capital gains tax rules contain an anti-avoidance provision that applies to arrangements entered into with a sole or main purpose of obtaining treaty benefits, allowing the UK tax authority to counteract tax advantages arising as a result. This provision is intended to prevent investors setting up new structures, and migrating existing structures to Luxembourg. The provision only applies where the tax advantage is 'contrary to the object and purpose' of the relevant treaty. The commentaries on the Principal Purposes Test provision in the OECD Model Convention5 raise questions as to the interpretation and scope of this provision. Arguably, it will not be contrary to the purpose of a treaty for investors to establish a vehicle in the relevant jurisdiction provided they have sufficient substance there and are making a genuine cross-border investment. However, the UK tax authority is likely to challenge a structure that is established in Luxembourg for the sole reason of obtaining the benefit of the treaty on future disposals.

i Cross-border considerations

The UK does not currently have any restrictions on either inward or outward investment (direct or indirect) in real estate.

ii UK holding vehicles for foreign investments

The UK has not historically been a popular jurisdiction to locate holding vehicles in structures that invest in non-UK real estate assets. This is largely because the UK's main capital gains tax exemption, the SSE, was limited to investments in trading companies and did not apply to investments in real estate (except where the real estate was used in a trade, e.g., hotels). The recent extension of the SSE to pure investments held by qualifying institutional investors may make the UK more viable as a holding company jurisdiction for real estate investors, although the current political uncertainty may act as a deterrent to investors. In addition, in March 2020, the UK government announced a new consultation on the UK's fund regime and the attractiveness for funds of the UK as a jurisdiction in which to base their holding vehicles. The government recognises that, despite a low main tax rate and other incentives, there are barriers to real estate funds using the UK to base their holding vehicles, including, for example, limitations on the SSE and certain conditions required for REIT status. The outcome of this exercise may be to extend the SSE to a broader range of investors and disposals, and to relax some of the REIT conditions, which may make the UK more attractive as a holding vehicle jurisdiction.

Vi Outlook

The main tax development affecting the industry in the recent period has been the extension of capital gains tax to non-resident investors in real estate. The period between the announcement of the extension and the introduction of the legislation was relatively short and there continue to be issues with the new legislation that require addressing as the impact of the new regime and its application to different holding structures become more apparent. Many investors are reviewing their holding structures to ensure that they can take full advantage of any relevant exemptions or elections. In general terms, the special rules for funds and joint ventures, including the ability to make exemption and transparency elections, have ensured that the main holding vehicles used for non-resident investment in real estate (in particular unit trusts) will continue to be effective from a tax perspective.

One concern for many funds and investors is the requirement for investors to file UK tax returns under the new capital gains regime, where historically they have not been required to do so. The UK tax authority has said it will consider introducing a system under which fund managers can file returns and account for capital gains tax on behalf of their investors. If the tax authority decides to offer this facility, it is likely to take some time for the relevant rules to be drafted and consulted on before coming into force.

Another development that will affect the impact of the new capital gains tax rules is the renegotiation of the UK–Luxembourg double tax treaty. Currently investors with holding vehicles resident in Luxembourg can take advantage of the treaty to avoid a UK capital gains tax charge on an indirect disposal of real estate, but this protection is likely to be removed from the treaty in the amendment process. Investors with Luxembourg structures will be monitoring the renegotiation process to determine whether the treaty is likely to protect them on an exit from their investment.

As noted above, the UK government is currently consulting with the funds industry on the use of UK holding vehicles by funds, including real estate funds. The outcome of this exercise may include changes to the current regime, or the introduction of a new regime, designed to make the UK more competitive for funds as a jurisdiction in which to establish their holding vehicles.

In April 2020, another major change to non-resident investors in UK real estate came into force, namely the extension of the corporation tax regime to these investors. The main impact of this change has been to limit the availability of tax deductions for interest on shareholder debt, owing to the corporation tax regime's corporate interest restriction (and anti-hybrids) rules that did not previously apply to non-resident investors. As with the capital gains tax extension, investors may need to restructure their holdings to address this change.

Another area of concern is the UK tax authority's approach to SDLT planning. Historically, it has accepted that the sale of a company holding property is not subject to SDLT and this has been regarded as legitimate mitigation of SDLT, and not vulnerable to challenge under SDLT anti-avoidance rules. The judgment in a recent case6 and the publication of revised guidance on these rules by the tax authority have cast some doubt on this position, suggesting that corporate sales could in some circumstances be subject to SDLT under anti-avoidance rules that can apply to any series of transactions where there is an SDLT saving. These developments, along with the introduction of capital gains tax on indirect sales, have given rise to concern that the UK government may extend SDLT to indirect real estate acquisitions as well as direct ones.


1 Kirsten Prichard Jones is a senior counsel at Macfarlanes LLP.

2 References to SDLT in the remainder of this chapter include LTT and LBTT.

3 Article 5(2B) of the Value Added Tax (Special Provisions) Order 1995.

4 Ardmore Construction Ltd v. HMRC [2018] EWCA Civ 1438.

5 The OECD Model Tax Convention on Income and on Capital.

6 Hannover Leasing Wachstumswerte Europa Beteiligungsgesellschaft MbH and another v. HMRC [2019] UKFTT 262 (TC).