Legal Updates
To REIT or not to REIT: that is the question
There can be little argument that those in the hospitality sector are facing a sea of troubles at the moment; not only are they having to cope with the general economic downturn, but they have had to deal with other industry-specific slings and arrows such as the high costs of compliance with the new licensing laws, the effects of the smoking ban, the registration requirements of the Private Security Industry Act and the loss of Industrial Buildings Allowances. Any glimmer of a silver lining in this depressing picture must surely come as a welcome change, and rather surprisingly it may have come in the form of a recent decision by HM Revenue & Customs.
Following considerable discussions, the Revenue have recently given Enterprise Inns the green light to convert to a Real Estate Investment Trust (REIT).
The tax rules and requirements for a company to convert to a REIT are extremely complex, and any organisation considering conversion should seek expert advice. At a very basic level, however, a REIT benefits from exemption from UK tax on their income and gains to the extent such profits arise from "qualifying activities", essentially the letting of UK or overseas land and buildings. Qualifying rental activities must be ring-fenced from any non-qualifying activities, and any company wishing to convert must evidence compliance with the following basic criteria:
- it must be quoted on a recognised stock exchange;
- it must not be a "close company" (ie not controlled by five or less participants);
- at least 75% of the total company profits in the accounting period must be qualifying profits and at least 75% of the total value of the company assets must be attributable to the tax exempt part of the business;
- it must invest in at least three properties and no one property must represent more than 40% of the total properties introduced in the tax exempt part of the business;
- it must not occupy any of the properties itself; and
- it must comply with other accounting requirements (the details of which are too lengthy to list in this article - again, seek expert advice!).
In addition to complying with the necessary requirements, a converting company must also pay an "entry charge", currently 2% of the market value of the investment properties at the time of conversion - payment of this charge can however be spread over four years.
Enterprise Inns are currently considering their position following the HMRC decision, and it could be months before a final decision is reached; if they do go ahead however, it could open the floodgates for conversion by a number of other pub groups - any conversion is likely to involve an internal restructuring to form separate property owning and operating companies ("propco/opco"), with the operating company taking interposed leases of the pubs in the portfolio from the property company as heritable owners of the pubs; analysts, however, believe that the tax benefits could well outweigh any initial restructuring costs. The operating company would collect rent, beer sales and gaming machine income from the occupational tenants and would then pay most of that over to the property company as rent under the new interposed leases.
If the REIT conversion route is followed by others, it may radically transform the existing pub sector, and already there are signs this may well happen, with other pubco's such as Whitbread, Punch, Greene King and Marstons reportedly investigating their options for conversion, and Mitchells & Butlers having already announced their intention to convert at some point in the future, once conditions in the market are "suitable".
Martin Bennett is an Associate in Archibald Campbell & Harley's Commercial Property Department and Head of their Hospitality Industry Group. For further information, please email martin.bennett@achws.co.uk or telephone 0131 220 3000.
The information contained in this article is for general information only. For specific advice, please contact at our Edinburgh office on telephone number 0131 220 3000.
