Introduction

During 2012, more than 160 Real Estate Investment Trusts (REIT's) were quoted on the New York Stock Exchange and represented an equity market capitalisation of approximately $600 billion. These investment vehicles paid out more than $27 billion in dividends during 2012. The origin of REIT's can be traced back to their introduction by former US President Eisenhower in the 1960's. REIT's were originally intended as an opportunity for small investors to reap the investment returns associated with large-scale, income-producing real estate. In more recent times, the global REIT market expanded rapidly until it was hit by the financial crisis (sub-prime loan problems and Lehman's). The financial fallout witnessed a drop to one third in value over a two year period. This has since turned around. In its March 2013 review, the NASDAQ noted that REIT stocks have outperformed the broader equity market in 2012 for the 4th straight year.

In his December Budget speech, the Minister for Finance announced Ireland's intended introduction of REIT legislation. This is now enacted in Finance Act 2013. The stated aim of Ireland's introduction of REIT's is to enable investors finance investments in a risk diversified manner. The secondary intention being to hopefully assist NAMA in de-leveraging its portfolio, and allow it to bring more sustainable activity to both the commercial and residential property markets.

Helicopter View

Finance Act 2013 introduces Part 25A which contains specific provisions relating to the taxation of REIT companies. The regime provides, on meeting certain specified criteria, for a tax exemption in respect of the income and chargeable gains of a property rental business. The income and chargeable gains can be derived from both residential and commercial properties. There is no requirement as to the location of the rental properties as the definition is broad.

Various conditions need to be met in order to qualify as a REIT. These include tax residence in Ireland and not being resident in another jurisdiction, being Irish incorporated and listed on the main market of a recognised stock exchange in a Member State. The earliest date from which a company can be a REIT is 1 January 2013.

The legislation provides for an existing company becoming a REIT. In such a scenario, the assets of the original company are deemed to have been sold immediately prior to it becoming a REIT and reacquired by the company immediately on becoming a REIT. The deemed sale and reacquisition are treated as being at market value. Any gain arising is subject to corporation tax under capital gains tax principles.

Where an asset of the REIT ceases to be used for the property rental business and begins to be used for the purposes of its residual business, there will be a deemed sale by the property rental business to the residual business at market value. Any resulting gain generated on the deemed disposal will be a chargeable gain for the property rental business. This treatment applies equally where an asset ceases to be used for the residual business and commences to be used for the property rental business.

Taxation of a REIT

As indicated, a REIT must be an Irish incorporated company. An election is to be made under the provisions of Part 25A of the legislation. Where the qualifying criteria has been satisfied, the REIT will not be liable to corporation tax on income or capital gains arising from its property rental business. Distributions made by a REIT will be subject to the normal dividend withholding tax provisions, subject to certain amendments outlined below.

Taxation of REIT Shareholders

The taxation treatment of REIT shareholders will be dependent on their residence position.

An Irish resident individual will be liable to income tax at their marginal rate, plus PRSI and USC, on distributions received. The disposal of shares in a qualifying REIT will be within the scope of Irish CGT and the normal provisions will apply. Where the shareholder is an Irish corporate, the receipt of distributions should be treated as Schedule F income.

When making distributions, the REIT will need to give consideration to the relevant dividend withholding tax legislation. Distributions to Irish resident individuals will be liable to 20% withholding. Distributions to certain Irish pension funds, insurance companies will be exempt from DWT.

It is intended that 20% withholding tax will apply on distributions to non-residents. It may be possible to avail of treaty benefits resulting in a recovery of withholding tax or obtaining a credit in the recipient's country of residence. The disposal by a non-resident investor will not be liable to Irish CGT. This is on the basis that the REIT will be publicly listed.

As noted, in order to be a qualifying Irish REIT, it is necessary for the company to be incorporated in Ireland. Consequently, the transfer of shares will be within the scope of Irish Stamp Duty. Duty at a rate of 1% will be payable on the conveyance of shareholdings.

Qualifying Criteria

In order to be a qualifying REIT and to be able to avail of the tax exemption, the following criteria must be satisfied:

1. being tax residence in Ireland and not being resident in another jurisdiction;
2. incorporated under the Irish Companies Acts;
3. be a listed quoted company which is traded on the main stock exchange in an EU Member State;
4. not be a close company
5. that 75% of the aggregate income of the REIT derives from carrying on property rental business. Provided this limit is respected, it can carry on “residual business”, defined as any business which is not property rental business;
6. the property rental business should consist of at least three properties, none of whose market value should exceed 40% of the total market value of the properties constituting the property rental business;
7. subject to having sufficient distributable reserves, it should distribute at least 85% of the property income for each accounting period. Where it fails to do so, a charge to tax under Case IV Schedule D arises on the amount of undistributed income up to the 85% required level;
8. it should maintain a property financing costs ratio of at least 1.25:1. Property financing costs are defined as debt finance or finance leases for the purposes of property rental business, including interest, discounts, premiums, net swap or hedging costs and fees or other expenses associated with raising finance.

Failure to Satisfy Conditions

Failure to satisfy the requisite conditions can result in harsh consequences. If a REIT makes a distribution to a shareholder who holds greater than 10% of the share capital or voting rights, the REIT may be subject to corporation tax at a rate of 25% on the amount distributed. Separately, failure to satisfy the financing or the distribution requirements will result in the REIT being liable to corporation tax at a 25% rate.

Anti-Avoidance

Section 705Q will disapplying the legislation to any transaction directly or indirectly entered into by or on behalf of a REIT, where the transaction is undertaken otherwise than for bona fide commercial reasons or where it forms part of a scheme or arrangement of which the main purpose or one of the main purposes is the avoidance of liability to tax.

International Comparison

REIT's have been a feature of international property investment for a number of years. In general, they exempt the investment vehicle from income and capital taxes. Differences tend to arise in relation to what category of property can be invested in, the location of the property and tax treatment of distributions to shareholders. The below table provides an overview of how REIT's operate in some other jurisdictions.

Ireland Inc.

As indicated, it is hoped that the introduction of REIT legislation will assist NAMA in being de-leveraged. There are however other potential benefits which should stem for the enactment. In particular this should result in the introduction of a new source of capital for the property market and hopefully reduce investor dependence on bank financing. This is particularly important in light of the reported increasing demand for investment in prime Irish commercial property. In its March press release, CBRE noted that circa 275 million of investment properties (valued at more than €1 million each) traded during the first three months of the year. This quarterly spend compares with €545 million invested in Irish commercial real estate for the entirety of 2012 and is significantly higher than that invested in each of the previous three years.

The enactment of REIT legislation is to be welcomed. It should hopefully enable Ireland to compete with established “traditional” REIT jurisdictions. In theory, it should segway well with our established financial services sector. While there appears to be activity in the Irish commercial property market, take up of Irish REIT's will ultimately be determined by the global financial market. Take up will be monitored by commentators with interest.

Cormac Kelleher is a corporate tax manager with Mazars and a tutor with the Chartered Tax Consultant qualification.

Email: ckelleher@mazars.ie