The future of tax relief for interest payments is uncertain, writes Daniel Cunningham
UK real estate lending has become embroiled in the government’s efforts to crack down on tax avoidance techniques by multinational corporations.
Interest payments on debt, considered an expense of doing business, have traditionally been tax deductible in the UK. A consequence is that large corporations have been able to load up with excessive volumes of debt, reducing their UK tax bill, and shift profits made in the country to jurisdictions with lower or no tax on business profits.
It is a global issue. In 2010, the OECD made recommendations aimed at tackling such practices, known as base erosion and profit shifting (BEPS). In part driven by news stories about well-known brands contributing little to the exchequer, the government has spent the last two years working up legislation to tighten rules on the taxation of interest payments. It was presented to parliament in March in the annual Finance Bill, with measures due to come into effect by 1 April.
So, how does this affect UK commercial real estate lending?
Due to the scale of the average commercial property investment, debt is routinely used to finance assets to a greater degree than in many other industries. Although the commercial property investment industry is not the intended focus of the government’s measures, it is in the firing line.
“Under the proposals, the more highly-leveraged a company is, the more it would be affected. Capital intensive industries such as real estate and infrastructure would be impacted,” says Ion Fletcher, director of policy, finance, for industry lobbying body the British Property Federation.
The BPF made clear to the UK government its concerns about proposals put forward in October 2015, which, it argued, would make the UK a more expensive place for property investors who required borrowings to do business. “The legislation as initially proposed would have had a huge impact,” says Fletcher.
The reforms included within the eventual Finance Bill have taken in some of the industry’s concerns, although there is still an element of doubt as to how future financing will be affected.
In January, the government announced draft legislation which included a significant concession; a Public Benefit Infrastructure Exemption (PBIE), which meant debt secured by properties rented to third parties would not be affected.
However, the government did not make an exception for debt with recourse to parent company guarantees. The problem for the property industry is that such guarantees are a typical feature of development finance loans, due to the need to mitigate the particular risks of development.
These concerns were taken on board, the composition of the eventual Finance Bill shows, but only to a degree. There were two main positives, Fletcher says.
Firstly, the government will ‘grandfather’ parent company guarantees, meaning that existing development loans will be eligible for the PBIE, if certain other conditions are met. Secondly, a ‘comparative debt test’ condition has been removed from the PBIE, which could have created further uncertainty.
However, what is less clear is the government’s position on parent company guarantees in future deals. It seems they will benefit from the exemption only if the guarantee is provided by a company which qualifies under the PBIE.
“It is not clear how easy it will be for guarantors to meet the conditions,” explains Fletcher. “Either the company will need to invest in real estate directly or its only assets or income will derive from companies which own real estate directly.”
The impact of the Finance Bill on commercial property development is difficult to gauge and could mean extra considerations for those aiming to source debt.