Budget 2006: Grant Thornton's analysis

Grant Thornton has analysed yesterday's Budget to determine whether the industry wins or loses from the new measures announced by the Chancellor. While the announcement on real estate investment trusts (REITs) will be largely welcomed by the industry, other measures are less welcome and will have wide-reaching consequences.

REITs  - a victory

Clare Hartnell, head of property and construction at Grant Thornton, commented: "The government has listened to some of the last-minute lobbying by the property industry and introduced some welcome changes to the draft rules. The conversion charge payable when a property company elects to become a REIT will be 2% of market value of properties under ownership. This is better news than many had expected."

The conversion charge will be collected with corporation tax payable for the first accounting period of becoming a REIT. Alternatively, a company may elect to pay the charge over four years.

The following are the key changes to the proposals:

• A reduction in the required annual distribution from 95% to 90% of profits of the exempt rental business computed for tax purposes.
• The distribution must be paid within twelve months of the end of the accounting period, instead of six months as previously announced.
• The interest cover ratio is reduced from 2.5: 1 to 1.25:1 (ie profit  must be 1.25 times the finance costs) and will now be based on taxable  profits calculated before interest and capital allowances.
• A breach of the 10% shareholding restriction will not cause loss of REIT status, however, tax will be levied on the REIT proportionate to the interests held by persons owning 10% or more of the shares. There will be no tax charge if the REIT has taken reasonable steps to avoid paying  distributions to such shareholders.

Unit trusts - a defeat

Marion Cane, tax director at Grant Thornton, commented: "There was less good news for property unit trusts. From yesterday, SDLT will be payable at 4% on the market value of property exchanged for units, which neutralises the attractions of unit trusts for SDLT purposes."

The complete removal of 'seeding relief' (the exemption from stamp duty land tax (SDLT) available on the transfer of property into a new unit trust) was unexpected. It had been hoped that it would continue to be available for genuine property investment funds with any changes affecting the use of unit trusts for tax avoidance only. It was also hoped that a similar relief would be extended to REITs but to no avail.

SDLT will be a real barrier to the formation of new REITs and property unit trusts (authorised or unauthorised) moving forward. Further, the change will be a real blow to the property fund  management industry in the Channel Isles which has built up around the popularity of JPUT and GPUTs (Jersey or Guernsey Property Unit Trusts) as vehicles for private property investment funds.

Authorised Investment Funds (AIFs) - match postponed

As yet there is no mention of any changes to the taxation of income arising to AIFs.  Under current rules such funds will pay corporation tax at 20% on income, with their distributions being taxed as dividends.

Cane commented: "To create a level playing field with REITs, an announcement was expected which would make them more attractive to exempt investors. However, it's possible that changes will appear with the revised legislation on REITs."

Planning gains supplement and brownfield land - a no-score draw

Property developers and landowners who were hoping that the Chancellor would drop the proposal to tax the uplift in land values when planning consent is obtained will be disappointed that the Planning Gain Supplement (PGS) is still on the agenda. A further announcement is expected toward the end of the year, which is likely to mean the Pre-Budget in November or December.

Cane said "There is faint hope in the words 'discussions with stakeholders will continue' that the government will modify or even abandon its proposals."

It would also appear that the government has dropped the proposal to extend the contaminated land tax credit to long-term derelict land. However, it says it does remain committed to achieving 60% of new development on brownfield land. At the very least, we hope that it means the government listens to the lobbying on PGS and exempts brownfield land from its scope.

The government also remains committed to the introduction of the Business Premises Renovation Allowance which was announced when Stamp Duty relief for Disadvantaged Areas was removed. However, State Aid approval remains outstanding.

New environmental relief - a victory

Energy savings allowances which are currently available for loft and cavity wall insulation and solid wall insulation in residential property for letting are also to be extended from 6 April to include draught proofing and insulation for hot water systems.

Hartnell concluded: "Overall, it was a mixed Budget for the property sector. The good news about REITs was tempered by changes to property unit trusts. However, the last minute changes to the REIT regime proves the government does listen on occasions!"

For more analysis by Grant Thornton, go to http://www.budgetcomment.com.