Choosing the right structure forinternational investment in UK real estateAn extract from UK real estate insights - Issue 12, April 2009

Asset Management

UK real estate insights

Choosing the right structure for international investment in UK real estateAs discussed in another article inthis edition of UK real estateinsights, UK property is starting tolook underpriced to overseasinvestors. One of the key issuesfor anyone looking to takeadvantage of the opportunities ishow to own the property,particularly if the investment is tobe via a fund or other pooledarrangement.

In the previous edition of UK real estateinsights, we looked at some of the keytax issues to be considered forinternational investment into UK realestate. How do those issues affect thechoice of structure, what are the otherfactors that are likely to influence thedecision and what are the optionsavailable for structuring UK propertyinvestment?

Factors affecting the structure

Who are your investors?

The appropriate structure for investmentinto the UK will depend on a number offactors. The best place to start is withthe needs of the investors, based onwhere they are tax resident and thevehicle through which the investorintends to invest. For example, theinvestors could include high net worthindividuals, European, US or otherinternational institutions such as pensionfunds, life companies and sovereignwealth funds or perhaps Shariah-compliant investors from the MiddleEast. The type of investor and the natureof the desired return from the investment(income or capital) will be significantfactors in determining the appropriatestructure.

Acquiring an investment or tradingasset – tax efficiencies

Another factor will be the nature of theassets being acquired. Is the activityintended to be one of propertyinvestment where property is held ordeveloped for the long term and for itsrental income, or is the primary aim oneof resale in the short term? Propertyinvestment will give rise to rental income

and capital gai ns on disposals, whilst atrading activity will realise trading profitson sale with possibly some rental incomeprior to a disposal. The nature of theproposed activities will impact on thestructure chosen and may even changethe investment approach, since there islikely to be much more UK tax leakageon trading activities than on investmentfor overseas investors.

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UK real estate insights

Choosing the right structure for international investment in UK real estate

It is often desirable to have the flexibilityto sell free of stamp duty land tax(“SDLT”) by selling shares in a companyowning the property, whether UKincorporated or offshore, or units in anoffshore unit trust. Managementincentives are another important area,and if carried-interest-type arrangementsare envisaged this can have a majorinfluence on the structuring of theinvestment. If companies holding

property are likely be acquired by thefund you will want to consider whetherthis will give rise to multiple layers of taxor bring into play UK anti-avoidancelegislation.

Legal and regulatory considerations

Legal and regulatory issues should alsobe considered at the structuring stage tohelp ensure that implementation

proceeds smoothly and unexpectedroadblocks do not arise.

If any activities in connection with theproposed structure are to be undertakenin the UK, the application of the UKregulatory regime under the FinancialServices and Markets Act 2000, asamended (“FSMA”), needs to beconsidered. A common misconception isthat real estate investment fundstructures and real estate fund managersare exempt from the application of theUK-regulated activities regime underFSMA because real estate is not aspecified investment for the purposes ofthe regime. This is not correct. Althoughdirect holdings in real estate are notinvestments governed by FSMA, any realestate investments held through acorporate or partnership vehicle do fallunder FSMA. Many other activitiesrelating to real estate investmentstructures, such as providing investmentadvice or portfolio management services,safeguarding assets and arranging dealsin investments, also require priorauthorisation if they are to be carried onin the UK. Some of the structuresdiscussed below may fall within thedefinition of a collective investmentscheme (“CIS”) and even real propertyheld directly can in some casesconstitute a CIS. A CIS must be

established, operated and wound-up(to the extent that those activities areundertaken in the UK) by a firmauthorised to do so by the UK FinancialServices Authority (“FSA”) (unless certainlimited exemptions apply).

Promoters of real estate investmentsmust also take care not to fall foul of thefinancial promotion restrictions underFSMA, which catch any invitation orinducement to engage in investmentactivity. The nature of the restrictions willvary depending on the type ofinvestment vehicle selected and thenature of the target investors. Where theinvestment vehicle is a CIS, stricterfinancial promotion rules apply. Aninterest in a CIS may only be promotedin the UK by a FSA-authorised entity tocertain limited categories of person,such as certified high net worthcompanies, trusts and individuals,investment professionals and certifiedsophisticated investors. A person who isnot FSA authorised can only promote thesale of interests in a CIS in the UK invery limited circumstances.

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UK real estate insights

Choosing the right structure for international investment in UK real estateStructuring alternatives

Partnerships – LPs and LLPs

Two common vehicles used for UKproperty investment are limitedpartnerships (“LPs”), of the English orScottish variety, and UK limited liabilitypartnerships (“LLPs”). These can bothbe used for investment or tradingactivities. Both LPs and LLPs allowactive management of the propertyportfolio to take place in the UK whilstgiving investors a tax transparentstructure (ie no tax in the entityitself).They are also viewed as relativelysimple, well known and non-aggressivestructures for property investment.

Holding property investments through aUK partnership will not create a UK taxresidence or permanent establishmentfor overseas investors, who will typicallyregister personally or through an offshorevehicle under the Non ResidentLandlords scheme to pay 20% UKincome tax on net rental income.Overseas investors into the UK have thegreat advantage of being able to realisetheir gains on sales of assets by thepartnership completely outside the UKand so effectively tax free unless theyare subject to tax in their home territory.However great care needs to be taken

with any trading activities or tradingassets since these are likely to be withinthe full scope of UK tax.

A Scottish LP is often used forstructuring management carryarrangements as, unlike its Englishcounterpart, it has separate legalpersonality.

The LP does not allow participation inthe management of the partnership if thepartners are to maintain their limitedliability status. The management iscarried on by the general partner of theLP. The general partner has unlimitedliability for the debts of the LP and iscommonly structured as a privatecompany limited by shares, but can alsobe an LLP. The formation and secretarialupkeep of the LP is not extensive orexpensive and the formation of the LPand subsequent changes in thepartnership are dealt with fairly easily.LPs are not required to file financialstatements for the LP, so this structure isa suitable vehicle where confidentiality offinancial information is important toinvestors and management. An LP canbe more flexible than a limited company:e.g. decision making can be made atone level, rather than the two-tiermanagement structure of a companyinvolving directors and shareholders.

Also, because LPs do not haveshare capital, capital maintenancerequirements such as the rules relatingto distributable reserves do not apply.

LLPs are technically corporateentities with certain partnership-likecharacteristics, including having theirown legal personality. The key featuresof a UK LLP are:

• Limited liability for its members;

• separate legal entity;

• broadly taxed as a partnership formost investors;

• has the organisational flexibility of apartnership;

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Choosing the right structure for international investment in UK real estate• any members’ agreement (LLP

agreement) is a private documentwhich is confidential to themembers; and

• its accounting and filing requirementsare broadly the same as those for alimited company.

As a UK LLP allows participation in themanagement by the LLP members, thisvehicle may be appropriate for a familyinvestment or a small number ofinvestors who wish to have an activepart in the running of the propertyportfolio. However, they do havesignificant tax disadvantages for certaincategories of investors (eg UK pensionfunds and life companies) and someoverseas investors may not like the levelof accounting disclosure required.

Jersey Property Unit Trust (“JPUT”)

A JPUT is a unit trust governed byJersey law and used to hold real estate.Guernsey and the Isle of Man offersimilar, but less frequently seen, vehicles.A unit trust is not a separate legal entity.Legal ownership of the trust assets isvested in a trustee who holds them ontrust for the benefit of the holders ofunits in the trust in accordance with theterms of the trust instrument. It has been

a commonly used vehicle for holdinginvestment property and previously alsoallowed the mitigation of SDLT onproperty acquisitions. SDLT can still bemitigated for a purchaser acquiring unitsin the JPUT holding UK property.

JPUTs are potentially a suitable vehiclefor overseas investors, as UK gains aretreated as realised by the offshoretrustees who will not pay tax on them inJersey. Net rental income is taxed on theinvestors, as it arises under the NonResident Landlords scheme. If you use aJPUT it is important to manage it in sucha way that it is tax resident in Jersey,and property management decisionsshould be made there by the trustees, tomaintain its offshore status for capitalgains purposes.

The degree of regulatory controlapplicable to JPUTs varies, dependingon the number and type of investors.

Tax haven companies

Often UK property, whether acquired forinvestment or trading purposes, is heldin a corporate structure wherecompanies are incorporated and taxresident offshore in territories where localtaxes (if any) are minimal e.g. theChannel Islands or more remote offshore

jurisdictions. Usually each property willbe held in a separate company topreserve the flexibility to sell the sharesfree of SDLT. This is a simple structure touse when investors are residentoverseas, although the selection ofoverseas directors and the compositionand frequency of board meetings cancause practical problems.

The structure does not generally requireany tax rulings to be agreed with theterritory’s tax authorities; dividends canbe paid free of withholding taxes andoverseas investors may be able to realisegains free of tax. Net rental income is,however, again subject to the basicincome tax rate for non-residentlandlords. It will be important to ensurethat the offshore residence of thecompany is maintained through itscentral management and control takingplace offshore, and to ensure that this isproperly evidenced through boardminutes etc. in case it needs to bedemonstrated to HMRC at a later stage.

This structure is not attractive for mostUK investors, as gains and income willoften be apportioned to them underanti-avoidance legislation. Most of theseterritories offer minimal protection fromdomestic taxation through their taxtreaties and may trigger tax problems for

investors in some jurisdictions, eg Irelandand France. Recent press commentindicates that such penalties for the useof “tax havens” are likely to becomemore common.

Entities established in offshore taxhavens are generally subject to a lighterregulatory regime than, for example, theUK. However, it is interesting to considerwhether this will always be the case. TheUK government has recently announcedan independent review of British offshorefinancial centres. The review will look atthe immediate and long-term challengesfacing British offshore financial centres inthe current economic climate, includingfinancial supervision and transparency;taxation, in relation to financial stability;sustainability and future competitiveness;financial crisis management andresolution arrangements; andinternational cooperation. The review isindicative of the more widespreadconcern of both regulators and investorswith increased transparency in thefinancial services sector.

Luxembourg structures

Overseas investors commonly use aLuxembourg corporate structure forinvesting in UK real estate, particularly ifthey already use Luxembourg as a

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UK real estate insights

Choosing the right structure for international investment in UK real estateEuropean base. UK property owned by aLuxembourg company is a relativelywell-recognised vehicle for purchasers ofUK investment property and, where theshares of the Luxembourg ‘wrapper’ areacquired, this can give rise to a stampduty and SDLT saving. The structurerequires that tax residence is properlymaintained outside the UK. A

Luxembourg corporate structure hasadditional benefits in that the tax treatywith the UK may provide protectionagainst the application of anti-avoidancelegislation, which can otherwise convertdevelopment gains into income. The factthat Luxembourg is an EU state mayalso improve the tax position of EU-based investors.

A key consideration with a Luxembourgstructure is the withholding tax ondividend payments to investors otherthan EU corporates. There are a numberof ways of structuring around this.Such structuring is usually followedup by obtaining a tax ruling from theLuxembourg tax authorities whichprovides the additional benefit ofcertainty in respect of the ongoingtax treatment in Luxembourg (providedthe factual circumstances set outin the ruling application are notmaterially changed).

Conclusion

A number of options are available forstructuring investment in UK real estateand it is important in each case toconsider which will work best for theinvestors, the local asset managers(if any) and the particular investmentcontemplated. It is also vital not to fallfoul of UK regulatory constraints.However, the UK still has a veryfavourable tax regime as far as inboundinvestment is concerned and it shouldbe possible for the well-advised inboundinvestor to achieve a low rate oftax leakage. This is clearly a complexarea and this article has only covered thegeneral features of the key structures.

Before an acqusition is made, thespecific circumstances of the investorsand transaction to be undertaken willneed to be considered and the impact ofthis reflected in the choice of structure.

Amanda Berridge is a partnerin the London office ofPricewaterhouseCoopers and specialisesin real estate companies and funds.

Laura Cox is a partner in the Londonoffice of PricewaterhouseCoopers Legaland specialises in UK financial servicesregulation and designing andimplementing innovative legal structuresfor new investment funds, including realestate, infrastructure and private equityfunds.

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