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We explore why the implementation of BEPS matters to the UK real estate industry.
The recent budget included a number of points relevant to UK real estate. As part of this, we received confirmation that the UK would be implementing the OECD BEPS (Base Erosion and Profit Shifting) recommendations in respect of interest deductibility by April 2017. While the motivation behind the OECD recommendations is well intentioned, if badly implemented this could negatively impact industries with traditionally higher leverage such as real estate.
The Government intends to introduce specific carve outs for certain public infrastructure projects (known as a ‘Public Benefit Project’ exemption), but as yet there have been no clarifications or carve outs specifically related to real estate more generally. Real estate companies, especially those who operate outside the UK, should closely monitor developments in this respect.
The intention behind the recommendations are well founded and, for example, are intended to reduce the risks of multinational groups undertaking actions such as ‘debt dumping’ (i.e. placing higher levels of third party debt in high tax jurisdictions) or ‘profit shifting’ (i.e. using intragroup loans to aggressively transfer profits from a high tax jurisdiction to a low tax jurisdiction).
To achieve these aims the OECD recommends introducing a fixed ratio rule (net Interest/EBITDA) whereby only interest that falls within this ratio would be tax deductible. The Treasury has confirmed it will apply a fixed ratio rule of 30% of a group’s UK EBITDA. While this should work for most investment grade corporate entities, it could substantially limit the amount of interest that would be tax deductible for low yielding and/or highly leveraged real estate vehicles.
The OECD has acknowledged that some groups are naturally more highly leveraged with third party debt (for non-tax reasons) and has proposed the introduction of a group ratio rule to provide more capital intensive businesses with a tax deduction for interest which is more commensurate with their activities. This essentially allows for an entity with net interest expense above the fixed ratio rule to deduct interest up to the net interest/EBITDA ratio of its worldwide group. We expect that this should mean that many 'UK only' property groups should not be unduly affected by the fixed ratio rule. However, those multinational property companies with more mixed levels of yield and leverage (e.g. holding a highly leveraged prime London office portfolio and a modestly leveraged Southern European portfolio) could still suffer under this rule.
There doesn’t appear to be much appetite for grandfathering on the introduction of these new tax measures, therefore it’s important that the ultimate tax rules that get implemented are fit for purpose.
With the vote on Brexit pencilled into our diaries for 23rd June, there is an expectation of a more detailed consultation before the referendum. As the Treasury continues to consult on implementation, there is still an opportunity to influence legislation through lobbying, which the British Property Federation (BPF) has been undertaking.
In order to present the impact of these changes in the context of the real economy, the BPF would welcome examples of developments that may be put at risk by the proposed changes - residential and non-London developments would resonate particularly well with government officials. Rachel Kelly firstname.lastname@example.org at the BPF can be contacted directly for further information on the BPF’s lobbying efforts or to feed in any examples of developments at risk as a result of these proposals.
 Any reader interested in a summary of the OECD recommendations can access it from http://www.oecd.org/ctp/beps-reports-2015-executive-summaries.pdf and make reference in particular to action 4 of the summary report.
 There is a de minimis threshold of £2 million (net UK interest expense) which is expected to exclude 95% of entities, who pose a low risk of BEPS in any case.
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