Industry wins significant Budget concession on development finance

By Paul Norman - Thursday, March 09, 2017 15:00

The UK property industry won a significant victory in this week’s Spring Budget which will see the revision of proposed legislation on tax relief for interest costs that industry experts had warned would “disproportionately and unnecessarily” punish the sector and put at risk as much as £20bn of development financing in the market.

Discussion on the measures began in late 2015 following recommendations made by the OECD aimed at clamping down on much publicised tax avoidance by certain global corporates. The latest round of consultation ended earlier this month and the new rules will apply from 1st April.

The new rules aim to limit tax deductions for interest expense and other similar financing costs. In particular they restrict the ability of large international businesses to reduce their taxable profits through excessive borrowing in the UK and form part of the government’s wider changes to encourage alignment of the location of taxable profits with the location of economic activity. They are consistent with the UK’s more territorial approach to corporate taxation.

The BPF is broadly sympathetic towards the government’s drive to ensure profits in the UK are taxed equitably.

However it has lobbied strongly to prevent real estate unfairly becoming what BPF director of policy Ion Fletcher describes as “collateral damage” from legislation aimed at preventing “Base Erosion and Profit Shifting” (BEPS), or tax avoidance strategies used by multinational companies to move profits from jurisdictions that have high taxes (such as the United States and many Western European countries) to jurisdictions that have low (or no) taxes.

The industry has pointed out that it is very hard for real estate debt finance to be used for tax avoidance, as real estate income is always taxed in the country where it is located. Instead, as a highly capital-intensive industry, real estate simply relies on debt finance more than most other sectors.

Following consultation the government last month published a number of exemptions aimed at addressing some of these concerns.

The industry welcomed a new so-called “Public Benefit Infrastructure Exemption (PBIE)” which aims to exempt property let to a third party from the new rules. This shows the government recognises that real estate is a highly geared sector that uses debt because it needs to rather than for tax avoidance.

However, the industry continued to raise concerns that the exemption - which takes in both real estate and infrastructure – includes onerous criteria that in practice will make it very difficult to claim.

In particular the industry is concerned by strict legislation exempting the use of parent company guarantees which effectively means that the proposed exemption does not accommodate most debt secured against real estate developments across the UK.

The problem occurs because most lenders to development projects require completion or cost over-run guarantees underwritten by a parent company to mitigate the heightened risk.

Based on the most recent De Montfort Survey the BPF says there is over £20bn of development finance at risk of suffering a restriction in tax relief under the rules, something that could clearly strangle development at a critical time for the industry and economy.

The BPF has urged government to reconsider draft legislation it says has not taken proper account of how real estate companies use debt.

It argues that the criteria around parent company guarantees must be revised to be proportionate to the risk to the exchequer and argues that any new rules should only be imposed only on new loan arrangements, to avoid borrowers having to renegotiate terms on existing debt facilities.

Wednesday’s Budget confirmed that “in the light of comments received” a number of revisions would be made to “ensure the rules don’t give rise to unintended consequences or impose unnecessary compliance burdens”.‎

Of particular significant to UK property the Budget confirmed: “The rules treat interest on debt guaranteed by related parties as related party interest, which can be subject to restriction - this rule will not apply to certain performance guarantees and all guarantees granted before 31 March 2017, nor will it apply to intra-group guarantees in the context of the group ratio rule.”

The revision it is understood answers the industry’s concerns around parent company guarantees and crucially confirms the legislation will not be retrospective.

BPF director of policy Ion Fletcher said: “We’re delighted that the government has acknowledged our concerns around parent company guarantees and what they’ve proposed is a welcome step in the right direction. Now we just need to see whether the letter of the law delivers this outcome.”

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