The UK Treasury has committed itself to introducing legislation for a tax-exempt Real Estate Investment Trust (REIT) in 2006.

In a paper published alongside yesterday’s budget, the Treasury said it was “committed in principle” to reforming the taxation of real estate investment. The discussion paper outlines the Treasury’s preferences on a number of points and asks for further comment from the real estate industry.

REITs, which were pioneered in the US, offer investors a liquid securitised exposure to real estate. Property rental income is also tax-exempt, eliminating the double taxation investors in UK quoted real estate companies suffer, where rental income has already been taxed at the company level.

The tax exemption and liquidity of a REIT would benefit pension funds, which have been keen to increase real estate exposure or invest in the asset class for the first time. Smaller pension funds tend to be excluded from directly holding properties due to the large lot sizes – a single shopping centre can cost more than €150m.

The discussion paper suggests REITs will divide their business into two parts, a ‘ring-fenced’ tax-exempt business, which collects rents from properties and an unfenced business which will cover ancillary services – management fees for example. Dividends from the ring-fenced business will be tax-exempt, as will capital gains which are distributed to investors.

REITs will be required to derive at least 75% of gross income to derive from ring-fenced activities and to distribute at least 95% of its net ring-fenced income to investors. The Treasury has not decided whether REITs must be listed or what the tax rate is to be (or how it will be calculated) for assets transferred into a REIT.

The Treasury has not yet concluded on the best way to treat non-UK investors and is looking for feedback on this matter.

The paper is available at: www.hm-treasury.gov.uk/budget/budget_05/other_documents/bud_bud05_odreits.cfm