IFM24050 - Real Estate Investment Trust : Property rental business income: investment/trading borderline: 3 year development rule: CTA2010/S556

If a UK-REIT develops a property with the intention of disposing of it, before or following completion of the development, any gain, loss or profit arises to the residual business. Likewise a disposal of property by disposing of the shares in a holding company before 6 April 2019 also falls to the residual business.

If a UK-REIT disposes of property used wholly and exclusively in the property rental business, any gain or loss arising on its disposal may be exempt (CTA2010/S535 & S535A). However if a UK-REIT develops a property with the intention of retaining it as part of the portfolio, but sells it within three years of completion, the disposal may be taken out of the property rental business and any gain, loss or profit arises to the residual business. (CTA2010/S556(3) & 556(3A))

Conditions

The rule in CTA2010/S556(3) applies to a direct disposal of property if:

  • the property has been developed since acquisition
  • the cost of the development exceeds 30% of the fair value of the property at the later of the date the company acquired the property and the date the company joined the regime, and
  • the company disposes of it within three years of completion of the development. 

CTA 2010/S556 does not apply to developments completed before entry into the REIT regime. ‘Fair value’ is to be determined in accordance with international accounting standards (see IFM22040). None of the other terms have any specific definition for the purposes of this rule.   Broad descriptions of how HMRC will interpret them in applying this rule are set out in IFM24060. 

The rule in CTA2010/S556(3A) applies to the indirect disposal of property, on or after 6 April 2019, by a company C if:

  • one or more properties acquired (directly or indirectly) by a relevant UK property rich company B have been developed since acquisition
  • the cost of the development exceeds 30% of the fair value of the property (determined in accordance with international accounting standards) at entry or at acquisition, whichever is later,
  • C disposes of any of its rights or interests in B, not intra-group, within three years of completion of the development

The rules apply in respect of developments completed after entering the UK-REIT regime, irrespective of when they commenced. Simply transferring the property from one member of a Group REIT to another would not trigger this rule. The rule does not say that the disposal is automatically to be taxable as a trading transaction.  The transaction moves to the residual business where the normal rules apply to decide if the disposal is by way of trade or capital in nature. 

If the property was owned when the company joined the regime, the deemed sale and reacquisition at entry are ignored. The cost of acquisition will therefore be the original cost of the property to the company, as enhanced by any subsequent capital expenditure. As well as the property reverting to its original cost, the company can claim repayment of any Entry Charge paid in respect of the property (see IFM24055).

Examples

Case 1

Company C acquired property P on 1 July 2015 for 800, which it rents out for 50 per year net of expenses.  C enters the UK-REIT regime on 1 January 2016, the market value (and fair value) of P is 1,000, and the market value of the rest of the property rental business properties is 9,000. 

In May 2017, the company completes an extension to the building, which cost 350. A too-good to miss offer is made and C sells the property for 2,500 in November 2017. 

The developed property is sold within three years of completion of the development, and the cost of development exceeds 30% of the fair value of the property at entry to the regime. The disposal therefore moves to C’s residual business. In the circumstances, this would probably be regarded as capital and not a trading transaction. 

The gain before indexation of is 1,350 = 2,500 – (800 + 350) (deemed sale and reacquisition at 1 January 2017 is ignored). The gain accrues to and is taxable as part of C‘s residual business.

Note that although the deemed sale and reacquisition on entry to the REIT regime is ignored, no adjustment is made to the profits of the property rental  business for the period 1 January 2017 to November 2017 to reflect the 50 annual rent. 

Case 2

Company B, a UK property rich member of UK-REIT group, acquired property P on 1 July 2019 for 800, intending to rent it out. B also has rental property Q. B has no residual business assets. In May 2021 B completes an extension to property P at cost 400.

In November 2020 Parent Company C sells B to an unconnected party and makes a gain of £2000. The gain attributed to P on disposal is 1500 and to Q 500.

The disposal of B is within 3 years of completion of development of P and the cost of that development at £400 is more than 30% of the value of P on acquisition £800. The gain relating to B £1500 is taxed in the residual business. The gain relating to Q £500 is not charged to tax (CTA2010/S535A).