Corporate interest restriction draft legislation released on 26 January 2017 BPF comments

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1 To: 23 February 2017 Introduction The BPF represents the UK real estate sector an industry with a market value of 1,662bn, which contributed more than 94bn to the economy in We promote the interests of those with a stake in the UK built environment, and our membership comprises a broad range of owners, managers and developers of real estate as well as those who support them. Their investments help drive the UK's economic success, provide essential infrastructure, and create great places where people can live, work and relax. The UK s Commercial Real Estate sector contributes about 5.4% of GDP, and directly employs 2.1 million people, or 6.8% of the labour force. It provides the nation s built environment and is spreading out from its core investment in the nation s offices, shops, leisure facilities and factories, to support the new economy through investments in logistics, healthcare, student accommodation, infrastructure, and increasingly through Build-to-Rent investment in new housing. The sector is one of the most successful in the world at attracting domestic and overseas long-term investment capital into the renewal of the UK s towns and cities. Such large, long-term, patient investors are critical to the urban redevelopment and regeneration of our country, which is so important if we are to feel we are all part of one nation and not being left behind. While we are wholly supportive of the Government s plans to clamp down on tax avoidance; we remain concerned that these measures are being introduced without sufficient time to consider and remedy unintended consequences or even allow businesses sufficient lead in time to introduce new compliance processes. In our view, that the speed at which government is rushing ahead with implementation of this measure and other measures by 1 April 2017 is putting a level of pressure on business which is completely unjustifiable. We expressed concern in previous rounds of consultation that these measures were not well targeted at the type of debt that facilitates BEPS, and as a result, third party debt used for genuine commercial purposes, as it is in real estate and infrastructure, will be inadvertently impacted. We welcome the broadening in scope of the Public Benefit Infrastructure Exemption (PBIE) which will help provide much needed certainty to those businesses that meet the necessary criteria. However, there are some challenges remaining which will need to be overcome if the PBIE is to have any meaningful practical application to the real estate industry. We remain concerned that many real estate businesses, particularly those with overseas operations, will be subject to the uncertainty of the group ratio as they are unable to meet the PBIE criteria. It is important the government continues to review the impact on this part of the market and seeks to improve the rules for taxpayers where there is clearly negligible BEPS risk. We welcome the opportunity to respond to comment on draft legislation and would like to acknowledge the significant stakeholder engagement that the Treasury and HMRC teams have carried out during the

2 consultation process. We hope that by continuing to work with Government, we can develop a framework that tackles tax avoidance without damaging investment. Our response is structured as follows: Part I: BPF key recommendations Part II: BPF detailed response Appendices: 1. Public Benefit Infrastructure Exemption a. Tainting issue and domino effect b. Parent Company Guarantees c. Mixed developments d. Non-Resident Landlords e. Joint Ventures (JVs) f. Comparative debt criteria g. Short lease requirement structures impacted h. Other issues: i. Irrevocability of elections ii. Ancillary iii. Transitional period iv. Definition of property business v. Limited recourse condition interaction with special distribution rules 2. Joint Ventures 3. REITs 4. Compliance and reporting 5. Other technical issues Group Ratio and Fixed Ratio 6. Clarity on TAAR We look forward to discussing our comments with you in more detail. Please do not hesitate to get in touch if you require further information. Rachel Kelly Senior Policy Officer (Finance) British Property Federation St Albans House, Haymarket London SW1Y 4QX rkelly@bpf.org.uk

3 Part I: BPF key recommendations 1. The Public Benefit Infrastructure Exemption (PBIE) must work for the real estate industry uncertainty remains around whether third party debt will get tax relief in all cases, even in wholly UK groups with no BEPS risk. It is hard to iron out these uncertainties completely within the framework of the fixed and group ratio rules and it is therefore particularly important that the PBIE is flexible enough to accommodate low-beps risk third party lending to all kinds of infrastructure and real estate. Our key priorities in this regard are: 1.1. There should be a flexible and proportionate approach to the parent company guarantee criteria, reflecting the fact that there are different types of parent company guarantee and that they serve a genuine commercial purpose, such as mitigating known risks of the lender during the development phase of a project. In addition, parent company guarantees criteria should only be imposed on new loan arrangements, to avoid borrowers having to renegotiate terms on existing debt facilities Public benefit infrastructure should include real estate and infrastructure under development and where it is intended that the property is developed for sale as well as for rent. It is very common for real estate businesses to carry out a combination of building for both sale and for rental, and indeed, it may be necessary to sell a portion of a development in order to make the whole project viable. We think that this activity should be considered ancillary to providing public benefit infrastructure and this should be made clear in guidance The rules should avoid creating a domino effect across a whole group. As drafted, if one company in a group does not meet the PBIE criteria, this prevents the rest of the group from qualifying. This seems disproportionate to us particularly where the criteria stop being met as a result of circumstances outside of a group s control. The REIT regime offers a helpful basis for dealing with temporary breaches of the PBIE conditions The comparative debt criteria undermines the certainty that the Public Benefit Infrastructure Exemption is supposed to provide. The existing criteria are sufficient to protect against BEPS risk, and therefore the comparative debt criteria is surplus to requirement and should be removed The rules must work appropriately for joint ventures Give the bulky and illiquid nature of real estate and infrastructure investments; it is common for investors to club together in joint venture arrangements There should be no double restriction of the same interest cost (i.e. in both the joint venture and its investors). There is a risk of this happening where as is common a JV partner borrows from a third party and on-lends it to the JV The PBIE should provide equal certainty for JVs as for a direct investment by a single investor. To that end; a blended ratio approach proposed for joint ventures should not just apply where investors apply the group ratio or fixed ratio rules; it should apply equally where some investors are qualifying companies for PBIE purposes. In this context, we welcome the government s suggestion that a joint venture could be deemed to be two companies for the purpose of accommodating PBIE and non-pbie investors in a joint venture arrangement and look forward to seeing the relevant legislation as soon as possible.

4 2. The UK should not act in haste. Over the course of the consultation it has become clear that implementation from April 2017 is far too ambitious given the complexity of the new rules. It will not allow sufficient time to consider the impact of these new measures; nor will it allow sufficient time for business to adapt or restructure where necessary. The haste of the consultation period has already damaged investor sentiment and increased uncertainty for businesses. In order to ease the burden on business, we would recommend the following: 2.1. Delay implementation to accounting periods beginning on or after April 2018 this will allow businesses to assess the impact of the final legislation and guidance before the rules are implemented and to better prepare for their implementation Grandfather the tax treatment of existing third party debt imposing these restrictions on third party debt will put undue pressure on genuine commercial arrangements, as businesses may be required to refinance or restructure as a result of these rules. Even without the interest deductibility rules, there is already a risk of pressure on covenants for property investors and developers due to the uncertainty surrounding Brexit and the risk of rents declining and yields going out, as anticipated by analysts at the moment. Third party debt is not the main target of these measures and therefore its tax treatment should be grandfathered in order to limit the negative impact on business The government should commit to a review of these measures within 18 months of implementation, to address any adverse impact on UK business. This should be a wide ranging review that considers whether fundamental changes to the regime are required to achieve a fairer outcome for business. In particular, the government should reconsider introducing an asset based group ratio or allocation test where this would provide a fairer result, and where there is a low BEPS risk.

5 Part II: BPF detailed response Appendix 1: Public Benefit Infrastructure Exemption This appendix contains our detailed response on the public benefit infrastructure exemption ("PBIE") and its application to the real estate industry. This appendix is broken down into the following sections: A. Tainting issue and "domino" effect; B. Parent company guarantees; C. Mixed use developments; D. NRLs; E. Joint ventures; F. Comparative debt criteria; G. Short lease requirement; and H. Other: (i) irrevocability of elections (ii) meaning of ancillary (iii) transitional rules (iv) Definition of property business (v) Limited recourse condition interaction with special distribution rules A. Tainting issue and domino effect 1. Below is an example of a typical UK real estate group.

6 2. As illustrated, the group holds different property investments, both UK and non-uk, which reflects its commercial strategy of creating a diverse property portfolio in order to manage risk. A typical property group will hold investment properties that are let to third parties, but will also actively manage their property portfolio by undertaking development activities to create new assets that generate an increased yield. The group may also undertake related activities such as property asset management. Typically the group will use special purpose vehicles to separately hold each property and to undertake different activities. 3. The nature of a mixed portfolio means that many UK property groups are likely to have companies which, when viewed in isolation, undertake non-qualifying activities for the purposes of the PBIE, but are a relatively minor part of the group s overall activities on a consolidated group basis. 4. As currently drafted the rules create a cliff-edge, such that one non-pbie investment in a group will cause the entire qualifying group to fail. In addition, the proposed mechanism for dealing with non-pbie activities will be difficult to satisfy in practice. S427(4)(6) allows a company to fall outside the qualifying conditions but still be treated as qualifying where the failure is due to circumstances that were, and were always intended to be, of a temporary natures and the failure occurs for no more than 5 days in the accounting period. We feel that the conditions are too stringent and that day by day monitoring of income levels and balance sheets is not practical for large property groups that comprise hundreds of companies. 5. As an alternative approach we consider that the REIT regime provides a helpful basis for dealing with temporary breaches of the PBIE conditions. REIT regime (i) Serious breaches 6. Under the REIT regime, if companies breach the 90% distribution requirement, the profit:financing cost test or pay a dividend to a greater than 10% to a corporate shareholder, this will result in tax consequences for the company but the company is allowed to remain in the REIT regime. Although these conditions are not analogous to the PBIE, the concept of a serious breach is something that could be incorporated into the PBIE with the company remaining in the PBIE, but its Tax EBITDA and Tax Interest would fall to be included as part of the fixed ratio or group ratio rules for the relevant accounting period. (ii) Temporary breaches 7. There are other situations where companies can remain in the REIT regime provided that the breach is quickly remedied. In particular, the balance of business conditions that relate to the amount of income arising for the tax exempt business and the assets involved in the tax exempt business. In summary the REIT test requires the following: 7.1. Income Test. The income arising from the tax-exempt business must be at least 75% of the total income of the group for the whole accounting period. If the REIT fails the income test in an accounting period the company can stay in the regime provided that the income of the tax exempt business does not fall below 50% for the accounting period. The income of the tax

7 exempt business can remain between 50% 75% for the following accounting period without triggering a termination of the regime Assets Test. This requires that 75% of the assets of the company must be involved in the taxexempt business. The test must be met at the start of each accounting period, but if it is not the company can remain in the regime provided that the value of the assets has not fallen below 50% of the total at that date. The value of the assets can stay at 50%-75% at the start of the following accounting period If the income or assets of the REIT fall below 50%, that is treated as a serious breach. 8. In a PBIE context we would consider that the minor breaches allowed a company to continue to qualify for the PBIE exemption and its interest be treated as fully deductible. If the breach was serious, the appropriate consequences of this would be that, in the relevant accounting period of the breach, the Tax Interest and Tax EBITDA of the company fall out of the PBIE, but would available for inclusion in the fixed ratio and group ratio rules. 9. In terms of a threshold, we would suggest that 10% of income or assets would be appropriate to guard against any BEPS risk whilst allowing companies some leeway in the nature of their income and assets. We consider that a period of 60 days to remedy the breach would be appropriate. 10. Drawing on the REIT regime, we have the following suggestions to guard against any risk of companies taking advantage of the PBIE for a BEPS motive Under the REIT rules there are limits to how often a company can breach the individual conditions and once that limit is exceeded in a 10 year period, the regime no longer applies. The number of breaches that are allowed depends on the condition that has been breached i.e. a sort of score card approach. If necessary HMRC could include a similar safeguard mechanism to avoid the risk of company s deliberately falling in and out of the PBIE regime There are also notification requirements which oblige a REIT to inform HMRC if it has breached any of the REIT conditions as soon as reasonably practicable after it becomes aware of the failure. Similar notifications could be included in the PBIE regime to allow HMRC to monitor a group s compliance with the tests and any patterns of behaviour that could be indicative of BEPS. 11. Finally, we note that the REIT rules operate on both a single company basis or a group wide basis. If HMRC are minded to adopt a REIT style approach in this we urge HMRC to consider if the PBIE rules in this area could operate on a similar basis. This would be particularly relevant for UK property groups that have to restructure into qualifying and non-qualifying sub-groups as it would allow them to assess the conditions at the qualifying sub-group level (i.e. a consolidated calculation) rather than for each individual entity. Such an approach would not represent a BEPS risk on the basis that the qualifying sub-group would only include UK companies.

8 B. Parent Company Guarantees (PCGs) 12. Parent company guarantees (PCGs) are common in real estate and infrastructure investments, particularly during the construction phase of a project, to protect lenders against certain known risks until the property is sufficiently occupied or generating income. While it is less common, there are still many cases of PCGs on debt facilities of completed investment properties. We set out below what kind of parent company guarantees are used in practice and what risks lenders typically seek to mitigate. 13. In the context of the proposed PBIE, any criteria around PCG s will have implications for a large proportion of existing debt secured against real estate and infrastructure. It could have a significant market impact if businesses are pushed into renegotiating their debt terms in a very short period of time. It is particularly important that any criteria in respect of PCGs is proportionate to the BEPS risk it is addressing and is only applied to new loan facilities. Existing PCGs should not prevent otherwise qualifying debt from falling with the PBIE rules. 14. This section of the appendix explores the following: (i) (ii) (iii) What types of PCGs exist in practice and what are the commercial risks they are mitigating for the lender? Market impact what would happen if borrowers were less willing to offer PCGs or they became more expensive and are there any realistic commercial alternatives to PCGs? What are the least disruptive options for the market if criteria around PCGs are included within the PBIE rules. (i) What type of PCGs exist in practice and what commercial risks do they mitigate for lenders? 15. In practice, PCGs are most commonly used in the context of development loans, simply because these tend to be riskier lending propositions that completed income generating assets, although there are cases where guarantees are in place for completed properties. An introduction to some typical guarantees and the risks that they mitigate are summarised below: Type of guarantee Commercial risks that lender is seeking to mitigate Development finance Completion guarantee The risk that a project never gets completed and therefore never gets turned into an income generating asset. This is simply a commitment of good intention from the parent company that they will not walk away from the project. (They are rarely called upon in practice, but they can give comfort to the lender particularly because there is effectively no limit

9 Type of guarantee Commercial risks that lender is seeking to mitigate to the amount that the parent company might be required to put in to complete the project.) Development guarantee The risk that the costs of a project go up or the length of time taken to complete a project goes up, which in turn accrues more interest expense on the debt facility. The parent company will often guarantee that it will step in to cover the additional costs or interest in these cases. It is essentially a contingency fund for unforeseen additional costs, which are typically limited in amount (often in the region of 15-30% of the loan principal it s rare that they would be unlimited in amount). The amount often decreases as development milestones are reached. The alternative would be for the parent company to deploy a physical contingency fund within a secured bank account until the project is complete. However, given it is very inefficient to hold money on account doing nothing, parent companies would rather guarantee the amount, and only pay the contingency sums if and when they are required. Similarly, companies may also obtain a letter of credit from another bank although this is a far more expensive approach than issuing a PCG as the bank will charge a fee. Stabilisation guarantee It is expected that properties will take a certain amount of time to become fully income generating assets after practical completion of the development not least because it is market practice to offer new tenants rent free periods as an incentive to take space, meaning that it will typically take several months before rental income starts coming in, even for a pre-let development. A certain amount of stabilisation risk will often be factored into a development finance facility. However, a specific stabilisation guarantee may be sought by a lender for speculative developments in particular, where a lender considers that the property being left void for a long period after development is a specific risk (or perhaps where the tenants are considered to be at higher risk of insolvency etc.).

10 Type of guarantee Commercial risks that lender is seeking to mitigate Investment properties Temporary rescue guarantees on breach of covenants Loan terms will generally include financial covenants around loan-to-value ratios and interest cover thresholds which must be maintained throughout the period of the loan term. On the breach of the banking covenant, the lender can immediately cancel the debt facility and request repayment of the loan in full. The most common risk for the borrower is that a large tenant unexpectedly goes bust which instantly reduces the rental income, in turn breaching the interest cover covenant. Typically, the borrower (or parent company on their behalf) will ask for a cure period to allow them some time to find another tenant and return to the agreed interest cover ratio per the loan agreement. If the lender agrees to give the borrower some time to find a new tenant, the lender will typically require either a PCG covering the interest expense during this cure period, or will ask for the interest payment to be made up front or held in a secure account for the duration of the cure period. Given it is not efficient to hold money in an account doing nothing, a parent company would typically rather guarantee that money if the lender agrees. Other PCGs on investment properties Typically a borrower will refinance a property after it has been completed, which means that PCGs are less common on fully let investment properties, because there are fewer risks to be mitigated. However, there will be cases where PCGs exist on investment properties perhaps one of the tenants is considered more risky and the lender wants additional comfort or in some cases, loan terms may have simply been rolled forward from a development facility and the PCGs were not removed. In addition to debt taken out on specific investment properties, a UK property group may require general funding to improve the overall quality of its property portfolio e.g. to refurbish property as lease terms come to an end, often to a higher specification; to acquire properties that come to the market; to create public realm that enhances the general

11 Type of guarantee Commercial risks that lender is seeking to mitigate environment as a means of attracting tenant etc. As such debt is not specific to any one property or a specific project where there is a quantifiable risk in the event of a default, lender will require security in a more general form, often by way of an undertaking that a group company will always hold assets of a certain value. (ii) Market impact what would happen if borrowers were less willing to offer PCGs or they became more expensive and are there any realistic commercial alternatives to PCGs? 16. The use of PCGs is clearly driven by commercial factors, most notably to mitigate specific known risks and to make lenders more likely to agree to financing agreements. 17. Without PCGs, lenders would need to seek different ways to mitigate their risk which would likely make funding developments more expensive and in some cases, where a lender s risks cannot be mitigated, the development simply would not go ahead. If the government is committed to encouraging construction, particularly on the riskiest development sites (like brownfield regeneration), care must be taken to ensure that new rules around PCGs do not inadvertently impact on the amount and price that lenders are willing to lend. It is important that new rules only apply prospectively to new loan facilities; to avoid the need for existing debt facilities to be renegotiated. 18. A potential alternative to mitigate a lender s risks would be for the borrower to hold an amount of money in a secure bank account until the asset is complete. Another option may be for the borrower to obtain a third party guarantee from another bank or institution. However, even if lenders were happy that these alternatives suitably mitigated their risks, it would add significant cost to funding development in the UK. (iii) What are the least disruptive options for the market if criteria around PCGs are included within the Public Benefit Infrastructure Exemption (PBIE) rules. 19. If the government is committed to introducing criteria around PCGs within the PBIE rules, we would suggest that PCGs provided by parent companies which are part of a wholly UK group should be excluded because they represent a negligible BEPS risk. 20. In addition, we would recommend that the following PCGs be safeguarded to avoid significant adverse impact on the real estate debt market: PCGs on existing loans - Renegotiations of debt terms around PCGs would be considered a material change to the loan agreement in many cases, particularly development assets where the guarantees are mitigating specific known risks. The costs and implications of renegotiating debt terms will vary on a case by case basis, depending on the relationship between the lender and borrower and how willing the lender is to continue lending to a given business or project. However, ultimately, borrowers would incur costs and some would be

12 put at risk of breaching existing loan covenants, which would have a negative impact on the market. Therefore, PCGs in existing finance agreements should not prevent an otherwise qualifying company from obtaining PBIE status PGCs on development finance - PCGs secured against developments are clearly commercially justifiable, mitigating genuine risks for the lender. It is not clear how material the BEPS risk is in respect of this debt but it would certainly have a detrimental market impact on the level of debt available for development and the price of that development finance. Given these PCGs are typically for a limited time, over the life of the development, this is actually a fairly immaterial time period relative to the total useful life of the asset. Therefore, PCGs in respect of development finance should also be ignored for PBIE purposes Other PCGs at the moment, the legislation creates a cliff edge, whereby the existence of a PCG would deem all of the interest on that debt to be non-qualifying where there is a PCG in place. We would recommend that some proportional restriction is calculated - for example, if the PCG represents 15% of the loan principal, the interest should only be restricted by a maximum of 15%. Or alternatively, some other appropriate apportionment using transfer pricing principals Interaction with comparative debt test where PCGs are used outside of a development project, the government may want to consider applying a comparative debt test in these cases only. Applying this test in the relatively small number of cases where the commercial rationale for the PCG is less clear, would allow the project to continue receiving a tax deduction for the interest expense where the project has a similar level of debt to comparable projects in the group, and therefore represents a negligible BEPS risk PCGs not recognised on parent company s balance sheet where the parent company does not recognise a liability on its balance sheet in respect of a PCG, it is clearly not expected that it will be required to make a payment. In such cases, the PCG should be considered immaterial to the lending and should not impact on the ability of the company to receive a full tax deduction for interest expense. It is more likely that cost-overrun guarantees may be provided for on the balance sheet as it may be easier to estimate the amount and the likelihood that the liability might materialise. However, given this type of guarantee is linked to the development of an asset, it recommended that such guarantees are protected and do not cause a company to fail the PBIE criteria - as per para 20.2 above. C. Mixed-use developments (i) PBIE scope 21. The PBIE is intended to apply to companies that carry on a qualifying infrastructure activity. 22. We understand that s429(5) is drafted such that property owned by members of the worldwide group that is (or is intended to be) rented to third parties qualifies as a public infrastructure asset.

13 23. It is clear from s429(4) that a building to be let to a third party should generally qualify, however, we feel that s429(5)(a) might be re-worded slightly to make it clear that a company can be intending to carry on a UK property business as the current drafting implies that this activity needs to be met at all times. For a special purpose vehicle ( SPV ) with one building under construction and where that building is not pre-let (e.g. as is very common in build to rent housing) the company may not be carrying on a UK property business. 24. There is a clear distinction between a project that is wholly build to rent and one that is wholly build to sell, with the latter (taxed as trading for CT purposes) not qualifying for the purpose of PBIE. However, in the case of a mixed use development the distinction is often very hard to determine. The following comments and analysis are aimed at trying to understand the parameters of the qualifying activity required to achieve the PBIE for a group that predominantly carries on a property investment business but carries out a mixed-use development involving for-sale and other activities that would be non-qualifying in their own right. 25. S429(1) This section refers to a company but we would assume that this drafting should be updated to reflect other transparent entities such as partnerships and unit trusts, as it may often be the case that the activity itself will be carried on by a transparent entity albeit with a UK company in the role of Partner or unit-holder being taxed as if it had carried on the activity directly. In this context, we seek the following clarifications: In order for a building to qualify as public infrastructure in respect of a company, an entry in respect of that building must be recognised in the hypothetical balance sheet of the company (new s429). Can it be made clear that an investor's balance sheet record of an interest in a partnership (which itself holds the property) is sufficient for this purpose? Interest is not exempted if the creditor has recourse to assets or income other than those of a qualifying company (new s431). Again it is unclear whether the assets of a partnership can in this context be said to be 'assets of' each of its investors. Whilst this would be consistent with the general approach to the taxation of partnerships, can this be expressly provided for? (ii) What activities qualify for PBIE 26. We understand from discussions during this consultation process that s429(1)(b) is intended to be widely applied, such that a company carrying on an activity that is itself qualifying, or is ancillary to, or alternatively facilitates the provision of a wider or larger qualifying infrastructure activity or project, carried on by another party, should qualify for the PBIE. 27. For clarity, we interpret ancillary as being an activity that is by definition, related to, but a smaller component of a larger main activity. It is likely to be but may not be an unavoidable byproduct of this main qualifying activity. Facilitating, suggests an alternative activity that has a purpose of enabling or potentially improving the ability to undertake the main qualifying activity, or that provides some other improvement (potentially to profitability, timing etc.) of the main qualifying activity. Much of the following analysis seeks to verify the above definition through the presentation of various scenarios that we feel should meet one of the above elements.

14 28. HMRC guidance will be crucial to add examples of what might qualify as ancillary or facilitating a qualifying activity or project, and central to that will be the definition of an activity or a project. 29. We understand that the government intend that an activity should be interpreted widely as any activity carried on by the worldwide group, regardless of the fact that it may be compartmentalised into separate group companies. Such an interpretation would be a good reflection of commercial reality, particularly for large property groups that often have to finance assets separately, or create joint ventures to enable an entire project to be created. We would welcome confirmation and guidance of this nature. 30. Given the above interpretations, most activities that are related in some manner to a mixeduse development project should in our experience normally qualify as either ancillary to or facilitating the qualifying activity unless there is no direct link to the qualifying activity carried on by a member of the worldwide group. We would expect the following examples of activities that would not qualify in their own right fall within the above: All social housing built, and sold, in conjunction with the development of other property that itself qualifies as public infrastructure assets, particularly where the building of social housing is required under planning requirements Any asset developed under the requirements of a planning consent or section 106 requirements, where the main property being developed is itself a public infrastructure asset Infrastructure (roads, pipes and other services) provided on a large mixed use site long in advance of the development of plots serviced by these services. For example, when developing a large mixed use site, the developer might put in all of the infrastructure first before embarking of phase 1 development which may in its own right be non-qualifying, albeit there is every intention that future phases to be developed later will be qualifying The development for sale of residential property that forms part of a larger development site: This is often required to be undertaken by a separate entity to that which might be building property for a rental business, for a variety of commercial reasons, including separate financing Development for sale that is a commercially viable activity in its own right. Very often a large mixed use site will consist of various separate property use types, all of which might be financially profitable in their own right, but which collectively facilitate the development of the wider site by: Providing or supporting financing for the development of the future investment activity For large regeneration projects, planning, and ongoing commercial reasons, development for sale will support a mixed use scheme being built rather than a single use scheme, and neither the develop to sale nor hold will be fully viable without the other.

15 For example, an existing low-rise office building with sizeable car parking land, might be redeveloped by the landlord to provide a larger modern office building to enhance its core property business. However, by using a more economical building footprint (higher rise buildings), this may also provide the opportunity to build residential property for sale on the same site. This may be determined to be non-ancillary (i.e. it is larger or more profitable than the build cost of the office). However, the development of residential may be deemed to facilitate the redevelopment of the office block and therefore the whole activity should qualify Another issue that often arises within a mixed use development is that the landlord may maintain a long-term physical presence on the development to enable it to better manage the asset both during and after development. This owner occupied element may cause the company to breach the above tests, unless the function of this office is wholly ancillary to or seen to be facilitating the activity Another feature common across many property groups and in particular with mixed use developments is the fact that a group will establish a separate SPV to operate a property or provide estate management for the assets it holds. This gives the developer the ability to control the site (for safety and also to maximise property values). This entity will be trading in nature for UK tax purposes, albeit it is an essential function of the UK property rental business in that it facilitates the ongoing activity. There may be an element of this business that provides services to third party landlords, particularly where services are concentrated on a large single development site. Therefore, it will be crucial to determine what level of activity is deemed to be insignificant Development management services carried on by a group entity (taxed as a trading entity) on behalf of various group companies collectively carrying out a mixed use development should qualify as facilitating the wider development Some land, particularly brownfield sites, is purchased subject to existing covenants that the landlord/developer has to comply with throughout the development phase and often long after. This can cover relatively small community based activities or events, can be restrictions on what or how property can be developed or can be much larger, such as providing ample parking for a nearby sports stadium. Complying with these covenants can be relatively costly, increasing the level of funding required, albeit the expenditure is likely to facilitate the development of the rental property. (iii) Activities that are not ancillary or facilitating 31. Despite the above there will be instances, albeit probably relatively limited, whereby activities do not fall to be ancillary and do not facilitate a qualifying activity. In this case the provisions of s427(2)and(3) allow an insignificant amount of income or assets to be ignored for the purpose of determining whether a company should be exempt under PBIE. 32. S427(2) and (3) refer to all but an insignificant proportion of income and assets of an entity in an accounting period deriving from qualifying infrastructure activity for a given period. It would

16 be useful to have guidance that provides some relative safe-harbours for what is meant by insignificant in this context. 33. We are not aware of an existing tax definition of insignificant, therefore we assume that this should take its everyday meaning, which in the context of a large property group and mixed-use projects in particular, is likely to leave a large gap in understanding that we would hope can be filled by guidance. 34. Insignificant is generally understood to be very small or unimportant, but it is not clear in this context what the BEPS risk is in relation to activity being very small or just small. To this end we wonder if an alternative word might be used to provide a little more latitude in determining what small alternative activities might be acceptable. In a property context, it is quite possible that non-related activities that might count for up to 10% of overall activity should be acceptable in avoiding a cliff-edge for a company qualifying for this exemption, without increasing the BEPS risk. It is highly unlikely that a large business would see merit in trying to manipulate its activities for such a small amount of additional benefit. We would welcome further discussion about a relaxation of the currently quite restrictive wording of insignificant to something else such as immaterial or unsubstantial. 35. Regardless of any change to the above, it will be important to determine what measures are likely to be acceptable for comparing non-qualifying activities with qualifying activities, such as: gross asset values, turnover, profitability. 36. All of the above may give quite different results for different groups depending on the nature of their specific activities, and providing a range of alternative acceptable measures via guidance would reflect the natural variety if the business world. 37. For example a UK property business that holds freehold property for rental purposes will find that they have significantly higher asset values than an identical entity that holds just 21 year leases that it sub-lets. Using asset values to determine an insignificant activity may provide very different results for what might be an otherwise identical business, in income or profit terms. 38. Differences also arise when looking at the difference between income and asset values, particularly in the case of income over a 12 month period, rather than in a longer-term context. 39. For a property group that is undertaking a mixed-use development, the need to determine whether or not activity is insignificant in each separate accounting period may give rise to some anomalous results. Property development, by its very nature, is a long-term activity and quite often the generation of profits in one period is crucial to the funding of future development activities. Also what is significant in one isolated accounting period might be determined to be insignificant across the life of the full project. 40. If the appropriate test of what is insignificant in this context could be determined across the life of a project or activity, rather than the currently drafted narrow accounting period position,

17 this would help to alleviate small timing differences that could have a cliff-edge impact on a group s ability to meet this exemption and claim interest deductions. We would welcome adjustments to both the legislation and guidance to support a wider application. 41. For example, land or buildings are often acquired before planning permission is fully obtained and it may be the case that land has the benefit of small non-qualifying income streams or even individual assets that cannot be immediately separated from the remainder of the site. However, such projects, which are partly funded by third party debt, should in our view be capable of qualifying for the whole period, even though the only income earned may be a very small amount of non-qualifying income in particular accounting periods. 42. An example of where income or assets may not be ancillary is that of certain wayleaves that are granted over long-term leases. The income from these is unlikely to qualify in its own right and may not be ancillary or even facilitate the development of qualifying infrastructure assets. Clearly whilst under development the income levels may cause the income test to be breached if there is little or no other commenced rental activity ongoing at that time. 43. For a large mixed use site constructed over a long period of time (particularly the creation of whole new neighbourhoods), the phasing of development may throw up other considerations. Firstly, it is crucial to create an environment that people are attracted to for a new development area, and various mean-time, or place-making uses that create interest and attract people to the site can often be crucial to the long-term success of the new site. These activities will often be trading in nature and may be profitable in their own right, and may be the only income earned in early years of a development project. Some may be treated as qualifying on the basis that they facilitate the future property rental business, but others, may seem more business like, particularly if they last for a significant period of time. Certain developers will use land for very short-term uses such as car-parking or events (informal markets, sports events etc.). Very often, due to the nature of such events, these will be trading rather than rental activities. 44. Provided that s427(2) is not to be interpreted such that the only income that can be qualifying for this purpose is income taxable as a UK property business (in the context of an activity under s429(5)), then most cases that we can conceive should be ok, as it is very likely that income from ancillary activities will qualify in its own right under s429(1). We would welcome guidance on this point. 45. For the asset strand of this test, it is possible that certain financing arrangements might mean that the non-qualifying assets of a mixed use development are held by a separate SPV to the qualifying assets, however, they may be held via the same overall holding company which is also the borrower under the existing debt facility. This would mean that the borrower holding company may not meet the assets test in its own right. In the future, taxpayers may be able to structure such activities with separate standalone financing companies but this will not always be practicable and does potentially cause concern for existing structures. For this reason, greater clarity over what insignificant is trying to capture would be helpful. Timing of asset test under s427(3) 46. s427(3) includes a requirement that the asset test is met on each day of an accounting period. Commercially it is unlikely that a significant non-qualifying asset will be held for just a short period within an accounting period rather than for a sustained period, other than in a period of

18 sale or acquisition, and as such this seems to be an overly onerous condition to ensure compliance with, particularly the requirement inherent in s427(5) to essentially re-create a balance sheet on any given day of the period. 47. A preferable test would be that the asset test is required to be met at either the beginning or end of an accounting period. Where the test is met on only one of those dates, there could be a requirement to proportionately restrict interest deductions in that entity, on a just and reasonable basis. This would enable deductions to be taken for qualifying debt in periods of acquisition and disposal of such assets, but should prevent companies from manipulating the rules. It seems that the likelihood of manipulation here is relatively remote given the costs associated with transferring ownership of real estate and other large infrastructure assets. 48. For this reason, the requirement to meet the test within 5 days of a breach in s427(6)(b) also seems overly onerous, given the likely commercial reality in this sort of situation. Furthermore, the first leg of the test in s427(6)(a) (that the circumstances that led to failing the conditions were only intended to be of a temporary nature), should be sufficient without the 5 day test. Developing for sale to another property investor 49. HMRC has indicated that an investor building properties that may not be core to its rental business might still qualify for PBIE, even where there is a disposal of such property to another investor in due course (although not where the sale is to an owner occupier). Very often, a developer of a large mixed use site will identify certain plots that lend themselves to a non-core investment asset and will take steps to obtain planning permission, and also a potential tenant for the property, securing the future rental status of the property, prior to selling the non-core asset to another investor. We assume this sort of activity will qualify for the PBIE, on the basis that the developer is providing a building to be let by the purchaser. 50. Another option for the developer will be to forward fund the construction of the plot by selling the land and also undertaking to manage the development of the plot for the purchaser in return for a development fee. In our view a transaction that is funded in this way should still qualify for the PBIE, because the developer is providing a building to be let, however we would welcome HMRC confirmation that this sort of development transaction would be qualifying for the purposes of the PBIE. We note that the developer in these sorts of transaction will not be carrying on a UK property business as defined in CTA 2009 Part 4 and therefore we assume UK property business in s429(5) will have a broader definition, if developers-to-sell are intended to be eligible for the PBIE where they sell to investors. Long leases 51. Ground rents are often a valuable by-product of developing both commercial and residential property. For certain investors, holding on to ground rents provides a stable income source that can support borrowing from third parties, which might help to fund future development of a site. These assets will normally generate rents that are taxable as a UK property business, but will relate to assets with a lease of over 25 (and in many cases over 50) years. 52. These assets can often be more valuable as part of a large stable portfolio, and as such the developer of a large regeneration scheme may seek to retain the ground leases until the end of the project to realise the full potential value of the ground rent as part of a more stable

19 portfolio. For these reasons we would expect any income received by a developer in respect of ground rents during the course of the development to be treated as deriving from an ancillary activity, or to be insignificant. D. Non Resident Landlords (NRLs) 53. We understand that HMRC s view is that holding an investment in a NRL should not be treated as a qualifying activity for the PBIE. However, our view is that it may be premature to form this view and it would be preferable to wait until a wider and ongoing consultation on bringing NRLs within the scope of corporation tax is completed. From a practical point of view, our concern is that groups will be forced to restructure to take NRLs out of the qualifying group and very possibly be faced with further restructuring once the NRL corporation tax rules have been enacted. 54. We would therefore ask the government to consider allowing a transitional period until the new NRL rules have been enacted. During the transitional period the holding of an NRL should not taint an otherwise qualifying group. In the interim period HMRC would still be able to apply other tax provisions if the level of debt in the NRL was considered excessive, in particular the use of transfer pricing legislation. 55. We would also like to clarify what is meant by activity in the fully taxed test (s427(10)). In particular, does activity only refer to the rental income producing activity or does it extend to the disposal of the property? This is relevant for some of our members who hold investments in a NRL structure (e.g. Jersey Property Unit Trusts) through a UK corporate. The UK corporate will pay corporation tax on its share of the net rental income arising in the Jersey Property Unit Trust, but will not pay UK corporation tax if the Jersey Property Unit Trust sells the property. We would note that in practice the UK corporate will pay UK corporation tax when the JPUT remits the sale proceeds back to the UK corporate investor because the distribution is treated as the sale of units by the unit holders. 56. We would also welcome confirmation that where a property is held in a non-resident unit trust or partnership that is transparent for income tax purposes, the unit holders/partners will be eligible to be treated as qualifying companies (assuming they have no other assets), on the basis that the unit trust s or partnership s property rental activities are deemed to be carried on by all the unit holders/partners. E. Joint ventures (JVs) 57. We recognise that the treatment of JVs is a difficult area and acknowledge the complexity in drafting rules to cater for JV situations. However, as JVs are such a common and important feature of the real estate industry we are keen to work with HMRC to address these issues and develop a practical solution. 58. In particular, our concern is that an investment in a JV held by both PBIE qualifying and non-pbie qualifying investors could taint an otherwise qualifying investor s ability to satisfy the PBIE as the