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Once again, I am grateful to the Financial Secretary for setting out the Government's case for not extending IHT relief by designating VCT shares as business property. I accept his argument, as well the argument about changing the structure of the income tax relief available to investors who held their shares
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beyond the sixth anniversary. Bearing in mind his explanation, I beg to ask leave to withdraw the amendment.
Mr. Francois: Clause 106 is arguably the key part of part 4, in that it defines some of the principal conditions that companies must meet in order to qualify for real estate investment trustREITstatus. That is why we selected it for debate in a Committee of the whole House. I am sure, however, that we will have plenty of opportunity to explore the other 42 clauses relating to REITs in more detail upstairs in Committee. I look forward to debating the subject with the Economic Secretary in a few weeks' timeI genuinely hope that it will be him.
As I said on Second Reading, Her Majesty's Opposition welcome the introduction of REITs in principle, having pressed the Government to adopt such a structure for several years. However, we are generally concerned to get the detail right, and we will table amendments that are designed to ensure that, from the outset in January 2007, the concept operates in the positive interests of the United Kingdom economy. That also applies to the amendments that we are debating today.
My first question to the Minister concerns the detailed regulations that the Government have offered to provide, which are designed to fill out some of the detail of how the provisions in the Bill, including clause 106, will operate in practice. When are those regulations likely to be published? Specifically, are they likely to be available before the Bill goes into Standing Committee next week? It would obviously be beneficial to have sight of the regulations, and ideally some time to digest them and consult on them, in order to give context to many of the clauses that we will subsequently be expected to debate upstairs. I am not alleging any skulduggery on the part of the Government, but merely saying that it would be handy to have a definitive date for when the regulations are likely to be published. Perhaps the
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Minister can seek inspiration on that point and let the Committee know before we conclude our proceedings on REITs.
The concept of REITs has been around for some time, having been introduced in the United States as far back as the 1960s. Similar vehicles exist in several other countries, including Australia, Japan and European countries such as France. Germany is also in the process of considering the introduction of a REITs regime, although I understand that its preparations are not as far forward as our own.
In essence, a REIT is designed to facilitate collective investment in property, which by its very nature often requires large amounts of capital. REITs will enjoy key tax advantages that create a transparency between the ultimate investors and the underlying investments, and they will be exempted from corporation tax on property income and from capital gains. In return, REIT companies must meet certain key conditions, including that 75 per cent. or more of their assets must be investment property, that 75 per cent. or more of their income must be rental income, and that at least 90 per cent. of their profits must be distributed as a dividend to their investors, who will then be taxed on those dividends as property-related income. As the explanatory notes to clause 106 state:
"The company conditions are designed to restrict the scheme to publicly listed companies with their equity and debt finance arranged in such a way as to ensure that tax-exempt profits are paid out to shareholders as taxable profits under Schedule A."
However, the Government have laid down in clause 106 several additional conditions that a company must meet in order to qualify for REIT status and the attendant tax benefit that it confers. Those six key qualifying conditions can be summarised briefly as follows. First, the REIT company must be resident in the United Kingdom. Secondly, it must not be an open-ended investment companyan OEIC. Thirdly, it must be quoted on a recognised stock exchange. Fourthly, it must not be a close company. That is usually defined as being controlled by five or fewer people, but I give the Minister notice that there is a particular technical point on that, to which I want to return in a few minutes. Fifthly, it must have only one class of ordinary shares, plus potentially only non-voting fixed-rate preference shares. In other words, it must be confined to only those two types of share capital. Sixthly, its borrowing must effectively be limited to reasonable commercial terms.
There is an additional point about the specific importance of the clause 106 conditions. Some other conditions for which the Bill provides, such as the income acid test and the gearing restriction, if breached, do not necessarily result in the withdrawal of REIT status. However, the strictures of clause 106 conditions could be harsher in that a breach would result in a company being expelled from the REIT regime. To use a footballing analogy, a breach of some of the non-clause 106 conditions can result in a bookinga yellow cardbut a breach of one of the clause 106 conditions is currently a sending-off offence. A company would be red-carded for such a breach.
Given the added importance of those conditions, our amendments are designed to elicit further information from the Government about how some of them would work in practice and whether any flexibility is envisaged for their operation. As we know from the consultation exercise, flexibility has been introduced for interpreting some of the other conditions in the Bill.
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Amendment No. 4 would expand a third of the qualifying conditions in clause 106 to include property investment companies that are listed on the alternative investment market of the stock exchange, or AIM, as it is more popularly known. I understand that there was something of a problem for the property industry during the consultation process. We are therefore understandably keen to press the Government on their thinking on the matter. We have received some representations about expanding the concept even for unlisted companies. However, for the moment, we have decided to confine ourselves to pressing the matter in relation to AIM.
AIM-listed companies already provide a legitimate form of collective investment, so why have the Government decided to exclude them from the REIT regime from the start? On a practical level, property companies that are registered as REITs are likely to enjoy significant tax advantages over thoseusually smallercompanies, that are denied the advantages that REIT status confers. There could therefore be considerable consolidation in the market as REITs take over other property companies, such as those on AIM, which cannot qualify for REIT status. That is potentially unfair and, over time, could mean that the UK property market was increasingly dominated by a relatively small number of large REIT companies. I presume that the Government did not intend that. We would move in the direction of an oligopolistic market and I am not sure that Ministers want that.
Moreover, AIM-listed companies might come under pressure to convert to a full stock exchange listing before they were ready for it, principally to qualify for REIT status, thus potentially causing a distortion in the orderly evolution of the market sector. Why not, therefore, expand the condition to cover at least AIM-listed companies, which meet all the other conditions that the Government have set, and thus facilitate greater diversity in the REITs market available to investors? There is a strong common-sense argument for doing that.
"The property industry in the UK believes the consequence of limiting REITs to listed companies will be to unnecessarily limit the development of REITs because it heightens the barrier for new entrants to the UK REIT regime and as a consequence makes it that much more difficult for new REIT companies to form. Clearly, this has consequences for those seeking to establish new investment vehicles in traditionally under-invested property markets, such as the residential private rented sector."
I am sure that the Government want to boost the residential private rented sector, not least to provide a supply of housing for those who find it difficult to obtain somewhere to live. It is worth bearing in mind that the BPF is intimating that, if the companies are not allowed to obtain REIT status when they are on AIM, that might hinder the objective that I outlined.
"The restriction is particularly difficult to understand when there are alternative markets that are an established feature of the UK collective investment market, including for example the Alternative Investment Market. AIM is specifically designed to help emerging companies that wish to be open to public investment yet would find it difficult to sustain themselves on a recognised stock exchange at an early stage in their development. The proposed Amendment"
"seeks therefore to open up the current Clause 106 legislation to allow companies listed via AIM to convert to REIT status. This would enable the development of new or smaller companies into the REIT market and thus help to ensure REITs are a sustained successful investment vehicle across the property markets."
"In summary therefore, our main concern with Clause 106 as it is written is that while it is likely that a number of existing listed property companies will convert to the new REIT regime, the provisions do not cater for the growth and enhancement of this market which will in turn bring forward investment benefits and opportunities to improve the quantity and quality of property investment in underinvested markets. In short, by so restricting the rate regime to only 'recognised stock exchange' listed vehicles the government may inadvertently smother the ability of the market to develop."
On 5 April 2006, the Financial Times published a special supplement entirely devoted to the subject of REITs, and it made very interesting reading. It gave a generally positive welcome to the concept. However, it also contained an article by Peter Damesick, the head of research at C.B. Richard Ellis, which was interestingly entitled:
"The rules further limit the pool of potential Reit creators by excluding companies listed on the Alternative Investment Market (AIM). An AIM listing could serve as an incubator for small Reit start-ups, potentially capable of growing into larger Reits with a full stock market listing. The hurdles put in the way of Reit creation stand in marked contrast to the provisions introduced in the US in the early 1990s to enable the easy transition of private property companies, trusts and partnerships into the listed Reits sector."
The Financial Times estimates that more than $300 billion is now invested in US REITs, and notes that spreading the listing base for the concept was important in generating that substantial degree of investment. That is presumably something that the Government would eventually like to emulate, at least on a relative scale for the United Kingdom. I think that $300 billion worth of investment in UK REITs within the first couple of years might be a rather ambitious target. Nevertheless, I am sure that the Government want to encourage as much investment into UK REITs as is practically possible. I would therefore stress to the Minister that the US experience has shown that widening the listing base has been instrumental in encouraging additional investment and in getting the concept to take off. I am informed that it was in the 1990s that it really took off in the United States.
The alternative investment market is generally regarded as a success story and, if the Minister will allow me to say so, it was a Conservative Government who
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introduced it in 1995. We would like to make REITs a success story too. Therefore, we would genuinely like to know why the Government are reluctant to consider expanding the REITs concept to the alternative investment market. We would like to hear their explanation. If they will not concede this point this afternoonI hope they willwill they at least make a commitment to keep the question under review once the REIT regime rolls out in practice next year, and to take another look at the matter once the regime is up and running? I look forward to hearing the Minister's response to this amendment with particular interest.
I turn now to the reasons behind our amendment No. 23, which relates to close companies. I should stress that this is a probing amendment, but it would, in principle, delete the fourth of the six qualifying conditions from clause 106. That condition is that a REIT must not be a close company, which is broadly defined as a company that is controlled by five or fewer people. If the other conditions remain in place and the company remains publicly quotedeither on the full stock exchange or AIM, as previously discussedwhy, in principle, should a company be forced out of the REIT regime because it is controlled by five or fewer people? We would be interested to hear the Government's thinking. For instance, a company that breaches that condition would automatically be removed from the REIT regime. Companies might therefore be required to monitor their shareholdings continuously to ensure that the condition is not breached. Because the actions are to some extent outside the company's control, however, the management might not be able to anticipate or even prevent such a breach, even though, were it to occur, it might cost them their REIT status, and in some circumstances it might not be their fault.
During the consultation exercise, the Government conceded to some extent on a different condition whereby they originally intended to limit individual shareholdings in a REIT to 10 per cent. Some flexibility has been introduced into the Bill whereby regulations will restrict distributions to holders of more than 10 per cent of shares in a REIT but, interestingly, will apparently not remove REIT status if the 10 per cent. limit is breached, as the condition in clause 106 relating to close companies would.
The Government have therefore given way to some extent on the 10 per cent. limit, and we appreciate that they might be reluctant to allow a single shareholder to control a REIT. We understand that that was a particular concern of the Government's throughout the consultation process, and we are not challenging that point directly. There is a difference, however, between one and five. Can the Economic Secretary therefore explain why the close company condition is still such a necessary one, especially given that if a company fails to meet it just once during a year it might lose its REIT status automatically, which could cause uncertainty for both the company's directors and potential investors. Investors might be worried about putting money into a REIT company if they thought that they might inadvertently breach that condition and therefore lose the REIT status and some of the tax advantages conferred by it. That is a reasonably important point, and we genuinely want to probe the Government's thinking on it.
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In addition, I want to raise a technical point in relation to amendment No. 23 and close companies, as I tried to intimate to the Economic Secretary when I began my remarks. A close company is defined in section 414 of the Income and Corporation Taxes Act 1988. Broadly, such a company is controlled by five or fewer shareholders. There are exemptions to that rule of thumb, however, as I am sure the Economic Secretary is aware. For instance, a company that would otherwise be a close company is not so if it is controlled by another company that is not close. As the British Property Federation, which has asked me to raise this question, has pointed out:
"As currently drafted the provisions would seem to catch shares held by an exempt pension fund as well as a non-close company. This is because section 414(5) is extended to pension funds by section 414(7)",
As one of the intentions of REITs is, I presume, to attract investment by institutional investors, not least pension funds, it would be helpful to clarify that question, either this afternoon or perhaps when the guidelines are published. I admit that the point is rather technical, but that is partly what this process is for, and it would be helpful for pension funds particularly to have any uncertainty removed. Perhaps the Economic Secretary will seek some inspiration and respond on that question this afternoon. If not, perhaps we will hear from him when the guidelines are publishedin the near future, I hope.
Amendment No. 24 asks for the Chancellor to prepare a report to Parliament by March 2007, and annually thereafter, on the operation of the REIT regime. The report should include the number of companies that have applied for REIT status, under the auspices of clause 109, and should also record their market capitalisation. The purpose is to monitor the initial operation of the scheme, and to report to Parliament on its progress
The first report would be due within three months of REITs' coming into force in January next year. I realise that that is quite a tight time scale, but there is an intention behind it. It would provide an early indication of the popularity or otherwise of the concept: we would see an early snapshot of the degree to which REITs are catching on in the United Kingdom. I think that that would be helpful, given that a number of peoplenot least Members of Her Majesty's Oppositionhave been pushing the Government to adopt the concept for a number of years.
Once the idea has bedded in, it would also be helpful to have annual updates on its progress, not least so that we can assess whether REITs are generating the income for the Treasury that it has estimated will be forthcomingchiefly from the entry fee for property assets which are being placed in REITs, which I think is now set at about 2 per cent. I appreciate that that fee can be paid in instalments over a period of four years, and that when we look at the figures for the first few years, if a number of companies that elected to pay in instalments are doing so, the full amount of money may not be recorded because some may only have paid part of the fee; but I think we can all allow for that statistical caveat. It would still be helpful information for the House, and indeed the market.
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The Red Book estimates that the income from REITs to the Exchequer is likely to be some £320 million by the end of 200809. In other words, the Treasury thinks that REITs will raise about a third of a billion pounds between January 2007 and then. It would be helpful to have a specific reporting mechanism enabling Ministers to tell the House whether the targets had been met, allowing for the caveat relating to the four-year spreading of the 2 per cent. entry charge.
As I said at the outset, we want the scheme to be launched successfully in January 2007, and we are prepared to work positively with the Government to that end. I hope that the Economic Secretary will accept that commitment in the spirit in which it is genuinely offered.
Clause 106 forms a key part of the REITs regime in defining some of the headline conditions that a company will have to meet to qualify for REIT status and the attendant tax advantages that it confers. We want to press the Government on why the concept should not be expanded to include companies listed on the alternative investment market, why they think that close companies should be barred from REIT status, and whether they would consider producing an annual report on the progress of the concept once it is up and running.
I look forward to hearing from other hon. Members and, I suspect, from right hon. Members, following the speeches on Second Reading. I particularly look forward to the Economic Secretary's reply, to which I shall listen with interest.
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