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Real Estate Funds - the new elections regime

The extension of capital gains tax to non-resident investors in UK real estate has made life more complicated for fund managers.

Until the recent changes - which came into effect on 6 April 2019 - the optimum way to structure inward investment was pretty straightforward.

Unless the fund was to set up as a REIT (or, as its open ended counterpart, the PAIF) - with all the regulatory and compliance burdens that those structures bring - the obvious choice was to establish one or more non-UK vehicles (perhaps a Jersey property unit trust or a Luxembourg SARL) to acquire the UK real estate.

The use of a non-UK holding vehicle had two main advantages:

  1. it allowed the real estate to be transferred free from registration duty (SDLT) by arranging for sales of interests in the vehicle; and
  2. it meant that capital appreciation in the value of the underlying real estate escaped UK tax.

The April 2019 changes

The April 2019 changes completely changed the tax planning landscape by extending the scope of UK capital gains tax (CGT) charge to all non-residents.

Prior to that change, only direct owners of residential property and closely held funds owning residential property were in the charge to UK tax.

As from 6 April, however, both sales of directly held real estate (whether commercial or residential) and sales of interests in "property rich vehicles" fall within the scope of UK CGT.

For these purposes a property rich vehicle is any company or vehicle that derives at least 75% of its value from real estate. The general rule is that where a shareholder or other investor holds 25% or more of a property rich vehicle then that person is liable to UK tax on any gain that they make or a sale (or other disposal) of their interest in the vehicle.

The issues for funds managers

So does that mean that fund managers will now set up new funds onshore and collapse existing structures?

The answer is not necessarily.

In the first place, transfers of interests in non-UK vehicles can continue to be made registration duty free. It may be only a matter of time before the UK government extends the scope of SDLT to transfers of property rich vehicles - many countries impose registration duty in this situation – but for the time being that remains a real advantage of staying offshore.

More fundamentally, however, the new capital gains tax rules operate in materially different ways for funds than they do for other taxpayers.

In one respect, investors in funds are treated less favourably than investors in other vehicles. This is because the normal rule[1] is that an investor in a fund (whether set up in the UK or not) is potentially liable to CGT on a sale of an interest in a property rich vehicle however large or small the interest may be (so that there is no exemption if the investor holds less than 25% of the fund).

More positively, however, funds set up outside the UK can elect for the new CGT rules to be altered by making an election.

Funds can elect for either transparency or exemption (but not both).

1. The transparency election

The transparency election is designed for offshore unit trusts (Jersey property unit trusts and similar vehicles in other jurisdictions).

Those vehicles are already transparent for income tax purposes and the effect of the election is to make them transparent for capital gains tax purposes as well.

The benefit of making the election is that if the unit holders are themselves exempt from UK capital gains tax (as they would be if, for example, they were UK pension funds or charities) then no charge to capital gains tax will arise at any level on the occasion of a sale of a UK property.

This means that Jersey property unit trusts will almost certainly continue to be popular vehicles for holding UK real estate.

One important point to note is that the transparency election can only be made if all unit holders agree. For this reason, the election is likely to be most commonly adopted by closely held funds.

Moreover, as the result of the election is to treat a fund as though it were a partnership, this election is most likely to be used by funds that have relatively few investors (joint venture structures and the like) or have investors which are exempt. This is because if new taxpaying investors were to come in after the fund’s real estate investments had grown in value, tax charges could arise at that moment (just as they would if investors came in to an actual partnership).

One other consequence of the transparency election is that taxable unit holders will be liable to tax on disposals of UK real estate whether the proceeds of sale are distributed to them or not. For those types of investor the second election – the fund exemption – is likely to be more attractive.

2. Fund exemption

Subject to meeting a number of conditions, a fund can elect for exemption for both the fund vehicle itself and all its subsidiaries.

Where the election is made, the tax charge arises at the level of the investors themselves.

One advantage of making the fund exemption election is that if funds have multiple levels of holding vehicles they will not be penalised (in the absence of the election, charges could arise at each level of holding vehicle – this is avoided if the election is made).

Moreover, if the fund’s investors are tax exempt, they will again not suffer a charge at any level.

The conditions that need to be met in order to qualify for the funds exemption are, however, quite detailed and fund managers will want to consider carefully whether or not they want to make the election or structure themselves in other ways.

Importantly, any fund that wishes to take advantage of exemption election is required to report detailed information on the identity of its investors to HMRC.

Furthermore, in order to qualify:

  • the fund vehicle must either be widely marketed or "non close" (so that private groups and families will find it hard to benefit from the regime); and
  • the exemption is only open to "property rich" funds (so the fund must derive at least 75% of its value from real estate).

Where the exemption election is made, investors will be taxable on disposals of their interests in the fund and in certain other circumstances (for example, where they receive capital distributions from the fund) so that if tax is due it is paid by the investors rather than at a lower level in the structure.

Making the elections

Only non-UK resident funds can make the transparency election or the exemption election.

Once made, the transparency election is irrevocable. It must be made before the end of 12 months after the first acquisition of real estate or interest in a property rich vehicle by the fund.

By contrast, the exemption election can be made at any time but can have retrospective effect for a period of up to 12 months.


The elective regimes allow funds to be treated for tax purposes in much the same way as REITs and PAIFs. That is to say, they provide for the new CGT charge to be realised at the investor level rather than at the fund level. Importantly, however, making either election does not carry any of the regulatory or compliance burdens of falling within those tax privileged regimes. But, as illustrated above, there are other consequences of making either election which will need to be considered carefully on a case by case basis by fund managers.

[1] There is an exception for certain pan European real estate funds

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