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HMRC internal manual

Guidance on Real Estate Investment Trusts

HM Revenue & Customs
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Conditions and Tests: Balance of business Conditions: Condition 1 (income test)

The income test provides that at least 75% of the ‘total profits’ of the company (group in the case of a Group REIT) must be derived from its property rental business. This condition must be met for each accounting period, subject to relaxation for minor breaches (GREIT07005).

Measure of profits

Total profits’ are the profits of the tax-exempt business plus profits of the non tax-exempt business. For this part of the UK-REIT rules, the term ‘profits’ means income (section 142(f) FA 2006). This means that capital gains on disposal of property are excluded from the measure.

The measure of ‘profits’ (i.e. income) for this condition is as provided for under international accounting standards (IAS), before the deduction of tax and excluding realised and unrealised gains or losses on the disposal of property, changes in the fair value of hedging derivative contracts (as defined in section 120(4) FA 2006), items which are outside the ordinary course of the company’s business (irrespective of their treatment in the company’s accounts) and taking into account the company’s past transactions. For Group REITs, regulation 7 SI 2006/2865, as amended by SI 2007/3536 applies the definition.

The restriction to ‘income’ means that changes in fair value (for example a derivative contract relating to an asset of the property rental business) that are taken to equity rather than P&L are excluded. The exclusion of realised and unrealised gains on property is there because, for example, where fair value accounting applies under IAS, unrealised gains on the disposal of property may be included in the measure of income. But the majority of fair value changes in interest rate swaps are taken to P & L and but for section 108(2)(b)(ii) they would be included in the IAS measure of income so they are also excluded from the measure of profits.

Note that this accountancy-based measure of income of the tax-exempt business for this test is unlikely to be the same as the measure of income used for the 90% Distribution requirement (which is a measure of income for tax purposes).

Funds awaiting re-investment

Although the cash can count as an asset of the property rental business for the second Balance of business condition for two years (see GREIT09010), interest or other income arising on the cash does not form part of the income of the property rental business.