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HMRC internal manual

Guidance on Real Estate Investment Trusts

Conditions and Tests: interest cover test (profit: financing cost ratio)

The UK-REIT legislation sets a limit on the amount of interest a UK-REIT can pay in connection with its tax-exempt business. If too much interest is paid, a tax charge is imposed on C (residual) - see GREIT02205. The limit is expressed in terms of the ratio of profits to financing costs (often referred to as an interest cover test) and is 1.25.

HMRC may waive a charge in respect of an accounting period where, in the accounting period, the company was in severe financial difficulties and breaches the profit: financing cost ratio due to unexpected circumstances and could not have avoided breaching the profit: financing cost ratio. Should a REIT find itself in such a position it is recommended it contact it’s CRM in the first instance.

The purpose of setting a limit is to ensure UK-REITs are not too heavily geared, and also to reduce the scope for extracting profits of the tax-exempt business as interest instead of property income distributions. Although transfer-pricing rules will operate as normal for a UK-REIT, these give little protection if one end of the transaction is in a tax-exempt environment.

The limit is set in section 115(2) FA 2006 and the consequence of breaching it are in regulations 12 and 13 SI 2006/2864. It is measured by reference to the rental profits (before interest and capital allowances) and financing costs of each accounting period.

For single company UK-REITs, the ratio is (Profits): Financing Costs.


These are the amount of profits of C (tax-exempt) for the accounting period, before the deduction of capital allowances, of losses from a previous accounting period and of amounts taken into account under section 120(3) FA 2006. The general definition of ‘profits’ meaning income (section 142(f) FA 2006) applies here. The measure of profits is as set out in section 120 FA 2006. This is property business profits before deduction of loan relationship and derivative contract debits that would be permitted as deductions by section 120(3) FA 2006.

Financing Costs

These are the financing costs incurred in the relevant accounting period in relation to the property rental business of C (tax-exempt). The definition of financing costs covers:

  • interest on loans and related costs with the exception of exchange losses;
  • debits or credits arising on derivative contracts in relation to debt finance;
  • finance costs arising under finance leases; and
  • other costs that under generally accepted accounting standards are considered to arise from a financing transaction.

Group REITs

A similar 1.25 limit applies to Group REITs but the terms in the formula and their definition are different - see GREIT12050.

Joint ventures

For a single company UK-REIT that has given a joint venture look-through notice in respect of a joint venture company, a similar 1.25 limit applies but again, the terms in the formula and their definition are different - see GREIT13035. For venturing groups, the profits and financing costs of the joint venture company are included in the Group REIT formula in the same way as for members of the group.