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HMRC internal manual

Guidance on Real Estate Investment Trusts

Group conditions and rules: Financial Statements: financing costs (External)

The amount of Financing Costs (External) is derived from the financial statement for G(property rental business). The aim is to capture the amount of interest etc paid to thirdparties so far as the loans giving rise to the interest relate to the property rentalbusiness of the group. How the group chooses to fund itself internally is immaterial forthe purposes of working out this number (although of course whether internal funding is bydebt or equity does make a difference for the calculation of the income of the tax-exemptbusiness).

Regulation 6 SI 2006/2865 sets out the steps for working out Financing Costs (External).

Step 1

The first step is to determine the amount of outside financing costs for the group inrespect of its property rental business. This is the costs of financing raised by groupentities from non- group entities, so far as it has been applied to the property rentalbusiness of group members.

If a group entity (other than the principal company) that has raised outside finance isnot wholly owned by group entities, the financing costs relating to that group entity arereduced by reference to the interest in the company held by non-group entities.

‘Group entity’ means a company that is a member of the group, or an entity thatis treated in the same way as a member of the group for the purposes of the FinancialStatements regulations. This includes joint venture companies where there is a‘look-through’ election in place, OEICs where the group has a significantinfluence (that is, owners more than 20% of the shares) and other non-corporate entitieswhere tax-exempt group has an interest of greater than 20%.

In the example in GREIT12150, the outside fianancing costs ofthe group in respect of its property rental business are 1,000 @ 4% and 300 @ 5% = 40 + 15 = 55.

Step 2

This step is to determine the percentage which relates to the ‘UK business’of G (property rental business) and how much to other activities carried on by the group.

Financing Costs (External) is that percentage of the outside financing costs that wereworked out in Step 1.

The regulations do not prescribe how the proportion that applies to the property rentalbusiness or the UK business of G (property rental business) is calculated. If an externalloan is clearly linked to a particular property, for example because a bond issue has beenmade to finance a particular acquisition, then that will be an important factor. If thereare no clear links, then an apportionment based on the fair value of the assets involvedin the different activities can be used.

In the example in GREIT12150, the ‘property rentalbusiness’ in step 1 above is the same as the ‘UK business’ of G (propertyrental business). There is therefore no need to take step 2, as Financing Costs (External)are the same as the outside financing costs, 55.