TrendsThe UK property industry is lobbying for tax exemptions for property companies, saying it would encourage onshore investment, help the economy and reduce the risks for 'moms and pops'. Juliana Ratner reports

Could the UK be next to offer tax exemption to property companies? The industry, which has hoped for a tax-transparent structure for 20 years, thinks so - based on positive noises from the government and a statement about considering the issue in the Chancellor's most recent Budget.

Ruth Kelly, Treasury finance secretary, says the government is considering the issue. "In the Budget we challenged the industry to provide robust evidence that tax changes can provide a more efficient and flexible property sector, consistent with a fair tax system."

Tax-transparent investment vehicles, like real estate investment trusts in the US, distribute nearly all their taxable income to investors in exchange for exemption from capital gains and tax at the corporate level, and investors pay tax on the dividends and capital growth at their own marginal tax rates. In the UK, both pay tax on income and on capital gains.

An industry contingent, including the British Property Federation, the Royal Institute of Chartered Surveyors and the Investment Property Forum, has met Treasury representatives to argue that a Reit-like tax structure would be good for the UK economy, pensions and small retail investors.

Yet even the most optimistic do not expect to see a change until 2005 at the earliest, as the government reviews the issue.

The two sides had discussed changing the tax treatment of property companies four years ago, but the Treasury decided against it. The issue has been reopened because the government has noticed an increasing shift offshore of assets that invest in UK property. Limited partnerships, which can be structured so investors avoid being double taxed, last year attracted £1.4bn of investment, while offshore property unit trusts attracted £1.6bn, according to Citigroup Smith Barney.

Michael Prew, a Citigroup analyst, has suggested offshore PUTs (Property Unit Trusts) would probably be exempted from UK tax in an attempt to bring them back onshore.

Some fund managers that offer the unit trusts say they already offer Reit-like investments in the UK. "Stock-transparent vehicles such as PUTs already provide most of what the industry is asking of a Reit structure - they offer tax-transparency and the ability to commingle different investors," says William Hill, managing director at Schroders Property Investment Management. What the UK does not have is publicly listed property trusts, "which could open them up to a broader investment base", he says: and that is where the case for Reits can be made.

Tax-transparent structures for listed property companies exist in the US, Australia, Japan, Singapore, Belgium, the Netherlands and France. UK advocates say investors have shied away from investing in property because they are double-taxed.

It is that "tax leakage" that is one of the reasons UK- listed property companies trade at steep discounts to net asset value per share. Listed tax-transparent property unit trusts tend to trade at either a premium or at a lower discount than in the UK, which makes it easier to attract new capital and continue investing in better-performing assets. In the US, many Reits are trading at all-time highs: in the year to date, according to CSFB, US Reits had total returns of 9.16 per cent; this compares with returns for UK property of 6.4 per cent, says IPD, a UK property data firm.

The discount makes it difficult for UK-listed property companies to raise new equity, which is why many have disappeared from the public markets. The equity market for UK property companies has shrunk by 25 per cent since 1998 as 12 companies went private and others bought back shares.

"I have always been surprised at the strength of the public UK property market given the tax disadvantages in the UK that do not exist in the US," says Lee Schalop, a real estate analyst at Bank of America in New York.

In its previous reviews of the industry, the Treasury may have been concerned about losing tax revenues if a Reit structure was introduced. But industry insiders say that without such a structure, the industry would shrink further, and so would the taxes it pays.

Property companies currently pay about £273m of tax, but that could decline to £108m in 10 years without a Reit structure, according to Goldman Sachs estimates. With a tax-transparent structure in place, taxes would initially drop to about £72m, but would grow to £153m in 10 years.

If the UK required companies to pay an "exit tax" in order to convert to a Reit, which is what the French model has done, the Treasury would receive the tax income straight away. A French property company converting pays 50 per cent of its contingent capital gains tax upfront, spread over four years. If styled on the French model, the total exit tax in the UK could be as much as £1.75bn.

But the industry does not want to focus on tax issues any more; it wants to talk about the benefits to everyone else. Property executives say real estate companies that were better able to attract capital and spread their investments could loosen the onerous UK lease structure, provide a stable investment for small investors, and satisfy a demand from pension funds for a more liquid tax-efficient way to diversify into property - and argue that the companies would be able to invest more in projects such as urban regeneration.

"We think property is an important foundation in the economy and the industry should be as efficient and liquid as possible, which will help economic activity," says Liz Peace, chief executive of the BPF. "A Reit-type structure would assist this liquidity issue."

Yet the industry concedes that there is no hard proof what the results would be if a Reit structure were introduced, and can only point to what has happened in other countries. The US is the most often cited, and Treasury officials have recently visited the US and the Netherlands to review the impact of Reits on the property market and the overall economy.

Without incontrovertible evidence, the industry is focusing on the perceived benefits to investors, in an appeal to one of government's pet concerns, pleading its case in order to divert attention from the fact that the move would be good for an industry long-perceived as one that does not need help.