UK – Pension funds and charities will no longer face a tax penalty if they invest in UK property authorised investment funds (PAIFs) from next year as government reforms will give the investments tax status equal to real estate investment trusts (REITs).

Details of a discussion paper issued by the Treasury reveal the taxation point on property AIFs is being moved from the fund to the investor so ownership of any fund holding will be treated for tax purposes in the same way as owning real property or UK-Reit shares.

PAIFS will pay out three types of income over the year – property income, other taxable income such as interest and non-UK dividends, and dividends – and will be subject to UK tax rules.

This means individuals or corporate investors will be treated as having property holdings while a non-tax paying entity, such as someone holding a individual savings account (Isa), a pension fund or charity will not face additional charges.

Under current rules, pension funds gains tax advantage from investing in Reits rather than authorised unit trusts (AUTs) so the Treasury is levelling the playing field to give PAIFs equal status, providing the AUT converts its legal position to an open-ended investment company (OEICs).

PAIFs will be required to ringfence their property income from other assets so it is identifiable when paid out to investors, in the same way as if they held property or a Reit.

But these changes to the tax treatment of PAIFs should mean the funds will in future be able to hold a combination of ‘bricks and mortar’ property and UK Reits.

The Treasury is still investigating whether it should allow PAIFs to hold Reits, such as German G-Reits, to be included in a fund’s portfolio but any PAIF invested in a UK-Reit will receive the Reit’s property income distribution without deduction of withholding tax.

Additional reforms are being proposed to give any fund converting to an OEIC 100% relief on the stamp duty land tax (SDLT) usually paid on property held.

One complication of the current proposals, however, is the investor will be required to inform the fund manager if they hold more than any more than an agreed level of holding or more than 10% of the fund.

This is similar to existing rules on Reits which stipulate dividends are not to be paid to any investor which has more than a 10% holding in the UK-Reit and the Reit has to take "reasonable steps" under regulatory rules to ensure this does not happen, or the Reit could be penalised.

The Treasury is inviting comments and feedback on proposals until September 28 and draft regulations will then be unveiled for the proposed tax regime of property AIFs.