In what some observers hope may lead to a REIT-version of the British invasion, the United States and the United Kingdom ratified a new income tax treaty on March 31 that creates an incentive for increased foreign investment in dividend-paying companies, including real estate stocks. The treaty becomes effective for dividend payments made on or after May 1, 2003.

Under the Internal Revenue Code, a U.S. corporation must withhold and remit to the IRS 30 percent of its ordinary dividends paid to non-U.S. shareholders. Since World War II, the U.S. has entered into many bilateral treaties that reciprocally lower withholding taxes to encourage cross-border investments. Under the prior tax treaty that was in force since 1980, a U.S. corporation withheld 15 percent of its dividends paid to shareholders that were U.K. residents.

Under the new treaty, most U.S. corporations will withhold NO tax on their ordinary dividends paid to shareholders that are U.K. pension plans (called "pension schemes"). A U.K. pension plan can obtain the benefits of the exemption so long as it owns 5 percent or less of a publicly traded REIT or 10 percent or less of any REIT—the assets of which are diversified.

In addition, other U.K. investors will continue to receive the benefits of the 15 percent tax rate (without a tax treaty, the normal withholding rate under the Internal Revenue Code would be 30 percent). Essentially, the two countries have decided to respect the tax-exempt status of their pension plans when they make passive corporate investments.

An exemption of dividends to pension plans has been a beneficial feature in the U.S. tax treaties with the Netherlands, Switzerland, Canada and Venezuela. The tax exemption of Dutch pension funds had a dramatic effect on their investment in U.S. real estate companies. With over $1.1 trillion in U.K. pension assets, according to a Phillips and Drew study, a similar provision in the U.K. treaty could have a similar impact.

"This treaty eliminates a barrier for U.K. investment in REITs and could open a significant new pool of international capital for domestic real estate companies," says NAREIT senior vice president and general counsel Tony Edwards, who spearheaded discussions with the U.S. Treasury Department to ensure the pension plan exemption included portfolio investments in REITs.