UK Consultation on a New ‘Sovereign Tax Status’ — Implications for Sovereign Investors, Funds, and Real Estate

Alongside Budget 2026, HM Treasury has published a consultation on replacing the UK’s non-statutory approach to sovereign immunity from direct tax with a new statutory ‘sovereign tax status’ from 1 January 2029.

It is proposed that sovereign investors will, for the first time, be taxed on UK real estate income and gains, while keeping some important exemptions. HM Treasury considers this new regime to be broadly in line with, or better than, those offered by most other countries. HM Treasury states that they ‘expect’ the main effect to be largely confined to directly held UK real estate, but in reality the changes will be significant for sovereigns with any UK real estate exposure and for the fund managers and joint venture partners who invest alongside them. The consultation closes on 20 January 2027. Unlike similar proposals floated in 2022, which were not taken forward, HM Treasury says it will legislate in Finance Bill 2027-28.

The General Position

• Who will qualify: foreign states (including all constituent territories of federal states, but not municipal authorities), heads of state acting in a sovereign capacity, governments, central banks, sovereign wealth funds, and other bodies performing government functions. In addition, the status would be available to 100% state-owned entities incorporated and resident in the sovereign’s home country. It is also proposed to introduce a new category of ‘State-operated Overseas Pension Funds’ (SOPFs) which would be exempt from tax on chargeable gains, although they would remain taxable on income from UK land and UK trading income. A formal application to HMRC will be required, including for sovereigns that benefit from immunity today.
• What will be taxed: as for other non-resident investors, income from UK land, gains on UK land and on interests in certain UK property-rich vehicles (other than for SOPFs), and UK trading income, with sovereign entities treated as non-UK resident companies within the charge to corporation tax.
• What will remain exempt: UK source interest, dividends (other than property income distributions (PIDs) from UK Real Estate Investment Trusts (REITs)), profits of UK investment offices managing the sovereign’s own portfolio and, for SOPFs only, real estate-related chargeable gains.
• Other features: continued qualifying institutional investor (QII) status for most UK fund-based tax regimes (including the Qualifying Asset Holding Company (QAHC) regime), but with no exemption (other than for SOPFs) on UK real estate-related gains, including under the substantial shareholdings exemption that applies to companies owned by QIIs (QII SSE). Access to the UK REIT regime is being redesigned, with the aim of there being effectively a 15% tax rate on PIDs.
• Transitional relief for restructuring: there will be rebasing to market value at 1 January 2029, a time-limited stamp duty land tax (SDLT) relief and targeted relief from the debt and derivatives anti-avoidance rules to support restructuring.

One positive feature of the proposed new regime is that interest would be able to be paid gross once HMRC have authorised this; how that will work in practice, including for interest received by sovereigns through fund partnerships and how sovereign status is evidenced to borrowers, is not yet clear but will be important. The Double Taxation Treaty Passport scheme will not, for now, be extended to sovereigns. Current immunity continues to apply until 1 January 2029.

Impact on Different Categories of Sovereign Investor

Sovereign Wealth Funds

For most sovereign wealth funds this would be an unwelcome change. It would be felt by those holding UK real estate directly or through tax-transparent vehicles, or with UK trading activities. Investments through funds and via REITs would also be impacted by the changes, including the withdrawal of QII SSE relief from corporation tax on disposals of shares in UK property-rich companies.

It is proposed that a 100%-owned entity will only qualify if it is incorporated and resident in the sovereign’s home country, which could require sovereigns’ existing UK real estate holding structures to be restructured in many cases; HM Treasury has asked about the impact of this, and we expect the industry to engage. In addition, the exemption for UK investment offices is welcome, but how it applies where an office co-invests with, or manages assets for, non-sovereign third parties will be important.

US State Pension Plans

This is likely to be a positive development for many US state pension plans. Today, whether a US state (as a constituent territory of a federal state) is treated as sovereign is decided case by case, and many state plans have not been able to rely on immunity with certainty. Under the new regime all constituent territories will be eligible, and pension funds established under a US state’s laws for (almost exclusively) public sector employees should qualify as SOPFs. SOPFs will be exempt from tax on gains (including on UK land and UK property-rich vehicles), keep the benefit of QII SSE on property-rich disposals and benefit from the interest exemption. SOPF status will also extend to wholly owned subsidiaries, wholly owned pooled investment vehicles and wholly owned special purpose vehicles established to invest for the SOPF, even where gains arise in those vehicles. Vehicles that are not wholly owned, such as a joint venture with a non-sovereign partner, do not appear to be covered by the consultation’s description.

Plans will need to apply, and funds established by local authorities or municipalities (for example, city or county plans) will be excluded. How the public sector employee requirement fits with the stated inclusion of state pension funds for the general population will need to be clarified. Income from UK land will be taxable for SOPFs, as for other sovereigns (the SOPF exemption covers gains only), so any state plan that currently benefits from immunity will be worse off as regards any directly held UK rental income, subject to the 15% REIT route described below.

Australian and Canadian Sovereign Investors and State and Provincial Pension Plans

Australia at the federal level and each of the six Australian states currently benefit from ‘Crown immunity for the Crown overseas’, which exempts them from UK direct tax. Canada and its ten provinces benefit from the same practice. This practice would be replaced by the new sovereign tax status, so these investors would be treated in the same way as other sovereigns. For those with directly held UK real estate or UK trading income this will be an unwelcome change. However, state-operated public sector pension funds established under federal, provincial or state legislation should generally be able to qualify as SOPFs, although whether particular arrangements meet the conditions will need to be checked. Some state or provincial pension plans have not been able to rely on Crown immunity with certainty, and for those that qualify as SOPFs the new regime may be a positive development.

What This Means for UK Real Estate

Direct and Tax-Transparent Holdings

From 1 January 2029, sovereigns will be taxable on UK rental income and (other than SOPFs) on gains on UK land and UK property-rich vehicles, subject to rebasing; the detail for indirect holdings is awaited. Holding directly or through income tax-transparent vehicles such as Jersey property unit trusts (JPUTs) will no longer preserve an exemption. The position of some corporate holding structures needs care. Where a company (for example, a Luxembourg company) is set up so that its constitutional documents treat the sovereign as beneficially entitled to its income and gains, the sovereign relies on its immunity, and the company is not itself taxed on those profits. Those profits will come into the charge from 1 January 2029, but investing through a company should not be assumed to be unaffected: the consultation does not say how the charge will apply where the company is not itself beneficially entitled to the income and gains, and we expect this to be an important point for industry engagement. Rents will continue to fall within the Non-Resident Landlord Scheme (with gross payment available on application in the same way as other non-residents), and development or other trading profits will be taxable.

REITs, Including Through Private Funds

Sovereigns will remain QIIs for the REIT regime and will be able to control or wholly own a UK REIT. However, where a sovereign holds 10% or more of a REIT (aggregated with connected persons, including its holding vehicles), the holders of excessive rights (HoER) rules will apply unless it holds through an optional ‘sovereign REIT holding company’: a UK company wholly owned by the sovereign, used only to invest in REITs and taxed at 15% on gross PIDs. Gains on disposals of REIT shares by the holding company will be taxed under the normal corporation tax rules, and sovereigns other than SOPFs will not qualify for QII SSE on disposals of UK property-rich companies.

The detail will be very relevant for real estate funds and joint ventures, in particular:

• how the 10% aggregation and connected-person tests apply to a sovereign investing through a fund partnership, given that partners are generally connected with each other under the usual rules;
• whether the sovereign REIT holding company can be used alongside co-investors or through a fund and who bears any HoER charge at REIT level (noting that existing documentation may already govern this risk);
• whether the stated aim of a 15% rate on both controlled and uncontrolled UK real estate investments will be implemented for minority stakes held through funds; and
• how the ‘excluded holder’ exemption from the HoER charge, which will no longer be available to a sovereign or to a connected person through which it holds its REIT interest (other than a sovereign REIT holding company), will apply to existing holding structures set up by sovereigns, on which the consultation asks for views.

Funds With Sovereign Investors

Continued QII status for QAHCs, Long-Term Asset Funds (LTAFs), the non-resident capital gains rules for collective investment vehicles and the REIT regime is helpful. Two points need attention:

• Exempt unauthorised unit trusts (EUUTs): sovereigns other than SOPFs will cease to be eligible investors. As all unitholders in an EUUT must be eligible investors, EUUTs with sovereign unitholders will need to be restructured before 1 January 2029.
• QII SSE: a company that is at least 25% owned by QIIs is exempt on disposals of substantial shareholdings (even where the company invested in is not a trading company) in proportion to its QII ownership, with full exemption where QIIs own 80% or more. Sovereigns (other than SOPFs) will remain QIIs but will not qualify for the exemption on disposals of interests in UK property-rich companies. It is not yet clear how this will work where sovereigns co-invest with other QIIs through the same holding company. If sovereigns’ interests are simply left out of the QII ownership percentage on such a disposal, a company that currently qualifies for full exemption could fall below the 80% threshold (or, in some cases, below 25%), reducing relief for its other investors as well. It will be important that the rules are designed so that only the sovereign’s share of the gain is affected.

Timing and Next Steps

The expected timetable is set out below. Dates and windows shown as expected are our estimates based on the usual Finance Bill timetable and may change.

There is no requirement for sovereigns to restructure immediately: current immunity continues until 1 January 2029, the SDLT relief will not apply until 2028 and key details may change following the consultation period. In practice, it will only really be possible to start making significant plans once the draft legislation is published (expected in 2027). From that point the window before commencement will be short, as final legislation is not expected until Finance Bill 2027-28 and real estate restructurings involving co-investors, lenders or fund documents take time. Sovereigns and impacted managers should therefore start to prepare now so that they are ready to move as soon as the draft legislation is available. The steps differ for sovereigns and for managers, but the sequence is broadly the same: diagnose now, design once the draft legislation is published and implement during 2028. The table below sets out the key steps for each in sequence.

Restructuring in this context requires a detailed understanding of the REIT rules and of typical joint venture and fund economics. Goodwin has played a leading role in developing the wider use of REITs in these structures and is well placed to help fund managers and sovereigns restructure and navigate the new rules. Please get in touch with your usual Goodwin contact or any of the contacts below if you would like to discuss how these proposals may affect you.