Where property values have reduced and traditional funding terms are harder to achieve, structured debt can be an effective way to support transactions. Structured debt arrangements bridge valuation gaps or lender risk appetite by combining a conventional coupon with equity‑like economics, such as profit participation, IRR hurdles, contingent returns, or exit‑linked fees.

These features can be commercially attractive to both lenders and borrowers. However, the UK tax rules do not always follow the labels used in a term sheet. Where returns are enhanced, contingent, or linked to asset performance, there is a higher risk of unexpected tax costs, either because deductions are restricted, or because payments are treated differently from what the parties involved had assumed.

Here, we highlight key UK tax issues to keep in mind when considering whole loans, profit share mechanisms, or other structured return features.

Transfer pricing and thin capitalisation: arm’s length still matters

Interest paid by a property company is generally deductible for corporation tax purposes. However, UK transfer pricing rules can restrict relief where the borrower is more highly geared than an independent lender would accept, or where the rate and terms are not arm’s length (i.e. on market terms).

This can be particularly relevant where leverage is high, security is limited, or the overall lender return is enhanced by equity‑like economics. For lenders, this matters because borrower cashflow and covenant headroom may depend on deductions being available; for borrowers, it matters because a restriction can materially increase the after-tax cost of the debt.

Recharacterisation risk: when “interest” becomes a distribution

Even if a financing is supportable on transfer pricing, UK rules can treat amounts described as interest as distributions where the return exceeds a reasonable commercial rate or where the instrument has equity‑like features.

This risk becomes particularly important where lender returns are even partly linked to the performance of the borrower’s business or assets (for example, a profit share linked to disposal proceeds). In some cases, this can result in the loss of tax relief on amounts the parties expected to be deductible, and it can also affect how payments are treated elsewhere in the structure.

Corporate Interest Restriction (CIR): structured terms can change the outcome

Where a group’s UK net tax‑interest exceeds the £2million de minimis threshold, the CIR rules can cap the amount of deductible interest, broadly to 30% of UK tax-EBITDA (or a group ratio), and subject to a debt cap based on the worldwide group's external net interest expense.

In real estate groups, the CIR position can be sensitive to volatility in tax-EBITDA (voids, capex, development phases) and to how amounts are classified. Structured returns can amplify that volatility and affect whether amounts are treated as related-party for certain CIR purposes. They may also affect the availability of the public infrastructure exemption (PIE), which can otherwise take qualifying interest out of CIR for long-let real estate held in a qualifying structure.

Hybrid mismatches: watch for cross-border deduction denial

The UK hybrid mismatch rules can deny a deduction where a payment is made to a recipient who is not taxed on the receipt because of “hybridity” somewhere in the document or structure. Common triggers include an instrument that is treated as debt in one jurisdiction and equity in another, or an entity that is treated as transparent in one place and opaque in another. The rules are broad and can apply where there is no tax avoidance motive, so they need to be reviewed on any borrowing transaction that touches more than one jurisdiction.

Withholding tax for overseas lenders

Withholding tax is a common hidden cost and administrative burden in cross-border real estate debt.

A UK company paying yearly interest is generally required to withhold income tax at 20% and account for it to HMRC, unless an exemption applies or treaty relief is secured. Accessing treaty relief can be administratively painful, whether through the Treaty Passport Scheme or by individual treaty claim, and getting the process wrong leaves the borrower exposed even where the lender would ultimately be entitled to the relief.

Structured financings also often include multiple payment types beyond the headline interest rate - arrangement fees, servicing fees, exit/prepayment economics and profit-linked amounts. The withholding analysis turns on whether a payment is interest, or interest in substance, which is not always the same as how it is described in a term sheet.

Conclusion

Structured debt can be effective, but where lender returns start to resemble equity the UK tax rules can materially change the result - through transfer pricing restrictions, distribution recharacterisation, CIR limitation, hybrid mismatch adjustments, and withholding tax exposure (particularly relevant for overseas lenders).

For lenders, these issues often determine whether the borrower can service the debt on the modelled basis. For borrowers, they determine whether the “all‑in” cost of capital is what was expected once tax is included.

We advise lenders and borrowers on the UK tax and financial diligence and structuring of new real estate debt to help model the actual tax cost of debt for the finance. We then work with your deal team to align the documentation and payment mechanics to the intended tax outcome, helping reduce unforeseen tax costs and execution risk.

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