New regime may hold unforeseen tax implications
28 June 2013
Posted by: Author: Thabang Mokopanele
Author: Thabang Mokopanele (Business day, bdlive.co.za)
A tax expert has warned that uncertainties and anomalies might exist in the new Real Estate Investment Trust (Reit) regime, but conceded that the legislation is set to usher in a new era for the local listed property sector by affording certain tax advantages and making listed property companies attractive to foreign investors.
The warning of possible pitfalls of the new legislation comes from Gary Vogelman, an Edward Nathan Sonnenbergs executive.
At least five South African property companies have converted to the Reit structure.
Mr Vogelman said in spite of the tax benefits that could be enjoyed by a property company and its shareholders upon the listing as a Reit, "it is crucial to be well read in the potential pitfalls" of the legislation.
A Reit is defined in section 1 of the Income Tax Act No 58 of 1962, broadly speaking, as a company that is a resident and the shares of which are listed on an exchange as shares in a Reit as defined in the JSE Listings Requirements.
On taxation, Mr Vogelman said, a Reit was entitled to deduct from its income the amount of any "qualifying distribution" incurred during that year of assessment by that Reit.
"Qualifying distribution" is defined to include any dividend declared or interest incurred in respect of a debenture forming part of a property linked unit by a Reit or a controlled property company (CPC), during a year of assessment, if more than 75% of the gross income received by or accrued to such Reit or CPC until the date of declaration, consists of rental income.
A CPC is defined as "a company that is a subsidiary, as defined in the International Financial Reporting Standard (IFRS) 10, of a Reit". The IFRS defines "subsidiary" as "an entity that is controlled by another entity".
In accordance with the JSE listings requirements, a Reit will be required to distribute 75% of its distributable profits. "Distributable profits" is defined in the JSE listings requirements as gross income, as defined in the Income Tax Act, less deductions and allowances that are permitted to be deducted by a Reit in terms of the act, other than the qualifying distribution as defined in section 25BB of the act.
Mr Vogelman said property companies often had assessed losses derived from "pre-production interest", property allowances or the interest costs associated with high gearing. It was not clear from the Reit-listings requirements whether such losses may also be taken into account in determining the "distributable profits" of a Reit.
"The Reit legislation may give rise to tax exposure for a property company to the extent that it enters into any hedging arrangements, for example, interest rate swaps in respect of its funding."
In terms of the Reit legislation any hedging gains would be considered to be income and may have to be distributed by the Reit in order to comply with the requirement that at least 75% of distributable profits must be distributed.
Under the legislation, dividends received by a Reit or a CPC on shares other than shares in a CPC or Reit, would be included in the Reit’s income. In order to avoid paying tax on such amounts, the Reit would have to distribute such amounts to its shareholders.
"The shareholders will be subject to income tax on such distributions (assuming that they are not exempt).
"In addition, the underlying entities in which the shares are held would in all likelihood have been subject to income tax on the profits which were distributed. As a result, effective double taxation may arise."
On the basis of the wording of the Reit legislation, he said there may be a risk that a buyback transaction entered into by a Reit or a CPC may give rise to a deduction being denied and the repurchase price being taxed as income in the hands of the shareholders.
Should a Reit or a CPC dispose of all of its assets and distribute the profits to its shareholders, it will effectively have the result that the capital gains (which are exempt in the Reit) become subject to income tax in the hands of the non-exempt resident shareholders.
Mr Vogelman said if a property company declared a dividend in a year of assessment and then was taken over by a Reit and became a CPC, there was a risk on the basis of the wording of the Reit legislation. Shareholders who received the dividend would be subject to income tax on such a dividend, despite such a company only becoming a CPC after the dividend was received.