One of the welcomed aspects that is dealt with in the latest draft of the Taxation Laws Amendment Bill, 2012 (Bill) is the introduction of the long-awaited Real Estate Investment Trusts (REITs). Should one consider the current structure that is used by property investment vehicles, it either comprises of:
· a property unit trust (PUT);
· property loan stock (PLS); or
· variable loan stock (VLS) structures.
The majority of the property structures in South Africa currently make use of the PLS/VLS structure in circumstances where investors acquire a so-called linked unit, that comprises of a share and a debenture that is issued by the company. In the draft explanatory memorandum to the Bill, it is indicated that there are currently over 20 listed entities operating as a PLS and less than 10 entities that operate as a PUT.
A PUT is a portfolio of investment growth properties that is held in the form of a trust and managed by an external company, being the manager. The PUT is governed by the trust deed in circumstances where investors acquire units in the trust. The holder of a PUT does not have any voting rights and the management of a PUT can only be changed with the assistance of the Financial Services Board (FSB). From a tax perspective, a PUT acts as a conduit on the basis that the investors are taxed on the distributions on the basis of these distributions constituting ordinary revenue. The net effect is that the rental income received by the PUT is effectively only taxed in the hands of the investors.
Should one compare a PUT with a PLS/VLS, the latter is a company on the basis that investors hold a linked unit on the basis that the debenture element of the linked unit comprises 99% of the value attributable to the debenture. The terms of the debenture are incorporated in a debenture trust deed and the trust deed provides for the distribution of most of the rental income of the PLS/VLS by means of 'interest'. Effectively, the interest deduction that is then claimed by the PLS/VLS results in the PLS/VLS not having substantial net income. The downside of making use of a PLS/VLS, is that the effective interest rate in respect of the debentures can sometimes be very high, and it creates the risk that the interest deduction is not allowed in the PLS/VLS on the basis of it being excessive. In the explanatory memorandum to the Bill it is indicated that the "excessive level of interest" makes this form of interest questionable in tax terms. The on-going acceptance of the dual linked structure is also problematic from a tax policy perspective.
In order to cater for the introduction of REITs, the entity must be listed with the JSE. In order to obtain such REIT listing, the following criteria must be met:
· The REIT must have a minimum amount of assets comprising interest in immovable property, interest in a lease relating to immovable property, interest in a property subsidiary or holdings in another REIT.
· The REIT must solely invest in immovable property assets and collateral debt instruments and hedges used to reduce the risk associated with property-related loans.
· The REIT must distribute most of its profits on an annual basis.
· The REIT must not have excessive borrowings in relation to the total gross asset value of immovable property held by it.
Given that a unified regime for property investments is now proposed, the tax consequences will be that a REIT will be exempt from capital gains tax. The holders of the interests in the REIT will be subject to tax (generally a capital gain). Receipts and accruals in respect of a financial instrument such as dividends, the disposal of shares and bonds and derivatives will be taxed as ordinary revenue. No regard will be had to any exemption that would otherwise apply. The distributions made by the REIT will be fully deductible from the ordinary revenue thereof on the basis that the recipients will be taxed thereon. The deduction will only be allowed if the distribution arises from income and receipts earned by the REIT within the current or the immediately prior year of assessment. The deduction will only be allowed to the extent that the total gross rentals received or accrued by the REIT is at least equal to 75% of the total gross receipts or accruals. If not, the distribution is treated as a dividend.
It is noted that no specific provisions have been inserted dealing with the conversion of a PUT or a PLS/VLS into a REIT. It is trusted that this legislation will also be introduced as it is expected that the property industry will immediately make use of this kind of structure. Effectively, investors will be taxed on the net rental income received by the REIT on the basis that the REIT would operate in a similar fashion than a portfolio of a collective investment scheme in securities, such as being exempt from capital gains tax.
Written by Prof Emil Brincker, Director and National Tax Practice Head, Cliffe Dekker Hofmeyr