“Real estate investment trusts” by Veronica A. Santos (May 24, 2010)
SUITS THE C-SUITE By Veronica A. Santos
Business World (05/24/2010)
Republic Act No. 9856 introduced a new legal creature which goes by the term, “real estate investment trust,” or REIT.
Despite its name, a REIT is a corporation that will issue shares, not trust certificates, to investors.
True to its provenance, REIT shares are intended to be alternative investment instruments which provide higher, more stable yields, compared with dividends on other listed securities and returns on direct investments in real estate.
A REIT is different from an ordinary corporation because it is subject to the regular corporate income tax only on its “taxable net income,” which is what is left after business expenses (and other allowable deductions under the Tax Code) and dividends distributed to shareholders (out of its distributable income as of the end of the taxable year) are subtracted from its gross income.
Therefore, the amount which would actually be distributed to a REIT shareholder would not have suffered income tax at the REIT level. If the shareholder is a domestic corporation or a Philippine branch of a foreign corporation, then there is likewise no tax on such dividends at the shareholder level. A shareholder who is an overseas Filipino investor will not be subject to withholding tax on dividends paid by the REIT, but only for a period of seven years from the date of effectivity of the implementing rules and regulations (IRR).
A 10% withholding tax on dividends is imposed on all other shareholders, unless, in the case of a nonresident shareholder, a lower rate under an applicable tax treaty is invoked.
The REIT, however, may continue to enjoy this tax regime only under the following circumstances:
• first, it maintains its status as a public company as defined in Section 8.1 of the law;
• second, it maintains the listed status of its securities on the exchange; and
• third, it distributes at least 90% of its distributable income to its shareholders.
The law allows for a “curing period” as may be prescribed in the IRR in case of failure to meet the listing, public ownership, or dividend payout requirement. The terms of such curing period should take into account the possibility, however remote at the time of the formation of the REIT, of an economic downturn during which a REIT will not have distributable income and instead will have only operating losses that can be carried over for only three years.
A REIT is different from a real estate company in that it can undertake property development activities only if it intends to hold the developed property upon completion; provided, however, that the value of such activities and its investments in uncompleted property developments do not exceed 10% of its deposited property, i.e., the total value of its assets.
At least 75% of the deposited property of a REIT must be invested in, or consist of, income-generating real estate. This means that a REIT has to acquire from real estate companies such income-generating real estate as malls, office buildings, or warehouses.
Notably, the REIT law provides no incentive for such transfer, except for a lower documentary stamp tax (DST) equivalent to 50% of what is provided in the Tax Code, and a 50% reduction on applicable registration and annotation fees.
The REIT should list on the exchange within two years from availment of these incentives; otherwise, the entire amount of the DST would be due and the REIT would be subject to the applicable penalties and interest, computed from the date the full amount of the DST should have been paid.
Conceivably, a transfer of property to a REIT will be structured as a tax-free exchange under Section 40(C)(2) of the Tax Code. Under this structure, the REIT will issue at least 51% of its voting shares to the transferor (or transferors, provided there are no more than five transferors) as consideration for the transfer.
Since the transferor gains control of the REIT, the transferor will not recognize any gain on the transfer and will not be subject to income tax, withholding tax, or capital gains tax.
However, the REIT, as transferee, will have the same cost basis in the property as the transferor.
While the transfer of the property will also not be subject to DST, the issuance of shares by the REIT will be taxed.
If the transferor has been holding such property for rent or sale, it remains to be seen whether the Revenue Regulations to be issued by the Bureau of Internal Revenue (BIR) will treat both the transferor and the REIT (as transferee), as real estate dealers. If so, then under existing rules, such tax-free transfer will not be subject to the 12% value added tax (VAT).
If the Revenue Regulations provide that the transfer of property to the REIT will be subject to VAT, then the transferor will pass on the VAT to the REIT, which will then have excess input VAT assets.
Since the VAT is based on the higher of the selling price or the fair market value of the real property, the implications of the substantial VAT passed on to the REIT have to be taken into account.
A REIT is different from an ordinary listed company since it should have, upon listing, minimum public ownership consisting of at least 1,000 public shareholders each owning at least 50 shares of any class of shares. These public shareholders must, in the aggregate, own at least one third of the outstanding capital stock of the REIT.
The term “public shareholder” is defined in the law, and excludes, by definition, entities such as the sponsor or promoter of the REIT; a director, principal officer, or principal shareholder of the sponsor or promoter of the REIT; a director, principal officer, or principal shareholder of the REIT; and certain other persons and corporations related to, or working for, these entities.
The law also requires that the percentage of the dividends received by the public shareholders to the total dividends distributed by the REIT should not be less than their percentage of ownership of the outstanding shares of the REIT.
In determining what types of payments constitute dividends, the IRR, as well as the Revenue Regulations to be issued by the BIR, will have to consider the definition of dividends not only under Philippine law but also under Philippine tax treaties.
REITs, either in trust or corporate form, have been in place in Thailand since 1992, Singapore since 1999, Japan since 2000, South Korea since 2001, Hong Kong and Taiwan since 2003, and Malaysia since 2005.
Among the more successful REIT markets are those in Japan and Singapore, largely because they allow their REITs to bypass corporate income tax on amounts distributed to investors. Their regimes also allow a reduction of taxes on the transfer of properties to their REITs.
While Asian REIT markets were affected by the global crisis in the capital markets, they are positioned for a rebound and we should at least make sure that Philippine REITs manage to be competitive and capture the investor funds flowing into this sector.
While the formation of a REIT is beset with structural challenges, we look forward to the issuance of the IRR and the Revenue Regulations that will provide the clarity and direction sufficient to jump-start our entry into play.
Once again, we have to catch up with our Asian neighbors who have been tackling REITs for at least a decade.
(Veronica A. Santos is a Transaction Tax Principal of SGV & Co.)
This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.