What are Real Estate Investment Trusts (REITs) and how do they fit into your investment portfolio?

What are Real Estate Investment Trusts (REITs) and how do they fit into your investment portfolio? With all the buzz on the landmark KL Pavillion REIT unveiled just end of last year, we chart the growth of REITs in Malaysia and unfold the story with the help of Jennifer Chang, Senior Executive Director of PwC Malaysia.

In 1989, the Amanah Harta Tanah PNB (AHT) debuted on Bursa Malaysia as the first listed property trust in Malaysia with the Amanah Harta Tanah PNB 2 (AHT2) and Arab Malaysian First Property Trust (AMFPT) after it. Malaysia is among the first in Asia to develop listed property trusts that encouraged small-time investments in the local property sector. Subsequently, the Government announced more incentives and provisions in the annual Budget to boost this sector. These set the scene for what is known today as Real Estate Investment Trust funds or REITs with the first REIT on Bursa Malaysia being the Axis REIT in 2004.

December 2011 saw the 14th and only premium REIT in Malaysia, the Pavilion REIT, listed on Bursa Malaysia, with the iconic Pavilion KL injected as its most valuable asset.
Though structurally similar to unit trusts, REITs are normally traded through stock exchanges. It provides returns to investors through capital appreciation from price changes and annual distributions from investment income such as rental. As a REIT holds rental properties, its main income is from rental - usually malls, offices, hotels or industrial buildings. Rental is a fairly consistent source of income, so if a REIT pays out at least 90% of its taxable profit as distributions to investors, the income stream should be fairly consistent, making REITs very attractive income-generating assets.

Favourable Tax Treatments

The Government has been progressively introducing tax incentives to promote the capital market, including REITs, which is reflected in the fact that most income earned by unit trusts and REITs are exempted from income tax. For example, interest on bonds, fixed deposits with licensed banks, gains on sale of investments and foreign sources of income are not taxed when received by unit trusts and REITs. Besides that, tax on moving of properties is also specifically exempted.

When a Malaysian REIT acquires properties, it also does not have to pay stamp duty, normally fixed at a maximum of 3% of the property purchase price. Likewise, sellers of such properties do not have to pay real property gains tax (RPGT).The RPGT levy is usually 10% on gains from the disposal of the property sold within two years of purchase and 5% if sold within two to five years. This represents huge savings to the REIT as well as to the seller of the properties.
In fact, Malaysia was the first country to provide zero tax moving costs to REITs and property sellers, with our southern neighbour, Singapore, following suit to promote their REIT market. Although some REITs may not state a distribution policy of at least 90% of its current year income, the tax structure may actually encourage REIT managers to do so.

Similar to other countries with a thriving REIT market, the Malaysian tax system has provided for tax transparency to Malaysian REITs. What this means is that as long as a Malaysian REIT distributes at least 90% of its current year taxable income, the REIT will be treated as tax transparent and would not be levied a 25% income tax. This will allow a REIT to declare and distribute income to investors on a gross basis.

Withholding Tax Mechanisms for Greater Transparency

As REITs are normally listed entities, REIT investors can be Malaysians, foreigners, individuals, companies or collective investment vehicles (such as investment funds). Where REIT distributions are made without the REIT paying a 25% income tax, Malaysian tax authorities would have a tough time tracking payment of taxes by investors on such distribution income. This is especially since it is quite common for investors in a listed entity to change periodically over the stock exchange.

As such, a withholding tax mechanism has been introduced as part of the tax transparency system where the REIT manager has to deduct withholding tax based on the profile of each investor. After declaring the distributions to investors, the REIT manager would then have to determine who the investor is and deduct the appropriate withholding tax. The Malaysian tax system has provided for the following rates of withholding tax based on the profile of the investor:

Malaysia has withholding tax levied on payments such as interest, royalties, lease payments and technical fees made to non-residents. This mechanism ensures that the appropriate tax is collected on recipients of income where the level of tax submission and compliance may be uncertain. Most countries have some form of withholding tax mechanism within their tax system and withholding tax on REIT distributions is nothing new. Countries like Singapore, the United States, Canada, Australia, Japan and Germany all have some form of withholding tax mechanisms on REIT distributions as well.

In comparing withholding tax rates around the world, the withholding tax rate on REIT distributions by a Malaysian REIT is lower than most countries, except Japan and Singapore. For example, Singapore levies a withholding tax of 10% on distributions to non-resident non-individuals, while individuals pay no tax at all.

Although the Malaysian withholding tax rates on REIT distributions is one of the lowest in the world, we will need to reconsider these rates to be as competitive with other regional REITs in Asia. According to former General Electric CEO Jack Welch, ‘an organisation’s ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.’ Similarly, in this competitive economic environment, countries – like companies and organisations - are constantly trying to outdo each other to attract investments. We need to take stock of what other countries are offering and examine how we can offer a more competitive landscape for the market, including enhancing our existing tax incentives to further promote our REITs market.

 

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 Article contributed by Jennifer Chang, a Senior Executive Director with PricewaterhouseCoopers Taxation Services. She is a member of the Institute of Chartered Accountants in Australia, the Securities Institute of Australia and International Fiscal Association. Her extensive tax and financial services experience both in Australia and Malaysia enables her to regularly advise clients on various tax matters including income tax, real property gains tax, stamp duty, service tax, applicable tax incentives and double tax treaties. She can be contacted at jennifer.chang@my.pwc.com.

Published in the February 2012 issue of iProperty magazine.