by Mike Teuchert, national head of taxation at Mazars
The introduction of the real estate investment trust (REIT) legislation, which came into effect from 1 April 2013, has given rise to a substantial REIT industry. To date, there are just under 30 REITs listed on the Johannesburg Stock Exchange (JSE), with an overall market capitalisation of close to R400 billion. These range from market capitalisation in excess of R70 billion for the largest REIT to under R3 billion for the smaller counterparts.
From an income tax perspective, to qualify as a REIT and to maintain this status, a number of requirements must be fulfilled on an ongoing basis. Where these criteria are not met, the company will cease to be a REIT.
This can occur when the exchange removes the REIT status, the REIT applies to the exchange to have its status removed or when it does not meet the income tax requirements. In particular, the JSE rules require, inter alia, that the distribution requirement, as laid out in the Income Tax Act, is complied with for the last two consecutive years. The distribution requirement necessitates that at least 75% of the income in the preceding year must consist of rental income.
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The definition of rental income includes a dividend from another REIT, a qualifying distribution from a controlled company, a dividend from a property company and certain allowances recovered that were previously granted. It is important to note that rental income does not include any gains made on the disposal of immovable property.
Where a REIT loses its status, the income tax consequences should be considered from the REIT and shareholder perspectives.
On the day that a company ceases to be a REIT, the year of assessment of the REIT is deemed to end and the following year of assessment will commence on the following day. In addition, the company will be subject to income tax under the general rules applicable to its legal form.
Where its legal form is that of a company it will be taxed at a rate of 28% on its taxable income as determined for companies without considering the special tax rules applicable to REITs. Dividends that are paid to shareholders will not rank as a deduction against taxable income and will attract dividends tax.
For trusts, any income that is not distributed to beneficiaries will be taxed at a flat rate of 45% in the trust’s hands. Where the net income is distributed to beneficiaries during the tax year that it is received, the net income will be taxed in the respective beneficiaries’ hands in the form that it was received by the trust, for example, rental, interest income or capital gain.
In addition, the now defunct REIT will be subject to capital gains tax on the disposal of immovable property, which was not the case when it qualified as a REIT. On the other hand, certain allowances that are normally deductible by property owning entities will now be claimable, whereas under the REIT regime these were not.
From a local non-corporate shareholders perspective, any dividends received will be subject to the 20% dividends tax. For resident corporate shareholders, they could qualify for an exemption from the dividends tax. For non-resident shareholders, they would, subject to Double Tax Agreement relief, still be subject to dividends tax at 20%.
The cessation of being a REIT could have major income tax implications for a REIT and the beneficial holders of its shares. It is therefore critical that the requirements are consistently monitored to avoid any adverse tax consequences.