REIT taxation structure may bring benefits to Investors

The adoption of the REIT structure, which is recognised in most of the key property markets internationally, may bring benefits to investors enjoying more tax relief on their interest income and dividends.

The adoption of the REIT structure, which is recognised in most of the key property markets internationally, may bring benefits to investors enjoying more tax relief on their interest income and dividends.

Real Estate Investment Trusts (Reits) are the globally preferred investment vehicle for listed companies that own and manage rental properties.

The JSE adopted the model this year to unify the taxation of these companies. "There was a lot of uncertainty regarding the tax treatment of property loan stock companies because the interest paid was so high in relation to the original issue price of the debenture," Webber Wentzel head of tax Mark Linington said earlier this week.

Previously, a property loan stock would receive rental income that it distributed mostly in the form of debenture interest. The company was allowed a deduction and the interest was taxed in investors’ hands. The property loan stock then paid tax on profits, after the deduction, at the company tax rate of 28%.

If the company paid dividends, a withholding tax of 15% would be levied and the investor would receive an exemption. The company would not get tax relief on the dividend. BDO head of income tax technical David Warneke said this was an effective rate of 38.8% for investors.

The Reit model pays pretax distributions, which are allowed as a deduction. Interest and dividends are taxed in investor hands. Dividends from a Reit are deemed normal income in the hands of a South African resident investor and will be taxed at the marginal tax rate applicable to that investor.

Interest received from a Reit is deemed to be a dividend and will also be taxed as normal income.

Depending on the investor’s income threshold for tax purposes, they could receive a tax benefit. "Investors may pay tax at less than 38.8%. So they may be better off," Mr Warneke said. He also said tax treaties may provide relief for foreign investors who pay dividends tax at 15%.

For an investor paying tax at the highest threshold of 40% there are other benefits. Reits are exempt from transfer duty and capital gains tax.

"This gives them the ability to trade out of mature properties without suffering any tax which is a benefit to investors," Edward Nathan Sonnenbergs associate Alexa Muller said.

However, investors will no longer get the interest exemption on interest income.

Natural persons under 65 were allowed a R23,800 total exemption and R34,500 for those older.

Java Capital founding director Andrew Brooking said very few property firms paid a dividend as they distributed most of the rental income, so the net tax position is neutral.

"Investors lose the exemption and Reits have a capital gains exemption," he said.

However, Mr Brooking said the rollover tax relief investors get when exchanging property for shares in a Reit, is beneficial. "This will make the model more attractive to investors," he said.