• REITs: Legislative alignment to commercial reality
Articles:

REITs: Legislative alignment to commercial reality

02 August 2019

Louis van Manen , Director , Tax |

Arguably the most important number for all listed Real Estate Investment Trusts (‘REITs’) is ’75’.   In order to maintain its listing on an approved exchange a REIT needs to distribute to its shareholders at least 75% of its distributable income on an annual basis, which distribution must qualify as a tax deduction.  REITs further need to achieve a 75% ‘rental income’ threshold on an annual basis to qualify for a deduction under section 25BB of the Income Tax Act of distributions made to its shareholders.    Failing to maintain either of the 75% thresholds would quite frankly mean financial suicide for any REIT.

With REIT investors especially valuing sustainable and predictable yields on their investments, REITs which have expanded their operations offshore typically need to hedge themselves against currency fluctuations.  Under current tax legislation exchange gains made on such hedges can negatively impact a REITs ability to maintain the 75% rental income threshold.

The Draft Taxation Laws Amendment Bill of 21 July 2019 (‘the Bill’) contains a positive proposed amendment which should assist REITs in maintaining this threshold, which we definitely welcome.

The proposed amendment aims to eliminate currency gains and losses associated with the hedging of rental income from the determination of the 75% rental income threshold.  The Bill seeks to achieve this by introducing a ‘rental income’ formula which respectively adds exchange gains to, and deducts exchange losses from, the originally defined concept of rental income.  The result of the formula must then be measured against the REITs total ‘gross income’ as defined to assess whether the required 75% level has been attained.

We believe the proposed amendment as it currently reads may need some modification or clarification before it can be enacted however, as the challenge under the current legislation arguably emanates only from currency gains and not currency losses.  As currency losses are not included in a REITs ‘gross income’ to start with, it stands to reason that such losses should not be deducted in determining a revised rental income level.  Such a deduction of currency losses would potentially add to the current problem as opposed to addressing it.

Alternatively, SARS and Treasury are envisaging perfect hedging scenarios whereby a currency loss suffered in a year of assessment is assumed to have resulted in an equal and opposite increase in the Rand denominated level of rental income in the same year.  If this is envisaged the proposed ‘rental income’ formula could make sense. The reality however is that a currency hedge entered into to serve as hedge in respect of an amount of ‘rental income’ may not yield a currency gain or loss which is equal and opposite to a rental income amount in either quantity or timing. We will be communicating this apparent oversight or commercial reality to the legislature’s attention before it issues the final amendment bill for signature.

This proposed amendment is set to apply to years of assessment commencing on or after 1 January 2020.  We believe this is too late and should rather apply immediately or at least with effect from current year of assessment ending on or after that date.

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