COVID-19 and REITS: Some considerations
14 May 2020
If we rewind pre-COVID 19 and pre-recession, most REITs were continuously making maximum dividend declarations vying for shareholder affection. REITs have not, however, been spared the effects of South Africa’s stagnating economy and COVID-19’s impact on global trade.
REITs are likely to retain at least some of their profits and cash resources to weather this storm, although property valuation levels are likely to dip, impacting a REIT’s balance sheet gearing levels. What does a reduced distribution and compromised balance sheet mean for a REIT and its unique income tax treatment?
JSE and other authorised exchanges regulations and Income Tax Act requirements essentially require a REIT to distribute at least 75% of its distributable income, and to maintain a healthy gearing level to retain REIT status. A REIT is further required to maintain a rental income level of 75% of its gross income.
Losing REIT status would among other things mean a property company will:
- once again be liable for capital gains tax (CGT) on the disposal of properties, which would also necessitate reinstating deferred tax liabilities previously abandoned
- not be able to deduct dividends declared to shareholders for income tax purposes and
- subject its shareholders to dividends tax.
These requirements are not insurmountable in many instances provided a REIT correctly navigates its way through the precise regulatory and legislative requirements, which needs to be considered on a case-by-case basis.
If a REIT is able to successfully retain its REIT status while reducing or limiting the level of distributions made, it will be left with a cash tax bill to settle to SARS. The REIT should then consider a number of tax aspects in managing its resources while remaining compliant with legislative and SARS requirements.
These would include the following:
- Making adequate provisional tax payments to ensure the 80% threshold is met;
- Paying very close attention to tax deductible items which may have been glanced over previously. Such items may include:
- Wear and tear allowances deductible under section 11(e) on qualifying assets. REITs are not prohibited from claiming these, but the benefit must be weighed up against potential recoupments down the road
- Renewable energy installation cost deductions
- Prepaid expenditure
- Section 24C allowances
- Doubtful debt allowances (SARS can be approached for higher percentage doubtful debt deductions in certain instances) or
- Paying staff bonuses by year end, as opposed to just providing for this.
- Disposing of assets to increase liquidity. While REITs are exempt from CGT on the disposal of qualifying assets, it should be remembered that REITs are not exempt from income tax. Profits realised on the disposal of assets acquired, held or disposed of for the purpose of making a profit will fall outside of the CGT web and rather be subject to tax at 28%. REITs should caution against crossing the proverbial Rubicon when deciding to dispose of assets to not fall into this trap.
- Certain REITs may have retained assessed losses from the pre-REIT tax regime which may now come in handy.
BDO is perfectly positioned to assist any REIT in navigating its way through these considerations and decisions relevant in these trying times.
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