27 August 2020 by Tax & Exchange Control Alert

New tax legislation proposed for REITS

The 2020 National Budget Speech (Budget) delivered by the Minister of Finance (Minister) contained various tax policy proposals including those aimed at refining the Real Estate Investment Trusts (REITs) tax regime. The proposals included clarifying the definition of REITs and the meaning of a share in the definition of REITs. For an overview of these proposals see our Special Budget Alert of 26 February 2020. The Budget also proposed amending the provisions regarding the taxation of foreign dividends received by REITs which we discussed in a little more detail in our Tax Alert published on 13 March 2020.

On 31 July 2020, National Treasury (Treasury) and the South African Revenue Service (SARS) published for public comment, amongst others, the 2020 Draft Taxation Laws Amendment Bill (Draft TLAB) which included the relevant proposals relating to REITs in the current legislative amendment cycle. This article provides an overview of the proposed amendments.

Amending the participation exemptions in respect of REITs

Section 10B(2) of the Income Tax Act 58 of 1962 (Act) contains what is generally referred to as the “participation exemption”. Section 10B(2) provides that any foreign dividend received by or accrued to a person must be exempt from normal tax if that person (whether alone or together with any other company forming part of the same group of companies as that person) holds at least 10% of the total equity shares and voting rights in the company declaring the foreign dividend.

Currently, where a REIT holds at least 10% of the equity shares and voting rights in a foreign company and foreign dividends are received by the REIT in respect of those shares, the foreign dividend will be included in the gross income of the REIT but will be exempt from normal tax as it will fall within the “participation exemption” in terms of section 10B(2). Furthermore, when the REIT makes a distribution to its shareholders of the foreign dividend income, the distribution will constitute a qualifying distribution, and will thus be deducted from its income in terms of section 25BB(2).

With reference to the Draft TLAB, Treasury now proposes that in order to address this mismatch, whereby a REIT or controlled company gets a full deduction when it on-distributes profits from exempt foreign dividends, a REIT or controlled company should not qualify for the “participation exemption” in respect of foreign dividends in terms of section 10B(2).

Interestingly, while Annexure C in the Budget made no mention of the corresponding “participation exemption” in respect of foreign capital gains, the proposal in the Draft TLAB extends the amendment to foreign capital gains ordinarily disregarded in terms of paragraph 64B of the Eighth Schedule to the Act. In this manner, it is proposed that REITs shall not qualify for the capital gains tax “participation exemption” on the disposal of shares in foreign companies.

Clarifying the meaning of a share in the definition of a REIT

In order to qualify as a REIT, the shares of the company must be listed on an exchange (e.g. the JSE) as defined in the Financial Markets Act 19 of 2012 (FMA) and licensed under section 9 of the FMA. Treasury has identified that some REITs are considering issuing and listing preference shares on a recognised exchange, which Treasury indicates is against the policy rationale of the REITs tax dispensation. The explanatory memorandum on the Draft TLAB states that this is due to the fact that holders of preference shares were never intended to benefit from the REITs tax dispensation because preference shares are mainly used for financing, and not to provide full equity exposure to investors.

Treasury therefore proposes that clarification be provided by specifically excluding non-equity shares from the shares that must be listed on a recognised exchange for purposes of the REITs special tax dispensation.

In accordance with the Annexure C Budget proposals, the Draft TLAB also proposes amending the definition of a REIT by changing the approval of listing requirements by the appropriate authority under the FMA. Previously the definition referred to consultation with the Minister and it is now proposed that the Minister will be substituted by the Director General of National Treasury in order to ease the administrative burden on the Minister. Lastly, a further amendment is proposed to the definition of REIT to bring it in line with the “Twin Peaks” model of financial sector regulation in South Africa.

Clarifying the tax treatment of doubtful debts for taxpayers conducting a leasing business and applying IFRS 9 for financial reporting

Currently all taxpayers conducting a leasing business and applying International Financial Reporting Standard 9 (IFRS 9) for financial reporting purposes cannot claim a doubtful debt allowance by virtue of the fact that lease receivables are specifically excluded from the doubtful debt provision in section 11(j) of the Act. The explanatory memorandum on the Draft TLAB explains that this exclusion was initially inserted on the basis that IFRS 9 lease receivables include all lease receivables even to the extent that the amount has not been received by or accrued to the lessor. There would therefore be an anomaly in that one would be able to claim a doubtful debt allowance in respect of an amount that had not been received or accrued for tax purposes, albeit that it had been impaired for accounting purposes.

However, the explanatory memorandum to the Draft TLAB explains that lease payments (in arrears) are in fact similar to other amounts that qualify for a doubtful debt allowance in terms of the provisions of section 11(j) of the Act. In addition, taxpayers not applying IFRS 9 for financial reporting purposes are able to claim a doubtful debt allowance in respect of in arrears lease payments, depending on the period that it has remained unpaid.

Treasury now proposes that changes be made to both section 11(j) and section 11(jA) so that taxpayers applying IFRS 9 for financial reporting purposes are allowed doubtful debt allowances in respect of lease receivables that have accrued to them but not in respect of future lease amounts.

REITs generally should not have any significant taxable income given their conduit nature, and therefore the section 11(j) doubtful debt allowance would generally not be of much significance. However, the proposed amendment may assist REITs under certain circumstances.

Public consultation process

The proposals set out in the Draft TLAB and explained in the explanatory memorandum thereto are still in draft form and must still undergo the standard public consultation process. The deadline for public comments on this round of the draft bills is upon us, being 31 August 2020.

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