The provisions in the Income Tax Act No. 58 of 1962 ("the Act") pertaining to the taxation of Real Estate Investment Trusts ("REITs") are contained in section 25BB and were introduced into the Act with effect from 1 April 2013.
Deduction of "qualifying distributions"
A REIT is a resident company which shares are listed on an exchange as shares in a REIT (as defined in the JSE Listings Requirements). Essentially, section 25BB allows for a "qualifying distribution" to be made by a REIT or a controlled company (a company that is a subsidiary of a REIT) for which the REIT or controlled company (that is a resident) gets a deduction from its income for the year of assessment to which that qualifying distribution relates.
Broadly speaking, a "qualifying distribution" means dividends paid or payable by the REIT or a controlled company or interest incurred in respect of debentures that form part of a linked unit in that company where 75% of the gross income of that company consists of "rental income". "Rental income" is amounts received or accrued in respect of immovable property, a dividend from a REIT, a qualifying distribution from a controlled company or a dividend or foreign dividend from a company that is a "property company".
A "property company" is a company in which 20% or more of the equity shares or linked units are held by a REIT or a controlled company and of which, at the end of the year of assessment, 80% or more of the value of the assets reflected in the financial statements for the previous year of assessment, is directly or indirectly attributable to immovable property. The definition of "property company" previously required that the financial statements must have been prepared in accordance with the Companies Act No. 71 of 2008 ("the Companies Act"). There has been a recent amendment to the definition of "property company" in the Taxation Laws Amendment Act No.43 of 2014 ("TLAA 2014") which allows the financial statements to also be prepared in terms of International Financial Reporting Standards ("IFRS"). The reason for the amendment is that foreign companies will not prepare annual financial statements in accordance with the South African Companies Act since this act does not apply to a foreign company. Accordingly, all companies incorporated in foreign jurisdictions were previously excluded from the definition of "property company". The amendment now makes it clear that a foreign dividend from a foreign company preparing its financial statements in accordance with IFRS should also be from a "property company" (provided the other requirements of the definition of "property company" are complied with) and therefore constitute "rental income" in determining whether a REIT or controlled company can make qualifying distributions.
The deduction that may be made by a REIT or a controlled company in respect of qualifying distributions may not exceed the taxable income for that year of assessment of the REIT or controlled company before taking into account any deduction in terms of section 25BB, any assessed loss brought forward and the amount of taxable capital gain included in taxable income.
Capital gains of a REIT or controlled companies
In determining the aggregate capital gain or aggregate capital loss of a company that is a REIT or a controlled company on the last day of a year of assessment, any capital gain or capital loss determined in respect of the disposal of:
- immovable property of a company that is a REIT or a controlled company at the time of disposal;
- a share or a linked unit in a company that is a REIT at the time of that disposal; or
- a share or a linked unit in a company that is a property company at the time of that disposal,
must be disregarded.
The requirement that the company must be a REIT or a controlled company at the time of disposal was introduced by the TLAA 2014 with effect from its promulgation (20 January 2015), and is applicable in respect of years of assessment ending on or thereafter. Previously, this requirement was not included and therefore a REIT or controlled only had to be a REIT or controlled company at the end of the year of assessment to qualify for the relief.
Further specific provisions
There are a number of further specific provisions dealing with the taxation of REITs and controlled companies, including, inter alia, provisions dealing with the receipt or accruals by a REIT or a controlled company in respect of a financial instrument, the disallowance of deductions in respect of immovable property and specific rules in respect of the receipt or accrual of amounts of interest in respect of debentures forming part of a linked unit.
Implications for investors
On the investor side, the dividend received by or accrued to the investor in the REIT will, however, not be exempt from income tax in terms of the ordinary dividend exemption provisions. Any amount of interest received by or accrued to an investor in respect of a debenture forming part of a linked unit in a REIT or controlled company must be deemed to be a dividend received by or accrued to that investors. The provision dealing with the receipt or accrual of interest previously referred to a linked unit in "a company". The TLAA 2014 introduced the amendments to clarify that what is envisaged is a linked in a REIT or a controlled company. This amendment is deemed to have come into operation on 1 April 2013, and applies in respect of years of assessment commencing on or after that date.
Accordingly, the investor will be taxed on the distributions received or accrued from the REIT or controlled company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.