Reits: Time to end tax breaks?

A slew of tax incentives 10 years ago fuelled the growth of Real Estate Investment Trusts or Reits in Singapore. It's time to retire some of them.

As people gear up for Budget 2015, one low-profile but important tax sweetener is being monitored quietly by investors and analysts.

This is the slew of tax incentives for the Singapore Reit market introduced in 2005, and renewed in 2010. They expire on March 31 this year, unless renewed in this Budget.

If the tax breaks are removed come April 1 in the new financial year, they could have an impact far beyond that on a few S-Reit funds and their direct investors.

For S-Reits, as they are called, are big owners of Singapore's shopping malls, commercial buildings and factories. How they adjust their way of doing business as a result of any tax changes may have an impact on business costs and that may, in turn, have a bearing on our costs of living.

Reits are "closed end" funds which invest in income-generating real estate assets. What makes them so alluring to investors is their tax-efficient structure.

If they pay out at least 90 per cent of their income as dividends, Reits are exempt from paying any income tax. Individual investors are also exempt from paying tax on the dividend they receive.

Tax incentives were launched 10 years ago to encourage the set-up of more S-Reits as well as to attract more foreign institutional and corporate investors to invest in the S-Reit market.

The incentives were given for five years initially, but they were extended in 2010 for a further five. In 2005 when the tax incentives were introduced, there were only five S-Reits with a total market value of about $9 billion.

Since then, the market has grown: there are now 28 Reits and six stapled securities - involving a Reit "stapled" to other forms of investment - with a total market capitalisation of $67 billion.

The market consensus is that the tax incentives will be renewed for another five years.

As DBS Vickers noted, competition posed by other countries in developing their own Reit markets makes a case for renewal. It said: "These tax incentives are key attractions which made Singapore one of the leading Reit hubs in the Asia-Pacific region. In addition, Singapore needs to stay ahead, given that India, Thailand and China have been fine-tuning and instituting their own Reit regulations to draw in capital investments."

However, a few analysts beg to differ. Nomura analyst Sai Min Chow said in a report that the renewal may not be a given, given the need to fund more social spending.

Others say the Government should not give a carte blanche extension on all the 2005 tax incentives offered to the S-Reit sector.

Ripe for removal

IF ANY incentives should go, the top one is the stamp duty concession given to Reits which has made it cheaper for them to acquire properties here.

Right now, stamp duty is waived for the purchase of properties by Reits IPO aspirants, or Reits already listed in Singapore.

This encourages companies owning properties to inject them into a Reit and spin it off as a separately listed firm without incurring the pain of paying a 3 per cent stamp duty to make the transfer on the properties.

Analysts say the stamp duty waiver also makes Reits more aggressive in acquiring properties here, as they take advantage of the tax incentive. Their gripe - rightly or wrongly - is that in order to make their purchases pay off, Reits then jack up rentals on the acquired properties. This, in turn, drives up the costs of doing business in Singapore.

So removing the stamp duty may dampen the appetite for S-Reits to tote up more property purchases here and, hopefully, soften the market for commercial buildings and malls, stopping rental appreciation.

Incentives that can stay

WHAT about other incentives that Reits enjoy?

Individual investors - local or foreign - do not pay any taxes on the dividends from their S-Reit investments. Corporate investors are taxed at their respective tax rates on Reit income, unless they enjoy an exemption.

However, to lure foreign non-individual investors to invest in S-Reits, the withdrawing tax on Reit dividends received by them was reduced to 10 per cent in 2005 for a period of five years and renewed in 2010 for another five years.

Mr Leonard Ong, a tax partner with audit firm KPMG, expresses concern that removing this tax incentive in the next Budget will likely see a lower net dividend payout for this class of investors and make S-Reits a lot less attractive to them. "This may cause some of them to exit their S-Reit investments and cause a significant drop in market value, if the exodus is en masse," he said.

The same argument applies on the tax exemption which S-Reits enjoy on the income which they earn on their foreign properties.

Such rental income is already subject to taxation in the country where the foreign property is located. When the income is remitted back to an S-Reit in Singapore, it does not suffer a second round of taxation, subject to certain conditions being met.

If this exemption is not extended, an S-Reit making fresh foreign property acquisitions after March 31 could potentially suffer double taxation on the same overseas rental income it earns.

But not all analysts think the same way. One corporate lawyer thinks over-reliance on S-Reits to spur investor interest in the stock market is unhealthy: "We have a lot of Reits already. It is time that the Government put our tax incentives to work in other areas to attract other asset classes to give greater depth to the SGX."

So whatever the Finance Minister announces on Feb 23, Budget Day, it would be wise for S-Reit investors not to assume that the status quo will remain. As the recent move by the Monetary Authority of Singapore to slow the appreciation of the Singdollar shows, policymakers can spring surprises.


This is the first of a three-part series on issues relating to Budget 2015.