Abdul Wahab, Nor Shaipah

Kasipillai, J.

English

Southampton (e-Prints Soton)

14 ACCOUNTANTS TODAY • September 2005COVERReal Estate SectorTAX STIMULUS FORCOMPETITIVE EDGEby Dr. Jeyapalan Kasipillai and Nor Shaipah Abdul Wahab15 September 2005 • ACCOUNTANTS TODAYReal Estate Sector: Tax Stimulus for Competitive EdgeBackgroundThe Government has introduced newfiscal measures to stimulate the growthof real estate investment trusts (REITs)in Malaysia. A REIT is a vehicle thatmobilises funds from unit holders com-prising individuals and companies for in-vestments in real estate. By providinggenerous tax incentives, the liquidity ofthe real estate sector will increase therebyboosting its contribution to the nationaleconomy. Malaysia has recorded spec-tacular growth of 4.9 and 6.5 per cent inthe real estate sector for the years 2003and 2004 (National Product and Expendi-ture Accounts 2003/2004). With the coun-try abandoning its seven-year currencypeg to the dollar for a managed float, thesplendid growth is expected to rise fur-ther in 2005. A flexible currency regimeis good for the real estate segment as itcreates a clearer investment atmospherefor both local and foreign investors.Real Estate Investments Trusts (REITs)and Property Trust Funds (PTFs) werefirst created five decades ago in the US.Although REITs only made their debut inSingapore three years ago, it already ac-counts for two to three per cent ofSingapore’s stock market capitalisation to-day. In Australia, it has reached nearly nineper cent (The Star, 2005). These invest-ment trusts would of course be able to con-tribute significantly to Bursa Malaysia’smarket capitalisation once this new assetclass bodes well with the investing com-munity. They are particularly popular nowas REITs and PTFs in developing countrieshave financially outperformed other eco-nomic sectors in recent years. In this ar-ticle REITS are meant to include PropertyTrust Funds.GuidelinesThe Guidelines on REITs issued by theSecurities Commission on 3 January 2005interpret them as investment vehicles thatinvest or propose to invest at least 50 percent of their total assets in real estate. Aninvestment in real estate may be by wayof direct ownership or a shareholding ina single purpose company whose princi-pal assets comprise of real estate. Theguidelines set out the rules that are to beadhered to by the REITs in order to pro-tect the interests of the investing publicand facilitate their orderly development.These REITs must be approved by theSecurities Commission in order for themto be eligible for the favourable treatmentincluding tax treatment. Failure to com-ply with the rules and regulations mayresult in the delay or cancellation of theapproval.Recent Budget AnnouncementIn the 2005 Budget, the Governmentannounced new tax incentives to promotethe growth of REITs and Property TrustFunds (PTFs) in Malaysia. Prior to theannouncement, a PTF was taxed as a unittrust but with special deductions in theform of capital allowance deductions (seeSection 63A ITA) and a deduction forspecified permitted expenses (Section63B ITA). These two sections (63A and63B) do not apply to a REIT. The amend-ments to the ITA on the tax incentivesfor REIT are covered in the Finance Act2004 (Act 639).In recent months, several public-listedcompanies such as AXIS-REIT, LandmarksBhd, Naim Cendera Holdings Bhd, SunwayCity Bhd and YTL Corporation Bhdlaunched their real estate investment trustfunds and are seeking listing of their REITson the Bursa Malaysia. There are indica-tions to suggest the REITs, once listed, willreceive good response from institutional in-vestors due to their attractive yields.Tax Treatment of the REIT/PTFThe new amendment to the taxation of aREIT is a ‘tax flow through’ treatmentwhereby the REIT will not have to pay anytax on distributed income but instead theunit holder will be subject to tax on the dis-tribution from REIT (Kasipillai J., 2005).This new incentive leaves the REIT in arelatively better position with more incomefor distribution to unit holders. This makesthe REIT more attractive as an investmentoption as compared to other unit trusts,which invest mainly in equities.  Distribution to unit holdersThe new Section 61A ITA exempts theREIT from the payment of tax on theamount distributed to the unit holders inthe basis period for a year of assessment.The balance of the total income that is notdistributed will be taxed at 28 per cent onthe REIT. This means the REIT effectivelypays less tax when it distributes its in-come.In June 2005, the executive director ofAXIS-REIT, Stewart LaBrooy, announcedthat the company expects to distribute atleast 95 per cent of the company’s taxableincome every year to its shareholders (TheStar, 2005). The company floated the firstreal estate investment trust on the mainboard of Bursa Malaysia. He was quotedto have mentioned the following: “We werelooking within the range of 90 per cent to100 per cent dividend payout for investors“A REIT is a vehicle that mobilises funds from unit holderscomprising individuals and companies for investments inreal estate. By providing generous tax incentives, the liquidityof the real estate sector will increase thereby boosting itscontribution to the national economy.”“With the country abandoning its seven-year currency peg to thedollar for a managed float, the splendid growth is expected to risefurther in 2005. A flexible currency regime is good for the realestate segment as it creates a clearer investment atmosphere forboth local and foreign investors.”16 ACCOUNTANTS TODAY • September 2005Real Estate Sector: Tax Stimulus for Competitive Edgeto feel comfortable. There is no point for usto keep the money as it will be taxed andshareholders also want dividends.”  Prior to year of assessment 2005When a REIT receives dividend in-come, the tax credit from tax at sourceis given to the REIT. Capital gains andcertain interest income will continue tobe exempt at the unit holder level. Priorto year of assessment 2005, rental incomereceived by a REIT was treated either asa business or non-business source basedon Section 4(a) or 4(d) of the Income TaxAct 1967. Section 4(a) relates to incomein respect of gains or profits from a busi-ness while Section 4(d) is income in re-spect of rents, royalties or premiums.The former is regarded as ‘active income’eligible for capital allowances while thelatter is regarded as ‘passive income’ andhence not eligible for capital allowancedeductions.  From year of assessment 2005The new Section 63C ITA provides thatincome of a REIT from the letting of realproperty will be treated as a business sourceand hence taxable under Section 4(a) andnot 4(d) ITA. This new section is also effec-tive from year of assessment 2005.As mentioned earlier, rental income fromletting of real property of a REIT receivesspecial treatment from year of assessment2005. There will be limitations imposedunder the new treatment. Normally, Sec-tion 43(2) ITA allows unutilised businesslosses to be carried forward to the follow-ing year or years. Such losses can be off-set from other business profits. However,with regard to the new provisions that areapplicable to REITs, any excess deductionsallowed in arriving at the adjusted incomeand any unabsorbed allowances underSchedule 3 ITA would be disregarded.Losses from letting of properties cannot bededucted against income from othersources of the REIT in the same basis pe-riod. Neither can the rental losses and un-absorbed capital allowances be carried for-ward to the following year of assessmentand used to offset against that year’s rentalincome.Income from all properties of the REITwill be aggregated and treated as a singlesource of income. Expenses wholly andexclusively incurred in the production ofincome will be deductible against the rentalincome under subsection 33(1) ITA. Theremuneration of REIT managers will nowbe deductible since the rental income istreated as a business source but thetrustee’s fee will not be allowed as it doesnot come within the ambit of subsection33(1) ITA.  Real property gains tax exemptionIn the case of a taxpayer who disposesof a property to a REIT and makes achargeable gain, the gain is exempted fromreal property gains tax with effect from 13September 2003.  Stamp duty exemptionThe stamp duty on such transactions wasalso exempted from 13 September 2003.Real Estate Investment Trusts were eli-gible for these exemptions prior to year ofassessment 2005 and will continue to beexempted hereafter.Tax Treatment of Unit HoldersIf the undistributed profits is eventuallydistributed to the unit holders any tax paidearlier by the REIT will be available as atax credit under Section 110 of the IncomeTax Act 1967 in the year of assessment theincome is brought to tax.Individual holders who are resident inMalaysia will be taxed at their respectivescale rates on the income distributed. Thescale rates vary from zero to 28 per centbut the unit holders will be eligible for set-offs under Section 110 ITA. Corporate unitholders receiving income distributed byREITs will be taxed at 28 per cent.Non-resident unit holders who are re-ceiving income distributed by REITs willbe taxed at 28 per cent. With reference toSection 109D ITA, REITs have to deductthe withholding tax upon distributing theincome to non-resident unit holders. The17 September 2005 • ACCOUNTANTS TODAYTable      Income Tax Computation of a Real Estate Investment TrustABC REIT receives the following income: rental, interest and dividends, for the followingtwo years, namely 2005 and 2006.Income Year 2005 (RM) Year 2006 (RM)Rental 15,000 13,000Interest 6,000 3,000Dividend (gross) 7,200 1,200The company distributes RM22,560 and RM20,000 of the total income to the unit holdersin 2005 and 2006 respectively.ABC REIT — Computation of Income Tax PayableThe computation of the tax payable at the REIT level would appear as follows:Details Notes 2005 (RM) 2006 (RM)Section 4(a) Business income (rental) 15,000 13,000Section 4(c) Interest 6,000 3,000Dividend (gross) 7,200 1,200Total income 28,200 17,200Less: Distribution 1 (22,560) (17,200)Chargeable income 5,640 NilTax payable (28%) 1,579.20 NilSection 110 set-off 2 2,016.00 336Tax refund 436.80 336The distribution by the REIT comprises of:Details Notes 2005 (RM) 2006 (RM)Income not subject to tax 22,560 17,200Income subject to tax 3 Nil 2,800Total distribution 22,560 20,000Computation of income tax by unit holdersThe computation of the tax payable at the unit holder level is as follows:Details Notes 2005 (RM) 2006 (RM)Distribution from REIT:  Not subject to tax at REIT level 22,560 17,200  Subject to tax at REIT level Nil 2,800Section 110 set-off 4 Nil 784Notes:1. The exemption on the distribution of the total income in year 2006 is limited to the total income ofthat year (i.e. RM17,200).2. Dividend income forms part of the total income of the REIT in both years. The REIT is, therefore,eligible for Section 110 set-off.3. In year 2006, the total distribution by REIT is RM20,000 and it includes RM17,200 exempt income ofthat year. The remainder RM2,800 (RM20,000 – RM17,200) is from the taxable income in 2005.4. The IRB Guidelines stipulate that the undistributed income of a REIT for any year of assessment,which is subsequently distributed to the unit holders, will be taxed on the unit holders in the year ofassessment that the income is distributed. Moreover, the guidelines specify that Section 110 set-offfor the tax suffered by the REIT would be eligible for unit holders.ATReal Estate Sector: Tax Stimulus for Competitive Edge“REITs offer a good business-restructuring alternative toproperty developers who facefunding constraints. They arestimuli that could boost the realestate sector by way ofincreasing the competitiveedge as compared to the othermajor financial sectors.”tax deducted shall be remitted to IRBwithin one month after distributing suchincome to non-resident unit holders. If thewithholding tax is not complied with, thetax arising will be increased by an amountequal to 10 per cent and will become a debtdue to the Government of Malaysia.An illustration on the income tax com-putation of a real estate investment trustis given in the Table.Concluding remarksREITs offer a good business-restructur-ing alternative to property developerswho face funding constraints. They arestimuli that could boost the real estatesector by way of increasing the competi-tive edge as compared to the other majorfinancial sectors. The relaxation of the taxtreatment on the income distributed byREITs or PTFs would provide a great op-portunity for the REITs or PTFs to in-crease the market capitalisation. InSingapore, tax incentives for unit holdershave proven to be very effective for theREIT’s rapid growth.The amendment of tax provision on thedistribution of total income by the REITsencourages the investor to invest more inthis industry. Hence, the exemption of thedistribution of the total income in the handof the REITs would indirectly increase itsshare of market capitalisation. In future, itis anticipated that the tax incentives couldbe an effective means to ensure the growthof REITs.Reference2005 Budget Commentary Tax Information,Malaysian Institute of Taxation, Malaysian In-stitute of Accountants and the Malaysian Insti-tute of Certified Public Accountants.Guidelines on Real Estate Investment Trusts,Securities Commission, 3 January 2005.Kasipillai J., (2005), A Comprehensive Guide toMalaysian Taxation under Self-Assessment,Supplement, McGraw Hill Education, KualaLumpur.National Product and Expenditure Accounts2003/2004, www.Statistics.gov.my/English/gdp/gdpq403.htm, 20 July 2005.The Star (2005), “Bursa Listing the Litmus Testfor REITs”, Star Publications Ltd, Kuala Lumpur,11 July.Dr. Jeyapalan Kasipillai is a Professor attachedto the Faculty of Accountancy, Universiti UtaraMalaysia (UUM). Nor Shaipah Abdul Wahab isa tax lecturer in the same faculty at UUM.

A Comprehensive Guide to Malaysian Taxation under Self-Assessment, Supplement, McGraw Hill Education, Kuala Lumpur.

Budget Commentary Tax Information, Malaysian Institute of Taxation, Malaysian Institute of Accountants and the Malaysian Institute of Certified Public Accountants.

Real estate sector: tax stimulus for competitive edge

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