REIT OBSTACLES CLEARED (BUT CERTAIN OBLIGATIONS REMAIN)
By: Euney Marie J. Mata-Perez on February 13,2020
The year 2020 started right for the viability of REITs or real estate investment trusts. The last of the major roadblocks for the creation of REITs has finally been removed, more than ten years after the passage of Republic Act (RA) 9856, or “REIT Act,” in December 2009.
In Securities and Exchange Commission (SEC) Memorandum Circular (MC) 1, Series of 2020 issued on Jan. 20, 2020 (Amended REIT Implementing Rules and Regulations [IRR]), the SEC lowered the required minimum public ownership (MPO) requirements of REITs to only one-third. This significantly reduced the MPO requirement that SEC previously set at 40 percent in the first year, to be increased to 67 percent within three years (SEC MC 2, series of 2011).
Revenue Regulations (RR) 3-2020 issued by the Bureau of Internal Revenue (BIR) on Jan. 29, 2020 affirmed the value-added tax exemption of transfers of properties to the REIT (which exemption was confirmed under RA 10963 or the ‘TRAIN 1 Law,’ provided that pursuant to the transfer, the transferor gains control of the REIT). RR 3-2020 also removed the requirement for a REIT to place in escrow as equivalent to the income tax collectible from the REIT on the dividends it declares and deducts from its taxable income, as well as the 50-percent documentary stamp tax (DST) given as incentive on the transfers of real property to the REIT.
To encourage the REITs, the following tax incentives were granted by virtue of the REIT Act: tax deductibility of dividends paid to its stockholders; 50-percent DST on the transfer of real property to it, including the sale or transfer of any and all security interests thereto; exemption from capital gains tax, income tax, and creditable withholding tax on the transfer of real property to a REIT’ and exemption from the initial public offering tax.
REITs, however, are subject to certain mandates intended to protect the investing public.
Any proceeds realized from the sale of REIT shares or other securities issued in exchange for income-generating real estate assets or any money raised by the sponsor or promoter from the sale of any of its income-generating real estate to the REIT are required to be reinvested in any real estate, including any redevelopment and infrastructure projects, in the Philippines within one year from the date of receipt of the proceeds or money. The Amended REIT IRR requires the REIT’s sponsors,promoters or principal shareholders to report their compliance with this reinvestment requirement in their annual, quarterly and current reports. RR No. 3-2020 also requires a REIT to submit to the BIR its reinvestment plan and certification of compliance from the SEC.
The REIT’s directors, officers, sponsors, promoters, fund managers, and property managers are subject to independence requirements, as well as to fit and proper rules, prescribed by SEC. However, to facilitate the meeting of such requirements, the Amended REIT IRR reduced the paid-up capital requirement of fund managers from P100 to P50 million. It also reduced the track record requirement of the fund and property managers from five to three years.
To ensure transparency, the Amended REIT IRR requires the creation of a related party transactions committee, majority of whom must be independent directors who shall vote unanimously in approving related party transactions.
Under the REIT Act, REITs are also obliged as follows:
REITs must distribute annually at least 90 percent of its distributable income as dividends to its shareholders;
For its investments:
• At least 75 percent of the deposited property of a REIT must be invested in income-generating real estate;
• A REIT may invest only in certain allowable investments, such as cash and cash equivalents, real estate-related assets, government securities, and securities issued by multilateral agencies;
• Not more than 5 percent of its investible funds should be invested in synthetic investment products;
• It must not undertake property development activities, unless it intends to hold the developed property upon completion, and the total contract value of property development activities undertaken and investments in uncompleted property developments should not exceed 10% of the deposited property of the REIT; and
• Not more than 15 percent of a REIT’s investible funds may be invested in any one issuer’s securities or any one managed fund, except with respect to government securities where the limit is 25 percent.
A REIT’s total borrowings should not exceed 35 percent of its deposited property, although this percentage may be increased up to 70 percent for REITs that have a publicly-disclosed investment grade credit rating.
A REIT that fails to meet its MPO requirement may be suspended or delisted. The delisting could trigger the conduct of a mandatory tender offer. The Amended REIT IRR further states that “any circumvention” of a REIT of the REIT Act and its IRR shall be subject to the appropriate penalty, without prejudice to other actions that the SEC may take. A REIT’s tax incentives may also be withdrawn, without prejudice to penalties that may be imposed.
Owning shares in a REIT is a way for the public to invest in the real estate sector without the need of directly owning the underlying assets. It is also aimed at spurring capital market development. To encourage investments in REITs and their establishment, incentives are being granted under the REIT Act. However, the REIT Act also seeks to protect public interest. Thus, several obligations are being imposed on REITs, as well as on their officers, directors, sponsors, fund and property managers. It is thus crucial that they comply with these obligations.