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Taxation of the REIT

(Article published in the Jun 23, 2010 issue of Manila Standard Today)   

It was taxation that then primarily discouraged Philippine fund managers and trustees from adopting the foreign version of the real estate investment trust (REIT) into their line up of investment products.  And it is taxation that now, under R.A. No. 9856, will principally determine whether investors will consider the REIT as an attractive placement of their funds.

 The general rule is found in Section 16. Unless otherwise provided under the REIT law, the national internal revenue taxes found in the National Internal Revenue Code of 1997 (“Tax Code”), as amended will apply.  The key therefore is how strongly the REIT law’s tax incentives, which improve on the taxation under the Tax Code, can induce investors to put some of their money in the new vehicle.

 The income taxation of the REIT, according to Sec. 10, is the same, as a general rule, as that of corporation which is what a REIT is.  There are three exceptions. The first is that, unlike an ordinary corporation, the REIT is not subject to the minimum corporate income tax of 2% of the gross income (“MCIT”).  Ordinary domestic and resident foreign corporations become liable for the MCIT whenever, beginning the 4th taxable year after starting business operations, said MCIT is greater than the ordinary corporation’s income tax liability as computed generally.

 The second exception is that the dividends paid by a REIT to owners of its common and preferred shares, pursuant to their respective rights in the articles of incorporation of the REIT, are, unlike dividends paid out by ordinary corporations, considered allowable deductions from the REIT’s gross income. 


This permission to treat dividends, which are really distributions of the net profit of the REIT, as deductions from gross income, however, would be lost, if the REIT ceases to be a public company, if its shares are delisted from the Exchange or their registration with the Securities and Exchange Commission is revoked, and if the REIT fails to distribute at least 90% of its distributable income as required under Sec. 7 of the REIT law. 

 The third exception is on the creditable withholding tax on payments to a REIT.  Instead of the usual percentages withheld from payments to ordinary corporate payees, withholding agents are required to withhold only 1% of their payments to a REIT.  This correctly prevents the withholding tax system from unduly shrinking the investible funds of a REIT which, as shown above, enjoys preferential treatment of its income.

 In the hands of the investors, the dividends (which as pointed out above are allowed deductions) are taxed like the dividends of any ordinary corporation, i.e. they are taxed generally at 10%.  However, those enjoying preferential treatment, such as nonresident alien individuals and nonresident foreign corporations keep their preferred status; domestic corporations, resident foreign corporations, and overseas Filipinos are exempt, except that in the case of overseas Filipinos are exempt for seven (7) years.

 The main stock in trade of a REIT is, of course, real estate; not any kind of real estate, but rather income producing real estate.  At least 70% of the deposited property of the REIT must be invested in, or consist of, income generating real estate. 

 The insistence in income earning real estate is very apparent in the law’s attitude towards property development.  A REIT must not undertake property development activities whether on its own, in a joint venture with others, or by investing in unlisted property development companies, unless the REIT intends to hold the developed property upon completion and thus receive income from it.

 The acquisition of real estate by a REIT, like the acquisition by any other person, is naturally not subject to income tax.  When the real estate is disposed of, VAT liability naturally is gendered because such a sale is in the ordinary course of its business.  VAT too arises when the real property held earns its income.  On this score, the REIT enjoys no preferential tax treatment, income-taxwise.

 But the transaction is given some relief from the documentary stamp tax (DST) as well as the necessary registration and transfer fees to collected by the register of deeds.  By way of moderating the pain of the DST and the registration fees. the REIT law charges only 50% of the applicable DST that imposed by Title VII of the Tax Code.  The applicable registration and annotation fees are also reduced by 50%.

 It is significant to note that these reductions may be availed of by the REIT even before it is listed, provided the listing in the Exchange is not later than two (2) years from the initial availment of the incentives.

 The foregone 50%, however, must be returned (with the consequent surcharges, penalties and interests) if the REIT fails to list within two (2) years; if the REIT ceases to be a public company; if it is delisted from the Exchange and its investor securities registration is revoked, and if it fails to distribute at least 90% of the REIT’s distributable income. 

 What does get traded among the investors is not the real estate but the investor shares in the REIT.  When these investors shares are initially issues, the same rates as those imposed on ordinary corporations in the latter’s original issuance of its investor shares apply. When the investor shares are traded and sold in the exchange, the stock transaction tax applicable to listed ordinary corporations also applies. But the DST is not collected in the case of its initial public offering and secondary offering, nor in the sale of said shares through the exchange.