The introduction of tax legislation pertaining to Real Estate Investment Trusts (REITs) has resulted in significant development of this industry over the last few years. Apart from the fact that a REIT is not subject to capital gains tax in respect of properties that it disposed of, an additional consequence is that dividends declared by a REIT to South African shareholders are not exempt, but are in fact part of taxable income.
The distribution is also deductible in the hands of the REIT on the basis that a flow-through principle is essentially adopted with reference to rentals and similar income that are received by the REIT.
Another principle of income tax is also that, should shares have been held for a continuous period of three years, the proceeds are deemed to be on capital account in terms of s9C of the Income Tax Act. Section 9C of the Income Tax Act currently provides that, to the extent that any deductions have been claimed from the income of a taxpayer in respect of the shareholding during the initial three year period, these expenses must be reversed. However, in a context of REITs expenses would be incurred not only to potentially make a capital gain on the sale of the REIT shares, but also to receive taxable income in the form of dividends. An anomaly has thus arisen that expenses incurred by a shareholder in a REIT in these circumstances must be apportioned.
It has been proposed that there should not be a reversal of expenses that have been claimed as a deduction given the fact that expenditure incurred to produce taxable dividends is effectively not deductible. The assumption is thus that the expenditure would not be deductible resulting in the expenses thus not having to be recouped. It is not clear whether this approach would be sound, especially in circumstances where a trader acquired REIT shares and where it in fact deducted the purchase price associated with the acquisition of the REIT shares on the basis that both the proceeds from the sale of the REIT shares as well as the dividends would be taxable. In circumstances where the REIT shares are held for a period in excess of three years, it seems anomalous not to allow any deduction to the trader in circumstances where the dividends were clearly taxable and were incurred as one of the purposes to generate income in the hands of the trader. Careful thought will thus have to be given before it is indicated that there are no recoupment of expenses in circumstances where there is a clear case to be made for the deduction of expenses pursuant to the fact that taxable dividends have been derived.