(Tax Series: Paper No. 2)
By Alberto C. Agra and Maricel L. Baltazar, Forensic Solutions

    On 17 December 2009, Republic Act No. 9856 or “The Real Estate Investment Trust Act of 2009” lapsed into law without the signature of then President Gloria Macapagal-Arroyo. The law was enacted to address the clamor to promote the development of the capital market, democratize the wealth by broadening the participation of Filipinos in the ownership of real estate in the Philippines, to use the capital market as an instrument to help finance and develop infrastructure projects and protect the investing public by providing an enabling regulatory framework and environment under which real estate investment trusts, through certain incentives granted under the law, may achieve the objectives of the government policy.

    What are REITS?

    Real Estate Investment Trusts (REITs) are generally entities that invest primarily in real estate and qualify for special tax status. Generally, REITs are publicly listed and are seen as a liquid real estate investment since investors are able to liquidate their position in a short time frame, despite the volatility in equity prices.

    REITs in the Global Setting

    The United States first introduced REITs in the 1960s to enable the investing public to benefit from investments in large-scale real estate projects. Since its introduction in 1974, the US REITs industry has grown significantly from only 53 publicly-traded REITs with a market capitalization of $712 million, to almost 200 publicly-traded companies with a market capitalization of over $300 billion to date. Meanwhile, in Asia, the growth of the real estate industry in recent years also prompted the introduction of REITs in a number of countries including Japan, South Korea, Singapore, Hong Kong and Taiwan. Malaysia and Thailand followed suit in 2003 and established their own version of REITs legislation.

    With the recent downturn of the real property market, where underlying property values still lag behind the wider economy, REIT stocks led other asset classes as prices declined and investors quickly sold down their positions. But just as they led the market into the downturn, global REITs are leading the way out. Share prices have rebounded sharply since March 2009, with many markets surging 60%–100% from their lowest points (although prices remain below the peaks of a few years ago). Since then, REITs have raised billions in capital through secondary offerings, and are using it mainly to reduce their debt, recapitalize their balance sheets and position themselves for growth.

    While the global REIT experience was consistent, with significant drops in market capitalization and negative rates of return, the Asian REIT markets, excluding Japan, experienced a milder decline and have already recovered. Rates of return in South Korea, Malaysia and Hong Kong are overall in positive territory at the end of three years. Of the Asian markets (again excluding Japan), only Singapore recorded a negative three-year rate of return of -4%. Compared with Australia, the United Kingdom and the US (-26%, -25% and -14%, respectively), the Asian region performed remarkably well. In fact, South Africa was the only REIT market outside of Asia that recorded a positive three-year return.

    REITS in the Philippine Setting

    The clamor for a special vehicle to help develop the capital market and to open investment opportunities to retail investors led to the enactment of Republic Act No. 9856 or “The Real Estate Investment Trust Act of 2009.”

    Under RA 9856, a REIT is a stock corporation established in accordance with the Corporation Code of the Philippines and the rules and regulations promulgated by the Securities and Exchange Commission (the “Commission”) principally for the purpose of owning income-generating real estate assets. For clarity, a REIT, although designated as a “trust,” does not have the same technical meaning as “trust” under existing laws and regulations. The term “trust” is used for the sole purpose of adopting the internationally accepted description of the company in accordance with global best practices.

    On 13 May 2010, the Commission approved the Implementing Rules and Regulations for RA 9856 (the “SEC Rules”) which prescribes that a REIT must comply with the following requirements:

        (a) Minimum Public Ownership. A REIT shall be a public company; and, to be considered as such, a REIT shall (a) maintain its status as a listed company; and (b) upon and after listing, have at least one thousand (1,000) public shareholders each owning at least fifty (50) shares of any class of shares, and who, in the aggregate, own at least one-third (1/3) of the outstanding capital stock of the REIT.

        A REIT shall, from the time of incorporation, issue shares to, or record the transfer of all its shares in the name of shareholders, investors, or securities intermediary in the form of uncertificated shares. It shall engage the services a duly licensed transfer agent to monitor subsequent transfer of the shares. Said registrar shall ensure that the shares are traceable to the names of the shareholders or investors, and that said shares are for their own benefit and not for the benefit of any of the non-public shareholders.

        The shares may be registered under a nominee and the nominee shall make available to the transfer agent the names of the shareholders in such frequency as may be necessary for the transfer agent to perform its basic functions.

        Compliance with the minimum public ownership requirement shall be duly certified by the transfer agent upon listing, as of record date, for any dividend declaration or any corporate action requiring shareholder approval and other relevant times as may be required by the Commission.

        (b) Capitalization. A REIT shall have a minimum paid-up capital of Three Hundred Million Pesos (Php300, 000,000.00) at the time of incorporation which can either be in cash and/or property.

        (c) Independent Directors. At least one-third (1/3) or at least two (2), whichever is higher, of the board of directors of a REIT shall be independent directors.

        (d) Organization and Governance. As a public company, the REIT shall have such organization and governance structure that is consistent with the Revised Code of Corporate Governance and pertinent provisions of the Securities Regulation Code and its Implementing Rules and Regulations. The REIT shall hold such meetings as provided in its Constitutive Documents (i.e. its Articles of Incorporation and By-Laws) pursuant to the Corporation Code.

    Under the Philippine setting, REITs are allowed to invest only in the following:

    1. Real Estate

        a. A REIT may invest in real estate located in the Philippines, whether freehold or leasehold. At least seventy-five percent (75%) of the Deposited Property of the REIT shall be invested in, or consist of, income-generating real estate. Deposited Property that should be invested in income-generating real estate located in the Philippines shall in no case be less than thirty-five percent (35%) of the Deposited Property.

        Deposited Property means the total value of the REIT’s assets reflecting the fair market value of total assets held by the REIT.

        b. A REIT may invest in income-generating real estate located outside of the Philippines, provided, that such investment does not exceed forty percent (40%) of its Deposited Property, and only upon special authority from the Commission. The Commission, in issuing such authority, shall consider, among others, satisfactory proof that the valuation of assets is fair and reasonable.

        c. An investment in real estate may be by way of direct ownership, or a shareholding in a domestic special purpose vehicle constituted to hold/own real estate, subject to the conditions provided under the SEC Rules.

        d. Acquisition of a real estate shall include the ownership of all rights, interests and benefits related to the ownership of the real estate.

        e. The real estate to be acquired by the REIT should have a good track record for three (3) years from date of acquisition.

    2. Real estate-related assets, wherever the issuers, assets, or securities are incorporated, located, issued, or traded.

    3. Evidence of indebtedness of the Republic of the Philippines (“ROP”) and other evidence of indebtedness or obligations, the servicing and repayment of which are fully guaranteed by the Republic of the Philippines, such as, but not limited to, treasury bills, fixed rate treasury notes, retail treasury bonds, (denominated either in Philippine or in foreign currency) and foreign currency linked notes.

    4. Bonds and other evidence of indebtedness issued by:

        a. the government of any foreign country with which the Philippines maintains diplomatic relations, with a credit rating obtained from a reputable credit rating agency or a credit rating agency acceptable to the Commission that is at least two (2) notches higher than that of ROP bonds; and

        b. supranationals (or international organizations whose membership transcends national boundaries or interests, e.g.: International Bank for Reconstruction and Development, Asian Development Bank).

    5. Corporate bonds of non-property privately-owned domestic corporations duly registered with the Commission with a current credit rating of at least “A” by an accredited Philippine rating agency.

    6. Corporate bonds of a foreign non-property corporation registered in another country, provided that such bonds are duly registered with the Commission, and the foreign country grants reciprocal rights to Filipinos.

    7. Commercial papers duly registered with the Commission, with a current investment grade credit rating based on the rating scale of an accredited Philippine rating agency at the time of investment.

    8. Equities of a non-property company listed in a local or foreign stock exchange, provided that these stocks shall be issued by companies that are financially stable, actively traded, possess good track record of growth and have declared dividends for the past three (3) years.

    9. Cash and Cash Equivalent Items

    10. Collective investment schemes duly registered with the Commission or organized pursuant to the rules and regulations of the Bangko Sentral ng Pilipinas (BSP); provided, however, that:

        the collective investment scheme must have a track record of performance at par with or above the median performance of pooled funds in the same category as appearing in the prescribed weekly publication of the Net Asset Value Per Unit of the Collective Investment Scheme units; and
        new collective investment schemes may be allowed provided that its fund manager has at least a three (3)-year track record in managing pooled funds.

    11. Offshore mutual funds with ratings acceptable to the Commission.

    12. Synthetic Investment Products which are derivatives and other securities created exclusively out of one or more financial instruments to simulate the returns of the underlying assets or indices of asset values, including, but not limited to warrants, options, interest rate, derivatives, currency derivatives, equity derivatives and credit derivatives such as credit-linked notes, collateralized debt obligations, total return swaps, credit spread options and credit default options, provided that:

    Synthetic Investment Products shall not constitute more than five percent (5%) of the Investible Funds of the REIT;
    the REIT shall avail of such Synthetic Investment Products solely for the purpose of hedging risk exposures of the existing investments of the REIT;
    the Synthetic Investment Products shall be accounted for in accordance with PFRS;
    the Synthetic Investment Products shall be issued by authorized banks or non-bank financial institutions in accordance with the rules and regulations of the BSP and/or the Commission; and
    the use of Synthetic Investment Products shall be disclosed in the REIT Plan and under special authority from the Commission.

    Investible Funds refers to the funds of the REIT that can be placed in investment vehicles other than income-generating real estates, as allowed under the SEC Rules.

    REITs are not allowed to undertake property development activities whether on its own or in a in a joint venture with others, or by investing in unlisted property development companies, unless:

    it intends to hold in fee simple the developed property for at least three (3) years from date of completion;
    the purchase agreement of the said property is made subject to the completion of the building with proper cover for construction risks;
    the development/construction of real estate shall be carried out on terms which are the best available for the REIT and which are no less favorable to the REIT than an arm’s length transaction between independent parties; and
    the prospects for the real estate upon completion can be reasonably expected to be favorable. The total contract value of property development activities undertaken and investments in uncompleted property developments should not exceed ten percent (10%) of the Deposited Property of the REIT.

    Tax Incentives Given under RA 9856

    Under the law, certain tax incentives are granted to a REIT to make it attractive to investors, help encourage the development of the capital market and use it as a tool to finance infrastructure programs.

    The tax incentives granted to REITs that are unique to their class are:

    The sale or transfer of real property to REITs, which includes the sale or transfer of any and all security interest thereto, shall be subject to fifty percent (50%) of the applicable documentary stamp tax (DST) imposed under the National Internal Revenue Code of 1997, as amended (the “Tax Code”);
    Lower creditable withholding tax of one percent (1%);
    Exemption from the minimum corporate income tax; and
    The taxable net income of a REIT shall mean the pertinent items of gross income specified in Section 32 of the Tax Code, less all the allowable deductions specified under Section 34 of the Tax Code, less the dividends distributed by a REIT from its distributable income after the close of the taxable year.

    The grant of the aforementioned incentives was viewed to be revenue-neutral and would not erode the collection efforts of the government.

    Income Tax

    A REIT shall be subject to income tax under Chapter IV, Title II of the Tax Code on its taxable net income, but in no case shall it be subject to the minimum corporate income tax. Moreover, for purposes of computing its taxable net income, dividends distributed by a REIT from its distributable income after the close of the taxable year and on or before the last day of the fifth month following the close of the taxable year, shall be considered as paid on such taxable year.

    Taxable Net Income, as defined under RA 9856, means the pertinent items of gross income specified in Section 32 of the Tax Code, less all allowable deductions enumerated in Section 34 of the Tax Code, less the dividends distributed by the REIT out of its distributable income as of the end of the taxable year as: (a) dividends to owners of the common shares; and (b) dividends to owners of the preferred shares pursuant to their rights and limitations specified in the articles of incorporation of the REIT.

    If the REIT fails to satisfy certain conditions after the curing period, such as maintaining its status as a public company; maintaining the listed status of the investor securities on the Exchange and the registration of the investor securities by the Commission; and/or to distributing at least ninety percent (90%) of its distributable income as required under the law, the REIT shall be subject to the income tax on its taxable net income as defined in Chapter V, Title II of the Tax Code, instead of its taxable net income as defined under RA 9856.

    Withholding Tax

    Income payments to a REIT shall be subject to a lower creditable withholding tax of one percent (1%).

    Documentary Stamp Tax and Stock Transaction Tax

    Transfer of real properties to a REIT, including the sale or transfer of any and all security interest thereto, shall be subject to fifty percent (50%) of the applicable documentary stamp tax (DST) imposed under the Tax Code.

    Original issuance of investor securities shall be subject to DST under Title VII of the Tax Code. Any sale, barter, exchange or other disposition of listed investor securities through the Exchange, including block sales or cross sales with prior approval from the Exchange, shall be exempt from DST, but shall be subject to the stock transaction tax as imposed under Section 127(a) of the Tax Code.

    Any initial public offering and secondary offering of the investor securities shall be exempt from the stock transaction tax imposed under Section 127 (b) of the Tax Code.

    Dividends Tax

    Cash or property dividends paid by a REIT shall be subject to a final tax of ten percent (10%) unless: (a) the dividends are received by a non-resident alien individual or a non-resident foreign corporation entitled to claim a referential withholding tax rate of less than ten percent (10%) pursuant to an applicable tax treaty, or (b) the dividends are received by a domestic corporation or resident foreign corporation, or an overseas Filipino investor, in which case, they are exempt from income tax or any withholding tax, provided that in case of overseas Filipino investors, they are exempt from the dividends tax for seven (7) years from the effectivity of the tax regulations implementing RA 9856.

    Value-Added Tax

    A REIT is subject to the value-added tax on its gross sales from any disposal of real property, and on its gross receipts from the rental of such property imposed under Title IV of the Tax Code .

    Revocation of Tax Incentives

    In the event that a REIT is delisted from the Exchange, whether voluntarily or involuntarily, for failure to comply with the provisions of RA 9856 or the rules of the Exchange, the tax incentives granted under the law shall be revoked and withdrawn ipso facto as of the date the delisting becomes final and executory, and any tax incentives that may have been availed of by the REIT thereafter shall be refunded to the Government, and the surcharge and penalty prescribed under Section 19 of the law shall apply.

    Proposed Revenue Regulations to Implement RA 9856

    The Bureau of Internal Revenue (BIR) issued the Proposed Revenue Regulations that will implement the provisions relating to taxes under RA 9856. The BIR, through the proposed Revenue Regulations (RR), seeks to implement the following rules with respect to the withdrawal of a REIT’s tax incentives:

        (Section 18) Withdrawal of Tax Incentives.

        (a) A REIT shall be subject to the applicable taxes, plus interests and surcharges, under the NIRC upon the occurrence of any of the following events, subject to the rule on curing period where applicable:

        Failure of the REIT to maintain its status as a public company;
        Failure of a REIT to maintain the listed status of the investor securities on the Exchange and the registration of the investor securities by the SEC;
        Failure of a REIT to distribute at least ninety percent (90%) of its distributable income;
        Failure of a REIT to list with an Exchange within the two-year period from date of initial availment of DST incentive; and
        Revocation or cancellation of the registration of the securities of a REIT;

        (b) The recovery of the applicable deficiency income tax and DST from a REIT shall be an exception to the Period of Limitation for the Assessment and Collection of Taxes under Section 203 of the NIRC and shall be subject to the following rules:

        For deficiency income tax, an assessment shall be issued by LTRAD 3 against a REIT in accordance with Section 228 of the NIRC and its implementing revenue regulations;
        The deficiency income tax of a REIT shall be computed based on its gross income as defined under Section 32 of the NIRC less the deductions under Section 34 of the same Code without the dividends paid deduction under the Act;
        On the other hand, the deficiency DST equivalent to 50% of the applicable DST, together with an applicable interest, surcharges and penalties, shall immediately be due and demandable, without need of an assessment, reckoned from the date of the initial availment of the incentives. For this purpose, a Formal Letter of Demand showing the details of the tax due shall be issued by the LTRAD 3 against a REIT and collection of the tax shall be enforced in accordance with Chapter II, Title VIII of the NIRC.

        (Section 19.) Delisting of a REIT and its Tax Consequences. In the event that a REIT is delisted from the Exchange, whether voluntarily or involuntarily, for failure to comply with the provisions of the Act or rules of the Exchange, the tax incentives, granted under the Act, as implemented by these regulations, shall be ipso facto revoked and withdrawn as of the date the delisting becomes final and executory. Any tax incentives that may have been availed of by the REIT thereafter shall immediately be refunded to the Government together with the applicable interests and surcharges under the NIRC and Section 19 of the Act. For purposes of this section, an assessment shall not be required to recover the deficiency income tax and DST due from a REIT. The deficiency taxes shall immediately become due and demandable and collection thereof shall be enforced in accordance with the provisions of Chapter II, Title VIII of the NIRC.

    Under the proposed Revenue Regulations, upon the happening of the following events:

    Failure of the REIT to maintain its status as a public company;
    Failure of the REIT to maintain the listed status of the investor securities on the Exchange and the registration of the investor securities by the Commission;
    Failure to distribute at least ninety percent (90%) of its distributable income;
    Failure to list with an Exchange within a period of two (2) years from initial availment of the DST incentive, and
    Revocation or cancellation of the registration of the securities of the REIT,

    a REIT shall be subject to the applicable taxes, plus interest and surcharges, under the Tax Code. However, it is given a “curing period” within which to address the above-mentioned events and avoid the assessment and payment of the taxes.

    Under the proposed Revenue Regulations, the period for recovery of the “deficiency taxes” appears to be imprescriptible since the recovery period was provided to be an exception to the Period of Limitation for the Assessment and Collection of Taxes under Section 203 of the Tax Code. This may be seen as iniquitous considering that even assessments due to fraud or false returns carry with them a prescriptive period of ten (10) years from the discovery of fraud.

    Assuming that a REIT availed of the fifty percent (50%) tax incentive on the DST for transfers of real property, and after twenty (20) years is delisted from the Exchange, will it be then assessed and required to pay for “deficiency” DST of fifty percent (50%) plus interest, penalties and surcharges from the time that the real estate was transferred to it? If such is the case, then a REIT will be better off paying the DST as imposed under the Tax Code rather than be faced with a much bigger amount down the road.

    Assuming also that the proposed Revenue Regulations will be implemented, will the REITs take the tax incentives (e.g. lower DST) with the knowledge that they may be assessed with a much bigger amount than the tax savings granted if even a single event from the enumeration above takes place? What about REITs that are start-ups and need time to develop their own income-generating properties, will their tax incentives be withdrawn upon failure to distribute at least ninety percent (90%) of their income?

    Delisting of a REIT

    Under RA 9856, the tax incentives granted shall also be ipso facto revoked and withdrawn as of the date a REIT is delisted from an Exchange whether voluntarily or involuntarily, and any tax incentives that may have been availed of shall be immediately refunded to the government, and the surcharge and penalty prescribed under Section 19 of the law shall be applied. On the other hand, the proposed Revenue Regulations seeks to impose additional interest and surcharges under the Tax Code. Moreover, under the proposed Revenue Regulations, an assessment shall no longer be required for the deficiency taxes as they are treated as immediately due and demandable, and collection thereof shall be enforced in accordance with the provisions of Chapter II, Title VIII of the Tax Code, which includes distraint and levy or collection by civil or criminal action.

    Note however, that under RA 9856, recovery of interest and penalties under the Tax Code was not mentioned in the event that a REIT voluntarily or involuntarily delists from an Exchange. It is only when the Commission determines that the REIT was established to avail of the benefits of RA 9856 without the true intention to carry out its provisions will the applicable taxes plus interest and surcharges under the Tax Code apply.

    Admittedly, granting tax incentives will erode the government’s collection efforts. However, if the government sincerely intends to develop the capital market, level the playing field and give opportunities for retail investors, the government must give a chance and encourage the development of REITs as a possible source of investment and another avenue for foreign investors to invest in real estate in the country.

    The business sector has been pushing for the REITs legislation to stimulate the capital market and encourage economic activity. The enactment of the law provides an alternative source of funding for issuers, especially for infrastructure projects, as opposed to bank borrowings that have a single borrower’s limit. It is another avenue for fund managers to expand their portfolio and at the same time allow retail investors to participate in large scale real estate investments, thereby broadening the stock market’s investor base.

    It is our position and belief that any incentive granted to the REITs will eventually be recovered by the government through other channels, and in the long run, REITs will prove themselves worthy of the incentives granted to them.

    It must be emphasized that REITs are VATable entities and are still subject to income tax and the stock transaction tax. Moreover, non-juridical resident individuals are likewise still subject to the ten percent (10%) withholding tax for the dividends that will be issued by REITs.

    Further, more development activities will lead to more revenue collection for the government, from the value-added tax on the materials that will be purchased by the developers and contractors, the service fees that will be charged by consultants, and the income tax on compensation of individuals employed by these firms and developers.

    The Commission and the Philippine Stock Exchange have already issued their counterpart implementing regulations, with the BIR still deliberating on the proposed Revenue Regulations as discussed above. Presently, Hongkong, Singapore and Malaysia are reaping the benefits of REITS as an investment vehicle with a weighted average dividend yield of 8.1%, 8.9% and 3.7%, respectively. The government must issue regulations which are responsive to industry growth and which allows the Philippines to participate in this billion-dollar industry and benefit from its economic viability.

    This is the official position of Forensic Solutions.

    Forensic Law and Policy Strategies, Inc. or Forensic Solutions is a think tank offering services in the fields of policy, law reform, advocacy and governance. The group provides forensic study and viable policy options, giving our clients a crucial advantage in navigating executive, administrative, legislative and judicial inquiries.

    Alberto C. Agra was the immediate past Secretary of Justice, Solicitor General and Government Corporate Counsel. He teaches Law on Public Corporations, Administrative Law, Law on Public Officers and Law on Local Governments.

    Maricel L. Baltazar is a tax practitioner. She is a Consultant of CD Technologies Asia for its Tax Project, former Senior Consultant, Pricewaterhouse Coopers Manila, Director V of the Department of Finance, and Tax Associate, SGV & Co.

    Republic Act No. 9856, Real Estate Investment Trust Act (2009) §2.

    Introducing Real Estate Investment Trusts: Prospects for the Philippines, House of Representatives Policy Advisory 2008-08.

    Ernst & Young, Global REIT Report (2010).

    Ibid.

    Supra note 1 at § 3(cc).

    Real Estate Investment Trust Act Implementing Rules and Regulations (IRR), Rule 4 §5.

    Ibid at Rule 5 §1.

    Ibid at Rule 5 §2.

    Supra note 1 at Article III §10.

    Ibid at Article III §11.

    Ibid at Article III §§12 and 13.

    Ibid at Article III §14.

    Ibid at Article III §16.

    Ibid at §19. Section 19 provides a fine of not less than two hundred thousand pesos (Php200,000.00) nor more than five million pesos (Php5,000,000.00), or imprisonment of not less than six (6) years and one (1) day nor more than twenty one (21) years, or both, at the discretion of the court.

    Bureau of Internal Revenue Draft Revenue Regulations Implementing the Provisions of Republic Act No. 9856, §§18 and 19. See bir.gov.ph.
    Supra note 1 at Article III, §17.

    Ibid.

    Ibid at Article IV, §18.

    Supra note 3.