What Reits should do if they can’t meet their obligations
Real estate investment trusts need to keep the JSE and market in the loop if they are at risk of losing their status
The challenges that accompany the coronavirus and resultant lockdown have affected the ability of companies that have been granted real estate investment trust (Reit) status to meet their obligations under the JSE’s listing requirements.
Reits are companies that own and operate income-producing immovable property. Certain criteria must be met to obtain Reit status from the JSE. Reits are also the subject of a favourable tax dispensation under the Income Tax Act.
Obligations that are of particular importance state that:
- The company must distribute at least 75% of its total distributable profits as a distribution to the holders of its listed securities by no later than four months after its financial year end, subject to the relevant solvency and liquidity test;
- Interim distributions may occur before the end of a financial year end;
- The company will ensure that, subject to the solvency and liquidity test, those of its subsidiaries that are property entities incorporated in SA will distribute at least 75% of their total distributable profits as a distribution by no later than four months after their financial year ends.
The requirement to maintain Reit status is therefore the payment by the issuer of at least 75% of its taxable earnings available for distribution to investors as dividends, giving investors certainty that net income will be paid out. This must be done no later than four months after the Reit’s financial year end.
Ordinarily, if a Reit fails to comply with this requirement it will be at risk of having its Reit status revoked by the JSE. However, the obligation to make the distribution is explicitly subject to the Reit satisfying the solvency and liquidity test set out in the Companies Act.
Therefore, if the Reit fails to make the required distribution within four months of its financial year-end, and such failure is as a result of the Reit failing to satisfy the solvency and liquidity test in relation to that distribution, then such failure will not result in the revocation of its Reit status.
However, the main appeal of a Reit lies in its favourable tax treatment, which is linked to another significant continuing obligation of the requirements, which states that:
- The applicant issuer must qualify for a tax deduction of an amount equal to its distributions under the Income Tax Act for the immediately preceding financial year end; or
- Must not have failed the Reit tax test for the last two consecutive financial year ends.
Where the distribution meets the requirements of a “qualifying distribution” in terms of section 25BB of the Income Tax Act, it will be deductible by the Reit for income tax purposes. Given the fact that Reits distribute most of their net income to their shareholders, Reits pay very little income tax, and it is the shareholders instead who pay income tax on receipt of such distributions. For the distribution to constitute a “qualifying distribution” at least 75% thereof must consist of rental income.
In the light of the government-imposed lockdown and the closure of all nonessential businesses across the country, such as retailers in large shopping centres, the future rental income stream for Reits does not look promising.
Accordingly, a significant consequence flowing from the nonpayment of the distributions is that Reits may not qualify for a tax deduction of distributions under the Income Tax Act, thus resulting in a loss of the favourable tax treatment afforded to Reits under the Income Tax Act.
If a Reit is otherwise concerned about meeting any of its continuing obligations under the requirements, it should immediately consult the JSE. In this regard, on March 25 the JSE issued a letter urging all issuers, in consultation with advisers or sponsors, to assess the effect of the Covid-19 outbreak on its ability to comply with the applicable requirements and the effect thereof on its Reit status. If there are any concerns in meeting such obligations, issuers are able to consult with the JSE.
It is also worth noting that earlier in April the SA Real Estate Investment Trust Association made an urgent request to the Treasury to provisionally relax the tax rules applicable to Reits in SA, including a request for a two-year reprieve from paying out dividends.
Once guidance has been received from the JSE and/or any official reprieve has been announced, Reits must take the provisions of the requirements into account, which oblige an issuer with Reit status to keep the market informed regarding its tax status by way of an announcement containing full details of the implications thereof for the issuer and its security holders, without delay.
• Lalla is a director at Werksmans Attorneys.
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