The dawn of REITs in Sri Lanka

Real Estate Investment Trusts (REITs) enable individual investors as well as institutional investors to earn a return from real estate investments sans the purchase and managing of the property by themselves. REITs have many positive features such as reliable income, liquidity, transparency, etc. The ability to pool capital from a large number of investors creates the perfect platform to attract investment to the real estate sector. The introduction of the regulatory framework for REIT is timely and the listed REITs can support the development of the Sri Lankan Capital Market. 

The introduction of REITs will also support the Sri Lankan Islamic Finance/Alternate Finance Industry since it will increase the repertoire of the Islamic Finance products in Sri Lanka. For sustainable growth of the industry product diversification in a manner to attract to institutional investors and foreign investor is vital. The Association of Alternate Finance Institutions (AAFI) had also made submissions in the past to the Ministry of Finance on the need for introduction of REITs in Sri Lanka and to provide a tax efficient level playing field for REITs to succeed. 

REITs regulation in Sri Lanka 

The Budget Speech for the year 2016, read in the Parliament in November 2015 included a proposal to introduce listed REITs to provide capital to real estate and infrastructure development. It was also mentioned that transfer of real estate assets to a REITs structure that distributes 90% or more of the income to REIT unit holders will be exempted from stamp duty. 

The Budget Proposals 2017 which were read in Parliament on 10 November 2016 also included a reference to REITs where it was stated that support would be extended to the Securities and Exchange Commission (SEC) of Sri Lanka to introduce amendments to the unit trust code. 

Almost three years and eight months thereon the SEC of Sri Lanka has introduced a regulatory framework for SL-REIT by way of the Gazette notification dated the 31 July 2020 (No.2186/29). The Gazette is issued in terms of Sections 53 and 13 of the SEC of Sri Lanka Act, No. 36 of 1987 and amendments thereto and seeks to extend the Unit Trust Code to accommodate SL-REIT. 

REITs in the Asian region 

REITs have been around for a long time in the global context and countries such as Japan and Singapore have booming REITs markets in the Asian region and can be considered as market leaders. The legal form of establishing REITs may differ country to country but the most commonly used legal form is the use of a Trust. Japan allows the establishment of REITs through investment trusts and/or investment corporations while in Singapore, the REIT is constituted as a unit trust. REITs in countries such as Malaysia, Hong Kong, India, Thailand, Taiwan, etc. are governed by the Trust Law. In Sri Lanka a REIT is constituted as a trust under the unit trust code. 

Tax concessions are a fundamental requirement to create an efficient REIT market. A glance of the tax treatments of REIT in other countries will reflect that most countries have adopted a tax transparent structure whereby the REIT is not taxable if the minimum distribution criteria is met and it is the unit holder that is liable to tax maybe in the form of a withholding tax. Depending on the domestic tax regime of the respective countries, dividends and/or return on capital may enjoy concessionary rates of Income Tax or even an exemption. Another key area of interest are the taxes applicable on the transfer of the property. This transaction may trigger Stamp Duty or Capital Gains Tax dependent on the applicable tax laws. 

In certain jurisdictions, the REITs framework segregates conventional and Islamic finance REITs. The main difference between a conventional REIT and an Islamic Finance REIT is that an Islamic Finance REIT must only include activities permissible as per the principles of Islamic Finance. 2 

Key features of SL-REIT 

a. Creation of REIT 

A SL-REIT is a newly created REIT and can take the form of any one or more of the following: 

a) The purchase of a property with the intention of leasing residential or commercial units of a building standing thereon for a certain period of time and terminating the SL-REIT upon a subsequent sale of the property; 

b) The leasing of a property with the intention of sub-leasing residential or commercial units of a building standing thereon for a certain period of time and terminating the SL-REIT upon the expiry of the lease; 

c) Any other property which has been approved by the SEC upon terms and conditions imposed by it. 

As per the regulations, all buildings on the property purchased outright or obtained via a lease must be fully completed. SL-REITs should have a life of more than five years from the inception and should be listed on a licensed Stock Exchange in Sri Lanka. 

b. Permitted investment 

As per the regulation a SL-REIT can invest in real estate, up to a maximum of 80% of the SL-REIT’s value (unless prior approval is obtained from SEC) and the balance 20% of the SL-REIT can only be invested in Government Securities and or in Cash or Near Cash. A SL-REIT’s property may consist of real estate-related assets and non-real estate-related assets. 

c. Distribution requirements 

Similar to many REIT structures world over, in Sri Lanka too the minimum distribution is 90% of the distributable income. The regulation further states that any deviation from the dividend distributions which is less than 90% shall result in disentitlement to any tax benefits available to unit trusts. 

d. Stakeholders of SL-REIT 

There is key stakeholder in a SL-REIT such as managing company, sponsor, trustee, property manager, valuer, compliance officer and such and the regulations include the duties and responsibilities of these key stakeholders. 

e. Listing requirements 

All REITs shall be listed within three months of obtaining approval from the SEC. The minimum value of SL-REIT at the time listing is Rs. 500 million. The SL-REIT would offer at least 20% of its units to the public at the time of listing and have a minimum of 100 unit holders at the time of listing. For the application of tax benefits, the SL-REIT should always maintain a minimum of 50-unit holders. Once the SL-REIT is listed the unit holders may only exit from the secondary market. 

SL-REIT and the Sri Lankan economy 

REITs are a vibrant instrument to attract both local and foreign investment and creates investor confidence due to the transparency stemming from the REIT being a regulated instrument. It is indeed a boon for the Sri Lankan real estate industry at a time where the economy is ready for post-COVID resurgence. 

Lack of clarity prevails over the tax implications of SL-REITs and it is of utmost importance that the policy makers clear any ambiguity in order to ensure a smooth path for SL-REITs to prosper. The tax policies have played a significant role in the success of the REIT structures in foreign jurisdictions and hence it might be favourable for the Sri Lankan policy makers also to relook at the tax framework. 

The benefits enjoyed by unit trusts at one time are no longer applicable under the Inland Revenue Act No. 24 of 2017 and as per the rules of the tax law, any unit trust carrying on the business of an eligible investment (a REIT would be considered an eligible investment) would be treated as a ‘trust’ for tax purposes as opposed to a ‘company’. In order to maintain tax transparency or for a trust to be treated as a pass-through entity, the ambiguity surrounding whether a unit holder is presently entitled to the income of the trust should be resolved. 

Capital Gains Tax, Stamp Duty and Value Added Tax (VAT on the transfer of immovable property other than land) continue to loom as a dark cloud and the policy makers should work towards removing this barrier in full or in part for the success of SL-REIT. Although the national budget proposals of 2016 referred to removal of stamp duty, there has been no further developments on the same. 

The REITs introduced following the Islamic Finance principles would have the potential to attract the much-needed foreign direct investments especially from the Middle East region.

(Rifka Ziyard is the Director of Tax and Regulatory at KPMG Sri Lanka. She can be contacted at [email protected].) 

(This article was first published in Islamic Finance news Volume 17 Issue 36 dated 9 September 2020.)