The government is planning to take steps including tax incentives for the development of Real Estate Investment Trusts (REITs) in the country in the coming budget (2019-20). Sources told Business Recorder that the Federal Board of Revenue (FBR) is seriously considering different budget proposals of the Securities and Exchange Commission of Pakistan (SECP) for the development of the REITs.
According to sources, the REITs distribute at least 90% of their income as dividend and are therefore tax exempt under Clause 99 of the Second Schedule, Income Tax Ordinance. Therefore, there should be no advance tax implications on REITs. To link with above REIT proposal, advance tax should also not be collected from a seller of immovable property to a REIT scheme.
Since transactions with REITs are carried on actual valuations and all other property transactions are reported at valuations several folds lower than the actual values; sellers of immovable property to REITs, and purchasers of immovable property from REITs, will be at a severe disadvantage when compared to informal sector due to the application of these Advance Tax clauses (236C and 236K) of the Income Tax Ordinance 2001.
A proviso be added under Section 236C of the Income Tax Ordinance 2001, the SECP proposed. Existing clause; Advance Tax on Sale or Transfer of immovable Property.
Section 236C. (1) Any person responsible for registering, recording or attesting transfer of any immovable property shall at the time of registering, recording or attesting the transfer shall collect from the seller or transferor advance tax at the rate specified in Division X of Part IV of the First Schedule. (2) The Advance tax collected under sub-section (1) shall be adjustable. (3) Advance tax under sub-section (1) shall not be collected if the immovable property is held for a period exceeding three years.
Proposed clause: A fourth (4) proviso be added under Section 236C as follow: (1) Any person responsible for registering, recording or attesting transfer of any immovable property shall at the time of registering, recording or attesting the transfer shall collect from the seller or transferor advance tax at the rate specified in Division X of Part IV of the First Schedule. (2) The Advance tax collected under sub-section (1) shall be adjustable. (3) Advance tax under sub-section (1) shall not be collected if the immovable property is held for a period exceeding three years. (4) Advance tax under sub-section (1) shall not be collected on immovable property transfers to and from a REIT scheme.
Sources said that the sale of real estate to a REIT scheme is an extra step which is only required so that property is transferred in the name of Trustee. No other form of organization such as a company, partnership or sole proprietorship has to undertake this transaction. It has no economic or business implication for the owner of the property. Capital gains accruing to the seller through this transfer (sale) are only paper gains as the owner is mostly issued REIT Units in lieu of his contribution in the form of real estate. Real estate transactions are generally reported at book value based on "valuation table" or FBR rates. REITs record all transactions on Actual transaction value, which could be manifold higher than the book value of the seller. Hence the deemed capital gain is significant. Imposition of any taxation on these paper gains renders the transaction uneconomical ab initio and prohibits launch of REITs. Under a Rental REIT, the owner would generally be able to raise liquidity to the extent of 25% of the property value only. Whereas, Capital Gains tax has to be paid as if the entire 100% sale value is realised. Therefore, it results in disproportionately higher tax incidence. In the case of a Developmental REIT, the owner generally just participates through contributing land but has to endure taxation without realizing any cash. Outside the REIT structure, owner does not have to transfer the property. Moreover, once the land is acquired the owner does not have to share the profit. Whereas, in case of REITs minimum 25% share is offered to public. Exemption from this gain tax, which was available till June 2015, is the most critical starting point to promote REITs in the country. Limiting the exemption of income tax to "Developmental REITs for Residential purposes" only, excludes all real estate projects as the overwhelming majority of the developments falls in the category of mixed use developments. The commercial component of a development generates surplus revenue, which makes the residential component more economical for the buyers.
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