According to plans announced in Malaysia's 2007 budget, new tax incentives will be implemented to lure investors to the country's Real Estate Investment Trusts (REITs).
The government has proposed that the tax on dividends received by foreign and domestic individual REIT investors be lowered to 15%. Foreign institutional investors in REITs, such as pension and collective investment funds, will have their dividends taxed at a 20% rate. Previously, the dividends of all foreign investors were taxed at 28%, while domestic investors could be taxed up to 20%, depending on their tax status. For domestic investors, institutional or individual, the tax level will now not exceed 15%, regardless of income. This will help the higher income individuals who typically invest in REITs.
The new rules also have benefits for REIT issuers. The trusts are managed by firms approved by the securities council, which are usually property development, finance or real estate companies. The trust managers hold or invest in multiple income-bearing properties such as office blocks or shopping centres. Unlike unit trusts, for example, REITs can be traded on the stock exchange and can be profitable either through appreciation or dividends.
Under the new rules, if the REIT distributes 90% or more of its income to investors, then it will be fully exempted from taxation on the remaining income. Previously, the REIT was taxed on remaining income regardless of the percentage distributed, and the investor was charged income tax. The latter led to the administrative hassle of ensuring that the tax was paid by investors.
Though there are still no compulsory distribution levels, the new exemption will likely encourage REIT issuers to distribute income to investors beyond the 90% threshold. This will free the issuer of income tax obligations and administrative duties, and increase cash flow for investors.
The proposed reduction of withholding tax will begin January 1, 2007 and will continue for five years. Both local and foreign corporate investors will be subject to the existing tax treatment and tax rates.
REITs are a relatively new addition to the Malaysian investment landscape. Guidelines governing REITs were put in place in 2005 to spark growth in the industry. Eight are currently traded on Bursa Malaysia, with several more in pipeline for this year.
"We need to diversify the capital market products to attract local and foreign investors... and REIT is one such product," Prime Minister Abdullah Ahmad Badawi said in his Budget 2007 speech on September 1.
REITs are attractive because they allow single investors units of large-scale commercial real estate in the same way they might invest in equities of companies. Just as shareholders benefit by owning stock in corporations, the shareholders of a REIT earn a proportional share of the profits earned through commercial real estate holdings - usually in the form of rents paid by tenants.
The new rules aim to increase these advantages and, according to analysts, this tax structure is in line with the policies of REITs in other countries.
However, challenges still remain in creating a world-class REIT market in Malaysia.
Many within the industry feel that the taxes on dividends should be reduced even further, to levels comparable to regional rivals. For example, Singapore taxes its REITs at 10% for foreign institutional investors, with a complete tax exemption for domestic and foreign individual unit-holders. Some could argue that Malaysian REITs could still be a hard sell for foreign investors, unless yields prove to be sufficiently large to overcome the high tax rates.
Another concern is the size of the REITs on offer in Malaysia. REITs in the country tend to be quite small compared with those offered in other countries. Malaysia's largest REIT is the RM1.2bn ($330m) Starhill REIT listed by the YTL group last December. In Q4 of 2005 alone, three REITs were launched in Hong Kong with a combined worth of almost $5bn, according to Macquarie Real Estate Asia.
There are ways, however, for Malaysia to get larger REITs on the market. Some banking insiders have called on the large government-linked companies, who have significant property holdings, to open up some of their assets as REITs. Salman Younis, CEO of Kuwait Finance House in Malaysia, told attendees at this month's Islamic Finance Forum in Kuala Lumpur that his company had approached several government-linked companies about issuing Islamic REITs in government properties. "It is good for the government as it keeps its reserves intact, while you unlock the value of the assets [for the public].
Malaysia also has the potential to find its niche in designing Islamic REITs that attract Middle Eastern investments. Typically investors from the region are attracted to real estate investments and high yield products like REITs. Combining this with shariah compliance is not as difficult as with other investment tools. This year, Malaysia's KPJ Healthcare Berhad listed the world's first Islamic REIT, and has raised some RM180m (US$50m) from retail and institutional investors so far.