Reit tax machinations just much ado about nothing
"Some tax incentives and relaxations on development should help the Hong Kong reit sector to capture the next wave of capital inflow from the world's largest real estate investors," said Victor Yeung, the chief investment officer at property management company Admiral Investment.
South China Morning Post, January 30
Note those two words "tax incentives". They are critical to the debate about whether local real estate investment trusts should be forgiven taxes that others must pay. I draw your attention to them because, in the latest instalment of this debate, they were avoided by the Securities and Futures Commission in a consultation paper on reits.
"None of our business. Go talk to the financial secretary," said the SFC in wording that strongly hinted, "and we don't fancy your chances".
Quite right. The real debate is not about whether a ban on reit participation in development ventures should be lifted. Developers say it would make reits too risky (as if they really care), while the SFC is happy with the idea as long as the right boxes are ticked. But the real debate is about tax.
Let's take a step back here. Reits are an American idea to give small investors direct participation in rental income from big investment properties that are otherwise held outright by financial concerns.
The key is that the reits pay little or no tax at the reit level so long as they pay out at least 90 per cent of their earnings in dividends. Uncle Sam then collects his toll lower down in the form of dividend, income, and capital gains taxes on the reit unit holder.
Reits have undoubtedly been very successful in the US, and countries with similar tax laws, in bringing the public into property investment.
But then we come to Hong Kong. We do not levy dividend taxes or include dividends in personal taxable income and we do not levy capital gains tax. If we also forgave reits profit tax our government would derive no fiscal revenue at all from reits.
Fine, you may say, but the difficulty is that tax-paying property investment companies widely held by the public already have a sizeable presence in our stock market and there really is not much to distinguish them from reits. They may not pay out 90 per cent of their earnings as dividends but their shareholders mostly do not want big dividends. They have invested in a property firm because they value its skills in the business. Why then take out money when it is best left where it is?
In fact, the only thing that really distinguishes a reit from the likes of a Hongkong Land is that the reit gets an official piece of paper, which says, "You now have the right to call yourself a reit", leaving unsaid, "if that really cranks your crank. Can't see why."
Things would be different, of course, if reits were forgiven profits tax. But this would be monstrously unfair to existing property companies unless we accorded them equal treatment. And then the utilities would line up. Why not tax-free utilities too?
This obviously poses a conundrum to the stockbroker who wishes to sell Hong Kong reits to a foreign client. That client is dunned for profits tax in Hong Kong but then is also hit for personal taxes at home. There is no advantage to him at all in buying a Hong Kong reit.
It is one of the big reasons reits have never really taken off in Hong Kong. They offer nothing special. They are a tax dodge that doesn't dodge taxes here. They are devised to create an investment opportunity that has long existed here. In Hong Kong, they are pointless.
So reit boosters now fall back on arguing either that we must have reits because they are a big thing in Singapore and Sydney, as if we really want the high-tax regimes of those places, or alternatively, that we will "capture the next wave" of investment inflow, as if this were a Somalia rather than a place that already has a surfeit of investment capital.
Take a hike, fellas.