You may have noticed an entry on your investment statements and IT3b tax certificate that says 'REIT income'.
REIT is a company that owns income-producing real estate, for example a shopping mall or office block, or finances the construction of these buildings. REITs allow investors to invest in portfolios of large-scale properties in the same way they invest in other industries by buying shares.
Just as shareholders receive dividends by owning shares in companies, the shareholders of a REIT earn a share of the income produced through the real estate investment - without actually having to buy or finance property.
Investors receive dividends and there's the potential of capital gains or losses - similar to holding shares. Collective investments (unit trusts) also invest in REITs. These investment vehicles receive rental income, which in turn is paid to the unit holders as REIT dividends.
Almost all funds, including equity unit trusts, are allowed to invest in REITs. Clients who have invested in these funds will therefore receive REIT income even if they're not directly invested in property funds However, real estate sector funds, including property funds, have the biggest exposure to REIT shares and consequently REIT income.
Previously in South Africa, property loan stocks (PLSs) and property unit trusts (PUTs) fulfilled the function of REITs, but a decision was taken to align our property investment structures with international ones and to clear up potential conflicting tax interpretations.
A change in legislation now allows PLSs and PUTs to be converted to REITs and the majority have already done so.
You may ask what the tax implications of REITs versus PLSs and PUTs are. When unit trusts invest in PLSs or PUTs the income is declared either as interest or 'other income'. However, the South African Revenue Service (SARS) also defines 'other income' as interest. The same SARS code on an IT3b (tax certificate) as interest is used, namely 4201.
In the past the income derived from PLSs and PUTs was therefore taxable as interest. But REITs declare dividends and these dividends, unlike dividends declared from non-REIT shares, are taxable at your client's personal marginal tax rate. The income being declared as a dividend is therefore not tax friendlier than when it was declared as interest. To the contrary, as the annual interest exemption may not be applied to REIT income.
It's important to note that financial institutions are compelled to withhold tax on dividends at a rate of 15%, unless you qualify to be exempt from withholding tax on REIT income.
As REIT income for natural persons staying in South Africa is taxed at the individual's marginal tax rate, they are indeed exempt from withholding tax on dividends, but only if they complete a Dividend Tax/REIT declaration form - the DTD/EX.
This only applies to discretionary savings products and where an existing declaration form does not exist. Contractual products (Investment Linked Living Annuities, Retirement Annuities and Preservation funds as well as pension and provident funds) are already exempt from dividend tax and this applies to REIT tax as well.
Endowments pay a default 15% dividend withholding tax, but are exempt from dividend tax on REITs. However, as Endowments are administered within the Individual policy holders fund, REIT dividends are taxed at 30%, which is the same rate at which interest declared from PUTs and PLSs was taxed.
