What more can be done for foreign-sourced income exemption for S-REITs
Further enhancements to section 13(12) of the tax exemption framework should benefit S-REITs with foreign assets.
Singapore’s foreign-sourced income exemption (FSIE) regime, which exempts foreign-sourced dividends, service income and branch profits (specified foreign income) received in Singapore subject to certain conditions, was first introduced in 2003. This is an alternative to the tax credit system to further simplify Singapore’s tax system and enhance Singapore’s attractiveness as a business hub. However, some taxpayers were still unable to meet the necessary conditions for the FSIE despite engaging in substantive economic activities overseas. Recognising this and also to encourage companies to remit their foreign income, the Minister for Finance had broadened the scope of the tax exemption for specified foreign income in 2006. Specified foreign income, which would otherwise not qualify for the FSIE, if remitted under certain specific scenarios or circumstances, would now be exempt.
In addition, the Minister for Finance also announced in Budget Statement 2006 that tax exemption will be granted on foreign-sourced dividends, interest and trust distributions (or Singapore real estate investment trust (S-REIT) foreign income) received by real estate investment trusts listed on the Singapore Exchange to encourage the development of Singapore’s capital market activities. This tax exemption for S-REIT foreign income is accorded under section 13(12) of the Singapore Income Tax Act and the qualifying conditions that need to be satisfied in order to enjoy the tax exemption were outlined in an e-Tax Guide published by the Inland Revenue Authority of Singapore (IRAS) subsequently on 31 May 2006.
At that time, S-REIT listings were gaining momentum with a number of successful listings and several more in the pipeline. Although most of the listings then were local property portfolios, S-REITs with foreign assets were starting to hit the market as some sponsors and banks tried to offer a differentiated product to investors. These cross-border S-REITs had to apply for ministerial exemption on a case-by-case basis if they were unable to meet the conditions for the FSIE. Therefore, the introduction of a tax exemption regime for S-REIT foreign income was timely as it helped to establish a clear framework1 that provides upfront certainty as to whether a listing structure can avail of tax exemption in respect of the repatriation of foreign income back to Singapore.
Recent refinements to the section 13(12) tax exemption for S-REITs
Today, most S-REITs (even those that have held only Singapore-based assets in the past) have exposure to overseas assets2. In fact, a significant number of S-REITs’ own real estate portfolios that consist entirely of overseas properties. Over time, the prescribed conditions for tax exemption for S-REIT foreign income have also been finetuned several times to ensure that the regime stays relevant and to keep administrative and compliance costs low. Most recently in December 2022, the IRAS updated its e-Tax Guide which, among other amendments, relaxed some of the conditions for an S-REIT to avail of section 13(12) tax exemption.
Previously, one of the conditions was that if the exemption was sought by a wholly owned subsidiary of the S-REIT, the full amount of the remitted income, less incidental expenses associated with the remittance, statutory expenses and administrative expenses incurred by the subsidiary, must be passed through to the S-REIT. In situations where the S-REIT subsidiary takes up a bank loan to finance the overseas investment itself, the subsidiary would technically breach this condition if it uses part of its remitted foreign income to pay interest expense to the bank. This is usually necessary since the subsidiary would be a special purpose vehicle without other income sources. Even if the S-REIT tries to resolve this issue by injecting additional capital into its subsidiary to fund such interest payments, the subsidiary may not be capable of distributing the full amount of remitted foreign income to the S-REIT as dividends given that its retained profits would likely have been reduced by the interest expense.
There could be various commercial reasons as to why an S-REIT may prefer to take up external financing at the subsidiary level (e.g., to ringfence risks or create a natural foreign exchange hedge). With the latest changes, this condition has been relaxed to also allow “financing and other expenses for the purpose of its investment in the underlying overseas properties” to be deducted against the remitted income, thus allowing more flexibility for S-REITs and their subsidiaries in managing their financing structures and cashflows.
Further, with effect from the year of assessment 2024, the exemption would be expanded to include not only wholly owned subsidiaries held directly by an S-REIT, but also wholly owned sub-trusts of an S-REIT, as well as wholly owned Singapore incorporated and resident subsidiaries held indirectly by the S-REIT. This change is reflective of developments in the S-REIT space in recent years where there has been a trend of S-REITs consolidating or merging to diversify, improve resilience and capitalise on growth cycles across a multitude of segments. As these mergers are typically structured by way of one S-REIT acquiring another S-REIT as a sub-trust, the expansion of the exemption framework to include sub-trusts and indirect subsidiaries helps to provide upfront certainty that the exemptions previously obtained by the acquired S-REIT can continue to be enjoyed by the acquiring S-REIT3.
Foreign distributions received from the financial year 2023 onwards from a Japan Tokumei-Kumiai (TK) could also qualify for the tax exemption. As a Japan TK is a partnership and not a trust or a company in terms of legal form, such distributions would, under the previous rules, fall outside of the scope of S-REIT foreign income. The S-REIT would then either need to rely on foreign tax credit claims to prevent double taxation in Singapore or make an application for ministerial exemption to the Minister for Finance.
Can more be done?
Looking ahead, overseas assets will likely remain a mainstay of the S-REIT industry given the high valuations and saturation within the Singapore property market. In the spirit of keeping up with the times, further enhancements to the section 13(12) tax exemption regime for S-REITs could be considered to ensure its continued relevance to S-REITs.
For one, the current framework for exemption for foreign interest income does not cover situations where no foreign tax is suffered on the interest income and the borrower acquired the underlying overseas properties indirectly via share acquisition of the holding vehicle, whereas direct property acquisitions under similar circumstances are covered. For such a scenario, a special application has to be made to the Minister for Finance. However, given that the mode of acquisition is often dictated by the vendor and outside of the S-REIT’s control and share acquisitions are also very commonplace, removing this distinction and amending the condition to also cover indirect acquisitions would be welcome. Further, due to the construct of base erosion and profit shifting (BEPS) Pillar Two rules, where certain equity gains (not including property gains) could be excluded from the computation of Global Anti-Base Erosion (GloBE) Income, vendors may have an added reason to favour share sales over asset sales in future.
Additionally, the environmental, social and governance (ESG) agenda has been steadily gaining momentum over the past few years and one of the ways that S-REITs can contribute to the global push to reduce reliance on non-renewable energy sources is through the installation of solar panels and photovoltaic systems on the roofs of their properties. However, it is currently unclear as to whether income from the sale of solar energy falls within the scope of underlying income from which S-REIT foreign income must originate to qualify for exemption. It would therefore be timely to extend the scope of such underlying income to specifically include income from the sale of solar energy generated from overseas properties.
Moreover, the recent refinements still do not fully address the case of an S-REIT subsidiary that is unable to distribute dividends due to regulatory restrictions. For example, if the subsidiary has recorded a notional accounting fair value loss on its investments, it may be unable to declare dividends until such time when the fair value losses are reversed. The “passed through to the S-REIT” condition can be expanded to include returns of capital and repayments of shareholder loans by the subsidiary. After all, S-REITs are yield-based products that are focused on optimising distributions and there is already an intrinsic motivation for an S-REIT to extract all available cash from its subsidiaries.
That said, it is understandable that any such enhancements or refinements must be carefully calibrated especially in light of international tax developments. A few years ago, Singapore’s FSIE regime was one of nine regimes selected for review by the European Union Code of Conduct Group (EU COCG). It was ultimately concluded that Singapore’s regime is compliant with the EU COCG’s identified criteria and should not be regarded as harmful. Additionally, in June 2023, the Ministry of Finance (MoF) proposed an amendment to the Singapore tax legislation to tax gains from the sale of foreign assets that are received in Singapore by businesses without economic substance in Singapore for public consultation. This is a significant departure from Singapore’s current taxation system and the MoF explained in its commentary that the proposed amendment was to align the tax treatment of such gains to the EU COCG guidance to address international tax avoidance risks.
Fundamentally, a key tenet of the section 13(12) tax exemption scheme for S-REITs is that the exempted foreign income generally has to be paid out of underlying property-related income, which has been subjected to tax in the overseas jurisdiction where the property is located. The enhancements or refinements to the exemption scheme as suggested above do not deviate from this core principle and therefore should not be regarded as harmful.
The co-authors of the article are Hong Shan’er, Partner, Tax Services from Ernst and Young Solutions LLP and Reuben Chew, Manager, Tax Services from EY Corporate Advisors Pte. Ltd.
