In most developed countries, the financial crisis seriously damaged asset values and confidence alike in the real estate market. The impact in Asia was less pronounced: although weaknesses and uncertainty remain in some markets, overall it has recovered quite strongly.
Despite the global depression in investment activity, substantial sums still exist, and continue to be raised, which require placing where they can earn a realistic return. Major pension funds in North America and Europe are entrusted with billions of dollars of funds. With other asset classes offering weak or patchy performance, Asian real estate provides one potentially profitable destination.
Five countries in the region, in particular, have generated strong interest: Australia, China, India, Japan and Korea. Substantial funds are flowing into China at present and Australia is now attracting significant investment; Japan, India and Korea are also attracting interest as opportunities present themselves. As ever, one of the key factors determining the comparative attractiveness of different markets and opportunities is the tax impost both during the holding period and on exit. Navigating the complexities of different tax regimes to create the most efficient and effective investment structure has always been difficult. Local changes in tax regimes in these countries can change the balance of returns very significantly. But some major current trends are making this more challenging still. Notable local features include:
China, in particular, remains an attractive market. Although the economy has cooled and measures have been taken to dampen the property market over the last couple of years, there is still solid growth. Good options for real estate investment remain, with comparatively beneficial tax treatments for the right structures which can provide the correct substance to utilize the tax preferences offered. Elsewhere in the region, two significant regimes for creating tax-efficient real estate investment vehicles are:
Australia: the Managed Investment Trusts (MIT) regime (see panel) allows preferential tax rates of 10-15 percent, compared to the 30 percent rate which would otherwise apply, making an MIT a very attractive vehicle for investing in Australian investment property and infrastructure projects.
Japan: the country has two structures with potentially beneficial tax consequences for real estate investment funds: the TK and TMK (see panel). Although the TMK was introduced to encourage securitizations, its potential advantages have been somewhat eroded, making the choice of specific vehicles more complex to evaluate.
In the wake of the financial crisis, governments and regulators are getting tougher on corporate taxpayers in all jurisdictions, reducing the scope of favorable tax regimes or special treatment for investment categories such as real estate. In addition, they are increasingly trying to enhance tax revenues, and developing approaches to tax value emanating from their domestic economies, regardless of formal legal structures.
So for example, India is persisting in its attempts to levy a USD2.6 billion capital gains charge on Vodafone over its purchase of Hutchison Essar in 2007. This is an especially pertinent case in that it involves the sale of shares in a Cayman Islands company, rather than any assets actually based in India. Although the Supreme Court upheld the company’s argument that no tax was due, the Indian government had subsequently retrospectively amended the law in order to tax the transfer of shares of an overseas entity whose value is substantially derived from assets located in India. This has created uncertainty with regard to taxation of international transactions in shares of real estate owning companies.
Recognizing the importance and need for providing a stable and an investor friendly environment, the Government of India set up an Expert Committee to review the amendments made in the law. The Expert Committee has provided its recommendations to carve out genuine transactions and restrict the applicability of these provisions only to sham and tax avoidance transactions. The recommendations are being evaluated and still under consideration with the Government.
More broadly, a number of governments in Asia are pursuing the introduction of general anti-avoidance regimes (GAAR), which can in principle nullify the advantages of any specific investment vehicle created for the purpose of reducing tax liabilities. In India, again, under the provisions of GAAR which will come into force with effect from 1 April 2015, any arrangement with “the main purpose of which is to obtain a tax benefit,” will be considered as an impermissible avoidance arrangement. Given the evolving Indian tax regime, it would be critical to demonstrate commercial substance for fund structures. Similarly, China introduced a GAAR in 2008 and is requiring disclosure of indirect transfers of China shares through the sale of offshore holding companies under its Circular 698 so as it can determine whether the GAAR applies.
Funds tend to be located in regional hubs where the tax regimes are more friendly, with representation or branches in target investment territories. Typically, real estate investment teams in Asia have been based in Hong Kong. Increasingly now, they are also setting up in Singapore, principally to target the Indian market, but also the hinterland around Singapore itself, which is offering more attractive opportunities.
Singapore has a fund tax regime which is very attractive to real estate funds, both those based on-shore and offshore. It also has a large number of double tax treaties and a particularly favorable treaty with India. Hong Kong has had a similar but more limited regime for offshore funds and the government has just announced its extension to include private equity funds which will benefit real estate. Hong Kong continues to conclude double tax treaties but is still to complete treaties with India, Korea and Australia. Singapore definitely provides an edge as a fund site from a tax perspective. However, the more expansive approach of countries like China, India and Korea to their taxing rights does make the desired outcome more difficult to achieve and a cost/benefit analysis is required before shifting deal terms.
Real estate investment in Asia looks to have a sound future in the short-medium term, as regional economies continue to recover, and as the global center of gravity continues to shift in favor of the East. However, despite the broadly encouraging outlook, governments and regulators are making it increasingly difficult to secure advantageous tax outcomes. The specific details differ from one jurisdiction to the other. But it is clear that finding the most robust and tax-efficient structures is a more complex challenge than before.
For a closer look at Australia’s Managed Trust Investment Trust regime and MIT Withholding Rules, China’s real estate developments and private equity issues, and Japan’s TK and TMK structures, download the full magazine.