A new dawn for the Belgian SICAFIs
(October 2011) For a long time Belgian public SICAFI’s (often referred to as the ‘Belgian REITs’) have been requesting legal framework changes to modernise the regime and to incorporate European and international tendencies. The recent financial crisis which struck the real estate business hard in Belgium, made it clear to the Belgian government that important amendments were needed to enable the sector to more efficiently find financial recourses, as well as to expand its action radius.
The Belgian real estate market is looking with great expectations at the implementation within the Belgian real estate landscape, of the new Royal Decree of December 07, 2010. Replacing the existing 1995 regulatory framework of Belgian REITs, it introduces important changes to the Belgian REIT status. In the contribution below we focus on two important elements included in the new legislation.
Access to the capital markets
The Royal Decree includes new methods for REITs to access the capital markets. Now, Belgian REITs will be able to issue bonds as well as introduce stock dividends into their bylaws.
With respect to the possibility to issue bonds, the two biggest REITS in Belgium, Befimmo and Cofinimmo, have already announced issuing convertible bonds for a total amount of EUR 300 million.
During the financial crisis, it became evident that the fact of having to distribute 80% of their profits as well as being confronted with an asset value drop, could push a REIT towards a negative spiral, especially taking into account the maximum debt level of 65%. In this respect, the stock dividend offers a solution to maintain the profits within the Belgian REIT, providing it with the opportunity to lower its debt ratio and to continue to acquire new investments without having to search for external financing. To illustrate the success of this new option, some REITs have publicly announced that a significant portion of their shareholders have preferred a stock dividend, increasing their equity. Consequently, the debt ratio drops, resulting in a total additional investment capacity.
Both measures will have a positive impact on the cash needed to increase the investments and to further reduce or manage the debt ratios.
Buildings from the portfolio of Belgian REIT Befimmo: Central Gate Brussels, La Plaine Brussels, Triomphe I Brussels, WTC Tour 3 Brussels.
The Institutional REITs
- Introduction of institutional REIT
Another important change the new Royal Decree brings is the introduction of the institutional REIT into Belgian legislation. This revolutionary concept contains the opportunity for public REITs to co-invest with non public real estate or other partners in an ad hoc vehicle benefitting from the REIT status.
Only “professional or institutional investors”, which include companies who have at least 250 employees, assets in excess of EUR 43 million and who generate net profits exceeding EUR 50 million, will be able to co-invest in an institutional REIT together with a public REIT. Exceptions can be made by the supervising authorities. These strict rules may give rise to questions as to how to deal with partners who want to join, but who are ineligible as they do not meet the above-mentioned criteria.
In order to protect the character of the public REITs as a broadly held investment vehicle, several mechanisms have been incorporated, safeguarding the shareholders’ interests. An institutional REIT will in any case have to be under the exclusive or at least joint control of a public REIT, holding in any case at least 50% of the capital of the institutional REIT. It will however, only be seen in practice, how these principles will coincide with the interests of the co-investors and partners joining the public REIT in investing in the institutional REIT. Certain concern is being voiced in that in some cases, the investing non-REIT partner can be forced out or that the public REIT can step out of the structure also triggering therefore, an exit issue from a tax and accounting perspective.
Public REITs investing in an institutional REIT will no longer be able to hold Belgian real estate subsidiaries. Indeed, the Royal Decree imposes an “all in or all out” clause, including, that once it is decided to incorporate an institutional REIT, the public REIT will be obliged to convert all its Belgian real estate companies into REITs. Most of the Belgian REIT’s are not at all happy with this difficult dilemma.
It is important to note that the maximum indebtedness of 65% will not be judged only at the public REIT level, but will be determined on a consolidated basis, (i.e. including its institutional REITs), leaving the possibility to leverage the subsidiaries themselves. The minimum distribution requirement of 80% has been retained but at the same time moderated: profits can be reserved in exceptional circumstances at the public REIT level, avoiding a 65% indebtedness conflict.
Strict investment policies and control rules have been introduced. If a public REIT is holding an exclusive control over an institutional REIT, these investments may not exceed 30% of the net assets of the public REIT on a consolidated basis. For institutional REITs under the joint control of a public REIT, (and other partners) the total investment of the public REIT may not exceed 20% of its consolidated assets. Furthermore, no joint control with another public REIT is allowed. Obviously, these requirements and rules will require certain structuring to find the most optimal structure, often depending on the specific sector/market segment in which the REIT is operating.
- Tax regime of Belgian institutional REITs
The concept of an institutional REIT enables public REITs to co-invest with non public real estate or other partners in a special purpose vehicle benefitting from the REIT status, including its corporate income tax status. Consequently, the profits generated within this special purpose vehicle will as such be practically “exempted” from Belgian corporate income tax, as Belgian REITs are taxed for corporate income tax purposes on a very minimal lump sum basis (i.e. certain disallowed expenses increased with not-at arm’s length advantages received by the REIT). As Belgian (institutional) REITs are subject to Belgian corporate income tax, they are able to benefit from the various double taxation treaties and invoke treaty benefits included.
The near non taxation at the level of the REIT mainly results in shifting the taxation from the REIT level to its shareholders (principally through a 15% withholding tax and non application of the Belgian participation exemption for Belgian corporate shareholders on the dividends received). Clearly, the tax consequences and downsides for the co-investing corporate companies will need to be taken into consideration when structuring investments in institutional REITs.
Other real estate linked taxes, such as transfer taxes, regional and local taxes, as well as VAT rules with respect to real estate (which result in important VAT leakages of input VAT in Belgium), are usually linked to the real estate business rather than depending on the (non)REIT status of a company. As illustrated by EPRA in its recent study, the Belgian REITs and their shareholders overall contribute significant amounts of taxes to the Belgian treasury.
The new legislation does not change the REIT tax regime and does not contain specific tax clauses. Therefore the tax contributions of REITs as such should not be impacted/lowered. On the contrary, the introduction of this new set of rules can be expected to have a direct positive budgetary impact for the Belgian government as the “all in or all out” clause is expected to trigger an exit tax upon conversion or transfer to the REIT-regime. Indeed, for corporate income tax purposes, the conversion of a real estate company into a REIT, is considered as being a deemed liquidation, resulting in the deemed realisation of the available real estate net assets, triggering a 16.995% exit tax (being 50% of the ordinary corporate income tax rate in Belgium). The new legislation may also benefit the Belgian state budget in an indirect way as REITs are being given more flexibility to collect funds enabling them to increase the number of transactions and continue their growth both at home and abroad, thus supporting the real estate sector as a whole.
- Opening to public private partnerships and other joint ventures
In order to facilitate the co-investment in institutional REITs, the definition of permitted real estate activities was expanded in the new Royal Decree a.o. by including leasing or “other similar rights” into the definition. The preparatory work explicitly states that this expansion was necessary to enable institutional REITs to enter into public private partnerships (PPP).
Also representatives of real estate companies show curiosity and enthusiasm at being able to step into projects with public companies which will obviously result in important benefits for both parties in exchanging their experiences and expertise. Practice will show how these benefits will overcome the possible (tax) downsides for the co-investors. For example, the rule that the public REIT in certain circumstances can force a co-investor to step out or that it can decide to step out itself, will have to be monitored and may also lead to the exit scenario mentioned below.
- Exit from institutional REIT
Although the lifetime of special purpose vehicles in the real estate business are typically limited in time, the Royal Decree does not contain rules to deal with a possible “exit REIT scenario”. However, as institutional REITs will be incorporated by a public REIT together with non-REIT co-investors, a possible exit and its tax consequences should be considered as important. Also for accounting purposes, no conversion from IFRS – mark-to-market – to Belgian GAAP is covered. Practice will demonstrate that these aspects are to be developed and that further regulation is needed.
- Road to success?
Interviews with CEO/CFOs of Belgium’s most important REITs show that some have high expectations but most also have mixed feelings and even skepticism or disappointment with respect to the legal framework in which the institutional REITs have been introduced. Moreover, as each Belgian REIT has its own specialisation, each REIT will interpret the new rules in view of its own market approach, resulting in different positions as to their willingness or need to step into co-investments. Furthermore, the “all in or all out” rule generates substantial incomprehension in the sector.
Conclusion
Although certain anomalies are still not covered and there are outstanding questions with respect to several formulated conditions, with the new Royal Decree however, a first but important step has been taken. Belgian public REITs are able to expand their activities and for the first time ever, co-invest in institutional REITs. Future collaboration between (public and institutional) REITs and co-investors will measure the success of the introduced changes, possibly after further amendments.
ENDS
Saskia Smet (saskia.smet@be.ey.com) : saskia.smet@be.ey.com
Bart Desmet (Senior Tax Consultant): bart.desmet@be.ey.com
Geert Gemis (Tax Partner): geert.gemis@be.ey.com
Ernst & Young Tax Consultants Belgium
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