Liquidity management in the special tax regime for REITs
Real Estate Investment Trusts (REITs) are a type of company whose main activity focuses on the acquisition, development and refurbishment of urban real estate for rental purposes. Legally, the legal regime for this type of company is set out in Law 11/2009, of 26 October, which regulates Real Estate Investment Trusts (hereinafter referred to as Law 11/2009).
In this article we are going to refer to one of the requirements demanded by Law 11/2009 for this type of company: the mandatory policy of distribution of results.
What is the mandatory profit distribution policy for REITs?
It should be borne in mind that this type of company enjoys a special tax regime that allows them, among other advantages, to apply a 0% corporate income tax rate.
This absence of taxation in the REIT itself entails the obligation to distribute a relevant percentage of its accounting results in the form of dividends (once the legal obligations established in articles 273 and 274 of the Capital Companies Act have been fulfilled) so that such results are effectively taxed to its shareholders.
Specifically, this obligation is regulated in Article 6 of Law 11/2009. The distribution percentages are as follows:
- 100% of the profits from dividends or shares in profits deriving from holdings in the company’s main corporate purpose.
- 50% of the profits derived from properties or participations assigned to the main corporate purpose of the REIT, provided that certain requirements are met.
- 80% of the rest of the profits obtained, including those linked to the leasing of urban property to third parties and also those from ancillary activities.
In addition, it should be noted that, with effect from 1 January 2021, a special tax of 15% is introduced on undistributed profits of this kind.
This legal obligation to distribute presents a challenge for cash management. Apart from the accounting methods for dealing with possible cash flow tensions (such as revising the SOCIMI’s asset depreciation policy), there are other ways to combat these situations.
A. Flexible dividends or scrip dividends
In this alternative, the REIT agrees to deliver free-of-charge allocation rights to its shareholders.
These shareholders have several options:
- Exercise their rights and acquire the fully paid-up shares in a capital increase;
- Dispose of these rights on the market;
- Sell them directly to the REIT itself for a pre-fixed price.
Recently, the General Directorate of Taxes (DGT) has analysed whether this alternative fits within the obligation to distribute profits when the shareholder is an individual resident in Spain. The conclusion reached by the DGT is that this remuneration alternative would not fit within the distribution requirement because the receipt of the bonus shares would not be considered as dividends for the individual and, therefore, no taxation would be payable.
However, although the DGT does not analyse this situation, we believe that, in the case of shareholders who are taxable persons for corporate income tax purposes, this alternative would fit within the scope of Law 11/2009 since, in this case, the shareholder would recognise financial income in its accounts for this distribution and, therefore, taxation would occur in the shareholder’s accounts (the objective pursued by the regulation).
B. Dividends in kind
The distribution of non-cash dividends is a fully valid option in accordance with the provisions of Royal Legislative Decree 1/2010, of 2 July, approving the revised text of the Capital Companies Act. This option has also been confirmed by the DGT in numerous consultations, since Law 11/2009 does not expressly exclude it.
However, it should be noted that this is a residual option due to its complexity (e.g. in the choice of assets or their valuation).
C. Dividend distribution agreement and subsequent capitalisation of the claim
This is one of the most commonly used options in practice and basically consists of the following two steps:
- The REIT agrees to distribute a dividend to its shareholders (in compliance with the requirements of article 6 of Law 11/2009).
- Subsequently, a capital increase is carried out by offsetting the claim due to its shareholders for this profit distribution.
This possibility has been expressly confirmed by the DGT and allows the REIT to fulfil the following three objectives:
- Firstly, to distribute its benefit in order to comply with the requirement set out in the aforementioned Article 6 of Law 11/2009.
- Secondly, taxation takes place at the level of the shareholders. This distribution would be treated as income, whether they are personal income taxpayers or corporate taxpayers.
- Thirdly and lastly, it allows liquidity to be held at the company’s own headquarters (except, where applicable, for any withholding tax on such distribution).
D. Shareholders’ loan to the company for the dividend to be received
In relation to the above, in order to avoid dilution of shareholders who prefer to receive the dividend, it has also been accepted as an option for shareholders to formalise a loan in favour of the REIT for the amount approved as a dividend. This option would also comply with all the requirements set out in the REIT regulations for the distribution of results.
Consequences for the shareholder of the profit distribution requirement in REITs
There is a negative component for the shareholder in these transactions, which allow the legal requirement of profit distribution to be met. Specifically, this unfavourable component consists in the fact that the shareholder will be taxed on income that he has not received in the form of money. Consequently, in order to mitigate this adverse effect (and whenever possible), mixed situations are usually envisaged within these options that also allow the shareholder to receive money.
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