REITs, or real estate investment trusts, refers to a kind of investment fund that raises funds from investors through the issuance of income certificates to form fund property, which is handed over to a professional investment organization to invest in, manage and operate real estate with relatively stable returns, take the returns generated from real estate as the main source of income and allocate the vast majority of the returns to investors in a timely manner. Since April 2020, China is piloting real estate investment trusts (infrastructure REITs) in the infrastructure sector, with investment scope including toll roads, industrial parks, warehousing and logistics, sewage treatment, clean energy, guaranteed rental housing and other infrastructure.2023 On March 7, 2023, the Securities and Futures Commission (SFC) issued new regulations to expand the scope of investment, expand the participation of the main body, and optimize the audit and registration mechanism to promote the further development of REITs. In view of this, this paper interprets the tax arrangements involved in REITs based on the current tax regulations, and points out the risks and responses.

I. Domestic REITs Pilot Runs Smoothly, Policy Expansion Promotes Further Development

(I) New regulations issued by the Securities and Futures Commission (SFC) to normalize REITs issuance

 On March 7, CSRC issued the Notice on Further Promoting the Work Related to the Normalized Issuance of Real Estate Investment Trusts (REITs) in the Infrastructure Sector, which made new requirements for promoting the normalized issuance of REITs in four aspects, namely, the construction of the market system, audit and registration mechanism, standardization and supervision, and regional and departmental supporting mechanisms. Among them, the asset types of REITs and participating entities have been expanded and the threshold of access has been lowered:

1. Consumer infrastructure is included in the scope of asset types for investment. In the existing warehousing and logistics, toll roads, water, electricity, gas and heat, sewage and garbage treatment, mainly involved in transportation, municipalities, pollution control, such as strong public welfare projects outside, for the first time to include department stores, shopping centers, farmers markets and other urban and rural commercial outlets projects such as consumer infrastructure.

2. categorized and adjusted the property rights, franchise type project yields and guaranteed rental housing project first asset size requirements.

3. Promoting the normalization of the expansion of issuance. After the release of the "Notice", March 31, the first batch of four single infrastructure public REITs expansion project to obtain the China Securities Regulatory Commission to change the registration approval, respectively, Huaan Zhangjiang Everbright Park REIT, CICC GLP warehousing and logistics REIT, Boshi Shekou Park REIT and Redland Innovations Yantian Harbor REIT, which is said to be the sound of the landing.

4. expanding the participation of market players in the main body, the insurance asset management companies and other financial institutions into the pilot.

5. in terms of supporting policies, emphasizing the integrated and coordinated solution of REITs involved in project compliance, transfer of state capital, tax policy, rights and interests recognition and other issues. Therefore, the tax compliance of the relevant projects can, to a large extent, be supported and pre-ruled by the local competent tax authorities to avoid risks.

(II) Main structures of domestic pilot REITs and their characteristics

As domestic REITs are still in the process of piloting, their establishment and operation need to be operated under the framework of the existing legal system related to securities funds, thus giving rise to some of their own characteristics and unique modes. As Article 72 of the current Securities Fund Investment Law stipulates, "Fund property shall be used for the following investments: (i) listed and traded stocks and bonds; and (ii) other securities and derivatives as stipulated by the State Council's securities and securities regulatory authorities." As a result, domestic REITs are unable to invest directly in the project company, but have to erect a layer of asset-backed securities (ABS) in the middle, resulting in the structure shown in the following figure, in which the SPV usually exists at the establishment stage and is subsequently merged by reverse absorption. 

According to the Notice of the China Securities Regulatory Commission National Development and Reform Commission on Promoting the Work Related to the Pilot of Real Estate Investment Trusts (REITs) in the Infrastructure Sector (CSRC National Development and Reform Commission [2020] No. 40) and related regulations, domestic REITs need to be set up in a stage where the original owner of the interest needs to consolidate and divest itself of its own assets, consolidate the real estate to the project company, and then, in the form of a 100% transfer of equity, to ensure that the fund completes the acquisition of infrastructure. As of now, there is a lack of clear tax policies in this segment.

(III) Tax-related issues in the main stages of domestic REITs

REITs have the following stages: 1. Preparation stage before establishment, mainly the original equity holders start to integrate and divest their own assets to the project company, to ensure that the project company holds clear ownership and meets the requirements of the pilot real estate ownership. 2. Establishment stage, the original equity holders transfer 100% of the equity of the project company to the REITs (i.e., the fund) to ensure that the fund completes the acquisition of infrastructure by controlling the project company. 3. acquisition of the infrastructure. The original interest holder then obtains the corresponding price or fund shares according to the appraised value of the assets.3. Operation stage, the invested project company distributes dividends and bonuses to the fund, and the fund shareholders transfer the fund shares, etc.4. Termination and liquidation stage, the transfer of the fund shares and issues in the liquidation of the property.

Generally speaking, the more important issues lie in the reorganization of the project company at the time of establishment and the transfer of fund shares in the operation, etc. Next, this paper will analyze the relevant tax policies.

II. Analysis of Tax Arrangements for REITs in Different Segments under Current Policies

(I) Status quo of tax policies for REITs: too few targeted documents

Currently, the only tax-related regulations for REITs are the Announcement of the Ministry of Finance and the State Administration of Taxation on the Pilot Taxation Policies for Real Estate Investment Trusts (REITs) in the Infrastructure Sector (Announcement of the Ministry of Finance and the State Administration of Taxation No. 3 of 2022, hereinafter referred to as Announcement No. 3 of 2022), which was jointly issued by the Ministry of Finance and the State Administration of Taxation (SAT) in January 2022, which is mainly related to deferral provisions for corporate income tax deferral provisions. Other issues relating to value-added tax and land value-added tax in the reorganization of the relevant enterprises and the operation of the fund will still be subject to the application of the relevant documents in the past, and therefore there is a certain degree of uncertainty.

(II) Analysis of major tax issues at the establishment stage

In the pre-establishment to establishment segment, the main arrangement lies in the divestiture of assets by the original equity holder, handing over the real estate and other assets to the project company for holding, and then transferring 100% of the equity interest of the project company to the REIT.

1.Deferral of corporate income tax and temporary suspension of taxation

Announcement No. 3 of 2022 stipulates that the transfer of infrastructure assets from the original interest holder to the project company to acquire equity interest in the project company accordingly is subject to special tax treatment, and no enterprise income tax will be levied in this segment. Since it is a transfer, the transfer of assets or equity must be made between a 100% controlled parent company, or subsidiary, e.g., the original equity holder establishes a new 100% controlled subsidiary and then transfers its own assets to it. Accordingly, this provision cannot be applied in the case of replacement or reorganization of assets by other affiliates that are not 100% controlled.

Upon completion of the reorganization of the project company, the original interest holder is required to transfer 100% of the equity interest in the project company to the fund and then obtain the price of the equity transfer or the fund share of the strategic placement. According to Announcement No. 3 of 2022, no income shall be recognized at the time of equity transfer, which is an alternative treatment to the Circular of the State Administration of Taxation on Certain Tax Issues Concerning the Implementation of the Enterprise Income Tax Law (Guoshuifan [2010] No. 79), which states that "the income from the transfer of equity by an enterprise shall be recognized at the time when the transfer agreement comes into effect and the procedures for the change of equity are completed". "After REITs complete fund raising, if the price of equity transfer is paid, it is recognized at the time of payment of the price; if the shares are strategically placed to the original equity holders, the income tax continues to be deferred to the time when the shares are actually transferred.

According to the provisions of these two articles, it can be seen that the cost of the equity is to be determined in accordance with the original tax basis of the infrastructure assets, as the real estate assets are transferred to the project company with the application of special tax treatment and no income tax is levied.

After holding the strategic placement shares, the original owner purchased the fund shares from the secondary market, and sold them in accordance with the principle of "first-in-first-out", i.e., because the strategic placement shares were acquired first, it was determined that the strategic placement shares were sold first.

2.Transfer of real estate and its related bonds, liabilities and labor together, no VAT is levied

Is the transfer of real estate assets from the original owner to its wholly-owned subsidiary to be treated as a sale? According to the "Announcement of the State Administration of Taxation on Issues Relating to Value-added Tax on Asset Reorganization of Taxpayers" (Announcement of the State Administration of Taxation No. 13 of 2011), a taxpayer's transfer of all or part of its physical assets, as well as its associated bonds, liabilities and labor force together to other units and individuals in the process of asset reorganization by way of merger, demerger, sale or replacement is outside the scope of value-added tax ("VAT") and the goods involved in the transfer do not fall within the scope of VAT. The transfer of goods involved is not subject to VAT. Since the project company needs to operate the real estate in order to obtain income, theoretically, it must be "transferring" its attached labor force, etc., and therefore does not belong to the taxable scope of VAT. However, if only the real estate is transferred without the associated debts, liabilities and labor, it will be treated as a sale and subject to VAT.

The transfer of equity interests in the project company from the original owner to the fund is outside the scope of VAT and therefore not subject to VAT.

3. Land value-added tax in doubt: the risk of penetration

The bigger problem actually lies in the area of land value-added tax (LVAT). The current land value-added tax regulations, mainly the Announcement on Continuing to Implement the Land Value-added Tax Policies in relation to Restructuring and Reorganization of Enterprises (Announcement of the Ministry of Finance and the State Administration of Taxation No. 21 of 2021), which stipulates that: a non-real estate development enterprise that uses real estate as the price of its shares in the restructuring and reorganization of the enterprise to make investments, and transfers or changes the real estate to the invested enterprise, will not be subjected to the land value-added tax for the time being. However, real estate development enterprises do not enjoy the above tax benefits. Since a real estate development enterprise establishes a new wholly-owned subsidiary and then transfers the assets to the subsidiary, the value of the subsidiary is highly correlated with the value of the real estate assets, which is in line with the characteristics of "real estate for shares".

However, the original owner can also claim that it is not a share purchase, but a gratuitous transfer within the group, due to Article 2 of the Provisional Regulations for the Implementation of Land Value-added Tax (LVAT), which stipulates that "the transfer of the right to use state-owned land, the buildings on the ground, and other attachments and the obtaining of income as referred to in Article 2 of the Regulations refers to the transfer of real estate by way of sale or in any other manner for a fee. " It is clearly stipulated that only paid transfer is the scope of land value-added tax, and the transfer of real estate to a wholly-owned subsidiary without compensation does not belong to the taxable scope of land value-added tax. This view is also recognized by local legislation in Chongqing and other places.

At the same time, it is worth noting that the transfer of 100% equity interest in the project company by the original equity holder is essentially a transfer of real estate assets to the fund for control, i.e., a "nominal share field". This may be considered as a transfer of real estate by way of transfer of equity, and thus may be subject to land value-added tax (LVAT) through penetration. This issue originated from the Reply of the State Administration of Taxation on the Issue of Land Value-added Tax on the Transfer of Real Estate in the Name of Transferring Equity Interests (Guo Shui Han [2000] No. 687), which stipulates that "assets in the form of equity interests are mainly the right to use the land, the buildings on the ground and the attachments", and that land value-added tax should be levied. Thereafter, the Approval Reply of the State Administration of Taxation on the Issues of Land Value-added Tax-Related Policies (Guo Shui Han [2009] No. 387) and the Approval Reply of the State Administration of Taxation on the Issues of Land Value-added Tax Collection on the Transfer of Land-use Rights by Tianjin TEDA Hengsheng (Guo Shui Han [2011] No. 415) expressed the same view. Then the risk is high in respect of land value-added tax.

4. Exemption of Deed Tax

The Announcement on the Continued Implementation of Deed Tax Policies on Restructuring and Reorganization of Enterprises and Business Units (Announcement No. 17 of 2021 by the Ministry of Finance and the State Administration of Taxation) stipulates that: "The transfer of land and building ownership between enterprises belonging to the same investment entity, including the transfer of land and building ownership between the parent company and its wholly-owned subsidiaries, between wholly-owned subsidiaries belonging to the same company, between the same natural person and his/her established The transfer of land and housing ownership between enterprises belonging to the same investment entity, including between a parent company and its wholly-owned subsidiaries, between wholly-owned subsidiaries of the same company, between a natural person and his/her established sole proprietorship enterprise or one-person limited company, shall be exempted from the Deed Tax. The capital increase of a parent company to its wholly-owned subsidiary with land and building ownership is regarded as a transfer and exempted from deed tax." According to this provision, the transfer from the original owner to the wholly-owned subsidiary is exempt from deed tax.

(II) Analysis of major tax issues in the operation segment

1. Corporate income tax issues for corporate investors

The income obtained by the enterprise investor is mainly divided into two pieces, i.e. income from distribution of the fund and income from transfer of fund shares. According to the Circular of the Ministry of Finance and the State Administration of Taxation on Certain Preferential Policies on Enterprise Income Tax (Cai Shui [2008] No. 1), the income obtained by investors from the distribution of securities investment funds shall not be subject to enterprise income tax for the time being.

However, the price difference income obtained by investors from the sale and purchase of fund shares shall be subject to enterprise income tax in accordance with the law. The original equity holders selling the shares of strategic placement shall recognize their costs in accordance with the aforementioned Announcement No. 3 of 2022.

2. Income tax of natural person investors

Pursuant to the provisions of the Circular of the Ministry of Finance and the State Administration of Taxation on Relevant Taxation Issues of Open-ended Securities Investment Funds (Cai Shui [2002] No. 128), the income from fund distribution obtained by natural persons shall be subject to 20% personal income tax withheld by listed companies, bond-issuing enterprises and banks upon payment of the said income to the fund, and no individual tax shall be levied on the allocation of such income to the natural person segments. Pursuant to this provision, the asset-backed securities shall fulfill the withholding obligation in respect of the portion of natural person investors when distributing the income.

According to the Circular of the Ministry of Finance and the State Administration of Taxation on Taxation Issues of Securities Investment Funds (Cai Shui Zi [1998] No. 55), "the spread income obtained by an individual investor from buying and selling units of a fund shall not be subject to individual income tax for the time being until the individual income from spread income from buying and selling of shares is resumed". Accordingly, the price difference income from the trading of fund shares by natural persons is not subject to personal tax for the time being.

3. Value-added tax

The VAT issue is mainly reflected in capital preservation income funds. Theoretically, although REITs are based on the stability of real estate, the income is more stable, for example, the establishment of REITs need to have a yield, distribution rate of the standard, but still can not promise to protect the capital, then it does not belong to the scope of value-added tax taxable.

Investors who buy and sell fund shares will pay VAT according to the "transfer of financial commodities". However, investors who purchase funds and hold them to maturity are not considered as transfer of financial instruments and do not need to pay VAT according to "transfer of financial instruments".

III. Summary: REITs Operation Focuses on Compliance in the Forefront

As the REITs pilot project is still relatively new, the relevant tax policy lacks targeted regulations, so the regulations are more complicated, especially in the perspective of land value-added tax there are greater risks. At this stage, due to the relatively high status of the relevant pilot project, it is bound to have communicated with the local tax authorities and received guidance and commitment from the tax authorities. However, with the expansion of the scope of the relevant pilot projects and the normalization of audit and registration, certain risks and disputes may arise. When operating real estate projects, the project company should strengthen tax compliance, manage invoices properly, and pay corporate income tax, value-added tax and surcharges, stamp duty and urban land use tax in accordance with the law to avoid incurring unnecessary losses. Managers of asset-backed securities and funds should also be aware of relevant tax issues to avoid triggering risks.