Thursday, February 5, 2015

Budget 2015

Feb 03, 2015


Reits: Time to end tax breaks?

A slew of tax incentives 10 years ago fuelled the growth of Real Estate Investment Trusts or Reits in Singapore. It's time to retire some of them.

AS PEOPLE gear up for Budget 2015, one low-profile but important tax sweetener is being monitored quietly by investors and analysts.

This is the slew of tax incentives for the Singapore Reit market introduced in 2005, and renewed in 2010. They expire on March 31 this year, unless renewed in this Budget.

If the tax breaks are removed come April 1 in the new financial year, they could have an impact far beyond that on a few S-Reit funds and their direct investors.

For S-Reits, as they are called, are big owners of Singapore's shopping malls, commercial buildings and factories. How they adjust their way of doing business as a result of any tax changes may have an impact on business costs and that may, in turn, have a bearing on our costs of living.

Reits are "closed end" funds which invest in income-generating real estate assets. What makes them so alluring to investors is their tax-efficient structure.

If they pay out at least 90 per cent of their income as dividends, Reits are exempt from paying any income tax. Individual investors are also exempt from paying tax on the dividend they receive.

Tax incentives were launched 10 years ago to encourage the set-up of more S-Reits as well as to attract more foreign institutional and corporate investors to invest in the S-Reit market.

The incentives were given for five years initially, but they were extended in 2010 for a further five. In 2005 when the tax incentives were introduced, there were only five S-Reits with a total market value of about $9 billion.

Since then, the market has grown: there are now 28 Reits and six stapled securities - involving a Reit "stapled" to other forms of investment - with a total market capitalisation of $67 billion.

The market consensus is that the tax incentives will be renewed for another five years.

As DBS Vickers noted, competition posed by other countries in developing their own Reit markets makes a case for renewal. It said: "These tax incentives are key attractions which made Singapore one of the leading Reit hubs in the Asia-Pacific region. In addition, Singapore needs to stay ahead, given that India, Thailand and China have been fine-tuning and instituting their own Reit regulations to draw in capital investments."

However, a few analysts beg to differ. Nomura analyst Sai Min Chow said in a report that the renewal may not be a given, given the need to fund more social spending.

Others say the Government should not give a carte blanche extension on all the 2005 tax incentives offered to the S-Reit sector.

Ripe for removal

IF ANY incentives should go, the top one is the stamp duty concession given to Reits which has made it cheaper for them to acquire properties here.

Right now, stamp duty is waived for the purchase of properties by Reits IPO aspirants, or Reits already listed in Singapore.

This encourages companies owning properties to inject them into a Reit and spin it off as a separately listed firm without incurring the pain of paying a 3 per cent stamp duty to make the transfer on the properties.

Analysts say the stamp duty waiver also makes Reits more aggressive in acquiring properties here, as they take advantage of the tax incentive. Their gripe - rightly or wrongly - is that in order to make their purchases pay off, Reits then jack up rentals on the acquired properties. This, in turn, drives up the costs of doing business in Singapore.

So removing the stamp duty may dampen the appetite for S-Reits to tote up more property purchases here and, hopefully, soften the market for commercial buildings and malls, stopping rental appreciation.

Incentives that can stay

WHAT about other incentives that Reits enjoy?

Individual investors - local or foreign - do not pay any taxes on the dividends from their S-Reit investments. Corporate investors are taxed at their respective tax rates on Reit income, unless they enjoy an exemption.

However, to lure foreign non-individual investors to invest in S-Reits, the withdrawing tax on Reit dividends received by them was reduced to 10 per cent in 2005 for a period of five years and renewed in 2010 for another five years.

Mr Leonard Ong, a tax partner with audit firm KPMG, expresses concern that removing this tax incentive in the next Budget will likely see a lower net dividend payout for this class of investors and make S-Reits a lot less attractive to them. "This may cause some of them to exit their S-Reit investments and cause a significant drop in market value, if the exodus is en masse," he said.

The same argument applies on the tax exemption which S-Reits enjoy on the income which they earn on their foreign properties.

Such rental income is already subject to taxation in the country where the foreign property is located. When the income is remitted back to an S-Reit in Singapore, it does not suffer a second round of taxation, subject to certain conditions being met.

If this exemption is not extended, an S-Reit making fresh foreign property acquisitions after March 31 could potentially suffer double taxation on the same overseas rental income it earns.

But not all analysts think the same way. One corporate lawyer thinks over-reliance on S-Reits to spur investor interest in the stock market is unhealthy: "We have a lot of Reits already. It is time that the Government put our tax incentives to work in other areas to attract other asset classes to give greater depth to the SGX."

So whatever the Finance Minister announces on Feb 23, Budget Day, it would be wise for S-Reit investors not to assume that the status quo will remain. As the recent move by the Monetary Authority of Singapore to slow the appreciation of the Singdollar shows, policymakers can spring surprises.

This is the first of a three-part series on issues relating to Budget 2015.


Will using more technology and local workers really raise productivity?

FEB 10, 2015

What if switching from foreign to local workers doesn't raise productivity? Read what Donald Low thinks


Productivity is expected to be an issue that will feature prominently in this year's Budget statement to be delivered on Feb 23.

In Singapore, foreign worker policies impinge directly on the country's efforts to raise productivity. And here, it would appear that some assumptions behind foreign worker policies in Singapore bear rethinking.

In an earlier piece for The Straits Times ("Focus on welfare, not wages, of foreign workers"; Jan 23), I had suggested that foreign worker policies in Singapore be guided by three broad objectives.

The first is to encourage employers to substitute Singaporeans for foreign workers.

The second is to reduce the growth of the non-resident labour force in Singapore and, in so doing, encourage companies to increase the skills and technology content of their operations.

And the third is to improve the welfare of the foreign workers in our midst.

It is generally assumed that the first two objectives work in tandem to raise labour productivity. There is also an unspoken assumption that the last objective of improving the welfare of foreign workers reflects more a humanitarian desire rather than a hard-nosed economic strategy to raise productivity.

In the light of current struggles to raise productivity, these assumptions ought to be questioned. Doing so leads to some uncomfortable conclusions and policy implications.

S'porean workers may not be more productive

Consider first the assumption that encouraging employers to replace their foreign workers with (more expensive) Singaporean ones would raise output per worker. A careful consideration suggests that this outcome is unlikely in the short to medium term.

It is entirely possible that the Singaporeans who are (re-)entering the workforce as a result of the labour crunch that companies now face are the less productive, "marginal" workers who were previously not in the labour force.

While lower and median incomes have increased in recent years, this could well be the result of employers responding to the tighter supply of foreign labour by increasing wages to attract Singaporeans. But unless labour-saving technologies are introduced or organisational processes and practices improved, it is quite unlikely that the mere substitution of Singaporean for foreign workers would increase labour productivity.

This does not mean that the Government should now reverse its course of trying to reduce the growth of the non-resident labour force in Singapore. Even if a tighter foreign worker policy does not increase productivity, reducing the economy's dependence on cheap foreign labour is a goal worth pursuing in its own right.

To the extent that current efforts increase labour force participation among older and female Singaporeans and raise their incomes, they support broader objectives of social inclusion and retirement security. Productivity growth is not, and should not be, the only goal of labour policies.

Automation, skills upgrading not enough

Second, consider the assumption that reducing the growth of low-skilled foreign labour in Singapore gives companies stronger incentives to introduce labour-saving technologies that require fewer, higher-skilled workers. This, in turn, raises labour productivity.

The Government has used tax policy - the Productivity and Innovation Credit and higher foreign worker levies - to encourage employers to substitute technology for labour and more skilled workers for less skilled ones. For more than a decade, the state has also poured significant resources into upgrading less skilled workers.

But what if technology and the skills of workers are not the main determinants of company-level productivity? Given that the cost of labour in Singapore has been depressed for many years (because of liberal foreign worker policies) while the cost of capital has been set by the market, it is quite likely that company processes have become reliant on the continuing availability of cheap labour. So one driver of productivity is likely to be business process innovation.

Changing these entrenched practices will take time; restructuring is unlikely to be a frictionless process that can be easily engineered by the Government providing more tax giveaways to companies or enrolling more workers in training programmes.

In a knowledge-based economy, worker motivation is probably another, if not the key, determinant of labour productivity.

Research from the behavioural sciences suggests that worker motivation may not be determined by performance-based incentives alone.

To the extent that workers view employment as a reciprocal, "social" relationship rather than an impersonal economic transaction, low worker identification with employers, low levels of worker empowerment, high pay disparities, and large power distances and steep hierarchies in organisations have been found to reduce worker motivation and performance.

An organisation's capacity is not just the sum of the skills of its members; it is also a function of the social capital they possess.

It is not immediately obvious what tax or expenditure measures by the Government can alter organisational practices and norms. The Government's recent calls for employers to reduce the emphasis on paper grades is a step in the right direction. But it does not go far enough in reforming current workplace practices and norms.

A more radical approach would be to question the longstanding emphasis on attracting and rewarding top performers handsomely.

For a small country like Singapore, the emphasis should surely be on ensuring that everyone is developed and given the opportunities to contribute, rather than on developing and rewarding a thin layer of talent at the top.

Beyond government rhetoric, economic agencies should also abandon the assumption that there is a single model of the productive company - one using lots of technology and hiring skilled workers. Economic development is similar to biological evolution in many respects. Just as evolution is the result of two principles - variety and selection - so too in business: Development is the result of a high degree of variation and differentiation among companies and competition in the marketplace to weed out the weak.

The implication of this is that industrial policy in Singapore should not only aim to attract successful multinationals, but should also be aimed at ensuring a wide variety of local companies. At the same time, the companies that the state supports should be judged by the market, not bureaucrats.

Equalising standards for foreign workers

Finally, consider the assumption that efforts to raise the welfare of foreign workers here, while necessary, are pursued more for ethical rather than efficiency goals.

Like the above two assumptions, this mental model should be critically examined.

Take, for instance, the most obvious disparity: The fact that resident workers enjoy unfettered mobility between employers, while foreign workers are tied to specific employers. Increasing the mobility of foreign workers addresses, partially at least, the extremely low bargaining power that they have. This should, in turn, force employers to improve their workplace practices, health and safety standards, and possibly other non-wage conditions of employment to attract better foreign workers.

At the same time, improving the non-wage conditions of foreign workers - for example, housing conditions, access to health care and social protection - makes for a more productive foreign workforce in the same way that the provision of public housing, good health care and social security enhanced the productive capacity of Singaporeans. Equalising standards for foreign workers may well be an efficient, growth-enhancing strategy.

So why isn't the Government more vigorous in raising these standards? I suspect that the reason it is not able to do so is more organisational in nature. Meeting the needs of foreign workers is not an integral part of the mission of public agencies that deliver these public goods. So housing foreign workers is not part of the mission of the Housing Board; providing them with good health care is not part of the Ministry of Health's mission, and so on.

Until this organisational bias is addressed, foreign workers here will continue to be a big part of the low-skills, low-wage and low-productivity equilibrium that characterises a significant segment of the Singapore economy.

Changing this equilibrium is critical in transforming Singapore into a productivity-driven economy. A good start to this change process is to question and, if necessary, jettison some of the mental models behind current labour policies.

The writer is the associate dean for research and executive education at the Lee Kuan Yew School of Public Policy, National University of Singapore.

This is the second of a three-part series on issues relating to Budget 2015.

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