Sunday, April 01, 2007

Real Property Gains Tax Abolishment (I)

Well... looks like age has caught up with me. I must remind myself that I'm no longer 18 years old with unlimited energiser batteries. I missed the trip to Penang this evening after catching a bad flu leaving me aching all over... thankfully, I'm not a key speaker for the dinner at Komtar, there are at least 6 other Yang Berhormats present ;).

But that leaves me with a bit of time to put together the presentation I did in Seremban on Friday on "Real Property Gains Tax Abolishment: Its Impact on Malaysian Economy" in text form for your reading pleasure here.

The Real Property Gains Tax Act was enacted in 1976, primarily to curb speculative activities in property market. It is a tax on gains derived from the disposal of property assets by both individuals and companies. The tax structure is tiered, with the highest rate being 30% for disposal within 2 years. Gains from disposals after six years of ownership are exempted.

It was announced by the Prime Minister, Datuk Seri Abdullah Ahmad Badawi a week ago that Malaysia will scrap the Real Property Gains Tax effective today. He argued that the move "will inject more excitement and dynamism into both the property and the financial sectors."

Industry responses, largely from the local property and construction sector was brimming with praise, and given major prominence by the local media for a few days. Tan Sri Liew Kee Sin, SP Setia Bhd chief executive officer said that "it would spur more property purchases in a market which has in the past three years, had been dominated by those buying for own use." In the first half of 2006, home property sales in Malaysia fell 3.4% to 85,153 units.

Many were hopeful that Malaysian property which is worth only some 30% of their counterparts in Singapore and Hong Kong will begin attracting more foreign investments. Choong Khuat Hock, who manages a RM400 million ringgit at Kumpulan Sentiasa Cemerlang argued that it is "very good for the property industry, Malaysia's properties are one of the cheapest in Asia and they needed an impetus to crystalize the value. It shows the government is flexible and welcomes foreign investment."

The Prime Minister also added that "Potential that has gone unrealized or under-optimized will be turned into new industries and businesses, new value creation and new jobs." Datuk Alan Tung of Bukit Kiara Properties, was excited about the multiplier effects of an expanded property development sector on some 140 property-related industries. Hence, there's a great deal of hope placed on the abolishment of the real property gains tax to reinvigorate our property sector, as well as the Malaysian economy in general.

Is the picture really that rosy?

The ability to attract foreign investment with abolishment of real property gains tax is open to debate. Peter Churchouse who runs a US$110 million Lim Asia Property Fund in Hong Kong argued that the "abolition of the tax was unlikely to cause much excitement among foreigners."
Foreign investors still face heavy legal restrictions on land ownership in Malaysia. At the margin it's positive, but foreigners have problems investing in Malaysia anyway.
In comparison, like Malaysia, Singapore has a real property gains tax system for properties sold within a 3-year period, but it clearly does not have major problems in attracting local and foreign investors to its properties. Both the United States and United Kingdom have property capital gains tax (not just for a 3-6 years period), and yet, both until fairly recently have enjoyed a housing boom.

Hence, clearly, the issue of reviving the Malaysian property sector has to do with more than just the real property gains tax. To quote Mr Tan Teng Boo, who manages a US$110m fund at Capital Dynamics Asset Management, “the incentives are very good on paper. Still, it will be crucial to ensure that the follow-through and implementation of the project is efficient.”

Other restrictive controls which deters investors are like our land ownership laws which are often complicated due to racial quotas. Our weak delivery system is epitomised by our local governments - the local councils headed by "little napoleons". With a majority of condominiums in Selangor not having received their strata titles, it is not surprising that even the Prime Minister himself has given the Minister of Housing & Local Government a public dressing down.

In addition, the performance of the local property developers play a key role in attracting the relevant investments. The system currently has plenty of loopholes which allows for property developers to get away practically scot free with half-built properties, and leaving property buyers with a 90% loan drawn-down to service. With plenty of Malaysian and foreign (especially Singaporean) buyers finding their investment locked into abandoned property projects throughout the country, it is unsurprising that foreign investors view Malaysian properties with great apprehension.

At the end of the day, the performance of the property sector is also a function of the performance of the overall economy. If the overall economy of the country is well managed like Singapore or Hong Kong, or perceived as holding vast potential, like China, then the property sectors will naturally boom. A sluggish or moderately performing economy will on the other hand, attract only meagre investment, even if there are no capital gains tax. (Or to put it bluntly, even if Iraq pays me money, I won't invest in a property there.)

More importantly however, as to why I'm skeptical as to how much the abolishment of the real property gains tax can re-energise our property sector, is the fact that most wealthy owners of such taxable properties are able to avoid having to pay such taxes anyway! Our tax regime is such that capital gains (e.g., buying and sale of both listed and unlisted shares) are not taxable.

Hence, putting it very simply, a way to avoid paying real property gains tax, you park your property under a company. And when you want to sell the property, you sell the shares of company instead to the new buyer. This way, no tax needs to be paid, or at least, not directly. What more, this mechanism is a lot faster than a real estate porperty transaction as well!

So the question is, given that many who are interested in investing in properties in Malaysia would have had the necessary expert tax-planning advice, would abolishing the real property gains tax make any significant difference to the key investment public (as opposed to the small time house-buyers like us)?

Therefore, while intuition tells us that abolishing the real property gains tax might just be the catalyst to spur additional transactions in the Malaysian property market, further analysis will throw plenty of doubt as to why the "spark" might just not be sufficient. I hope it works, but I'm just not sure it will.

In my second part to the same topic (if you are not already bored to death on the subject!), I'll discuss the potential socio-economic impact of such a move in abolishing such a tax, as well as whether a permanent abolishment of the tax is necessary. ;)
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