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by Deloitte's Tham Lih Jiun, John Whitehead and Joe Galea
Discounts of 50% to their peak values! Malaysians have seized opportunities to purchase apartments, houses and top-end properties in the UK, US and Australia at favourable prices. They have experienced the thrill of acquiring high-grade properties in choice locations at a steal with the prospect of value appreciation in three to five years. They have also tasted the euphoria of clinching units that appeared to be sold out within hours. But when it comes to overseas real estate investments, what are some of the considerations? In this article, we will focus on foreign exchange opportunities, risks associated with such investments and some tax issues, which are less glamorous aspects of these deals but with significant impact on profits.
Forex opportunities and risks
Many with deep pockets have merely wired out the purchase price from their ringgit or foreign currency accounts. However, such cross-border acquisitions present both foreign exchange opportunities as well as risks. In addition to gaining from real estate appreciation, there is also the possibility of profiting or losing from foreign currency appreciation or depreciation.
Veterans in Australian property investment can tell us stories of the days when they realised good Aussie dollar capital gains from the sale of properties there. However, the results were dismal after the proceeds were converted back into ringgit. The depreciation in the Australian dollar against the ringgit extinguished their investment gain which was originally funded in ringgit.
An investor may take the position that he does not wish to be exposed to foreign exchange risk. One obvious way to do this is to hedge the foreign currency against say, the ringgit by establishing a forward purchase contract. However, this transaction may be costly and cumbersome. Another option is to borrow in the currency in which the investment will be realised. Others address the forex risk by borrowing in the currency in which loan repayments are to be funded.
Identifying lenders is an interesting experience. If the property is located in the US, potential borrowers typically meet mortgage brokers rather than bankers there. However, foreigners or aliens find it difficult to borrow in the US. If an attempt is made to borrow in US dollars from Malaysian banks, you will find that most such banks here have little experience in this matter. The process is therefore tedious, time consuming and costly. An approach to foreign banks may yield the desired results.
More aggressive investors may take the view that a particular currency will depreciate within the next three to five years. For example, if the perspective is that the US dollar will depreciate in that time frame, the investor may choose to borrow in US dollars to finance property acquisitions in say, the UK. If the US dollar depreciates, the borrower may realise a foreign exchange gain when settling the US dollar loan in addition to capital appreciation gained from the sale of his UK property.
An added attraction to borrowing in US dollars is the current low interest rates. Funds which would have otherwise been used to acquire the UK property may be invested in bonds or other instruments that yield a higher return than the cost of the borrowing.
Other currencies that are currently offered at low interest rates include the yen, Hong Kong dollar and Swiss franc. Euro, Canadian dollar and Sterling borrowings cost a little more. It is also possible to switch currencies in which finance is raised during the period concerned. Compared with loans in the foregoing currencies, borrowing in ringgit is more costly.
Several permutations are available. The prudent investor would seek no foreign exchange risk. The more aggressive investor may take on foreign exchange risk as well as opportunity. Just as the aim is to buy property low and sell high, we may extend this principle to borrowing low and investing high by earning a higher return from investments than the borrowing cost, as well as borrowing in a currency which is projected to depreciate.
Tax planning
Apart from forex, owning property overseas creates tax exposure in the investee country, which requires consideration and planning. Without wishing to pour cold water on any real estate investment overseas, the usual foreign tax and related implications that may arise include:
• Stamp duty on acquisition and divestment,
• Income tax on rental income;
• Property tax like assessment;
• Withholding tax on rental, interest, partnership distributions and so on;
• Goods and services tax (GST)/value-added tax (VAT);
• Capital gains tax upon divestment gains;
• Estate duty;
• National and state taxes; and
• Filing of various tax returns.
Thankfully, overseas properties rented out generally constitute foreign sources of income, which do not fall within the Malaysian income tax net. Further, they also are outside the scope of Malaysia’s real property gains tax.
An important tax consideration is the minimisation of annual income tax on rental income.
Deductions available include interest expense on borrowings used to acquire property. This factor will influence the manner in which a property transaction is financed. However, where interest is paid to non-residents, withholding tax often arises. Lenders often require this withholding tax to be borne by the borrower. There is therefore the need to minimise such withholding tax through, for example, the proper use of tax treaties and the correct choice of location of lenders.
In addition, in the US for example, buildings, houses and apartments are tax depreciable. The claim of such depreciation on buildings as well as on plant such as lifts and heaters, interest expense together with other costs like property management fees, repairs and property taxes could reduce income tax on rental income to nil.
Tham Lih Jiun is an executive director of Deloitte Malaysia’s tax practice who has assisted Malaysians in their overseas investments. John Whitehead is a real estate tax partner at Deloitte LLP in London. Joe Galea is a real estate tax partner at Deloitte in Sydney.
This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 893, Jan 16-22, 2012
