Recovering from a pandemic: Examining transactions in the real estate sector
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Recovering from a pandemic: Examining transactions in the real estate sector

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Bill Yohana, Chad Lusted and Stan Hales assess how the COVID-19 economic environment has affected tax and transfer pricing (TP) considerations associated with the real estate sector.

In many countries, the real estate sector has been negatively impacted by the recent COVID-19 epidemic through the introduction of rent deferral programmes and a reduction in demand by commercial tenants. For real estate that is owned and/or managed on a cross-border basis, this sudden change in the real estate environment has potentially raised a range of important TP considerations.

At the same time, as part of the OECD's BEPS initiative, individual taxation authorities have significantly increased their scrutiny of cross-border related-party transactions, including those in the real estate sector. While some taxation authorities may temporarily reduce reviews of TP positions in the COVID-19 economic environment, they may subsequently feel pressure to raise collections to pay for enhanced fiscal expenditure during this period.

While TP rules generally apply to cross-border intra-group transactions, they may be relevant in other contexts as well, with a significant example being real estate investment trusts (REITs) in the US. The REITs are required to transact with their taxable REIT subsidiaries (TRSs) on arm's-length terms in order to avoid substantial tax penalties and, in some cases, preserve their tax-advantaged status. This article will address both cross-border related-party transactions and domestic transactions in a REIT context, as the issues raised by both can be very similar.

This article considers how economic changes driven by the pandemic have impacted TP in the real estate sector. The real estate sector incorporates a wide variety of activities, from investing through commingled funds, to the assumption of real estate exposure through private equity funds, as well as construction and ongoing management of a real estate asset, to the sales of buildings and rental space. Accordingly, the types of transactions typically undertaken by real estate-oriented businesses are examined, bearing in mind that any given transaction may not apply to all types of real estate investors.

Financing transactions

The pandemic has had a significant impact on many real estate investors. Government-mandated quarantines and social distancing have shut many offices, shopping malls, hotels, restaurants and other sectors of the property market. Starved of business, tenants have sought remissions of rent payments from their landlords, while many residential tenants have also expressed an inability or unwillingness to pay their agreed rent amounts. Many property owners, in turn, have requested waivers of interest and modifications of debt from lenders.

From a tax authority perspective, in a third-party context, such modifications are considered commercial arrangements. However, in instances where both the borrower and the lender are under common control, a tax authority may question any waiver or deferral of interest as an attempt to shift income from one entity to another, or one jurisdiction to another.

As a result, participants in the real estate sector that have needed to forgo interest payments on their cross-border loans may face the burden of demonstrating that the non-payment of interest for a period of time was consistent with arm's-length behaviour, even though it was contrary to the agreed contractual terms of the loan.

As memories can quickly fade, real estate investors that deviate from the terms of their cross-border loan agreements during the period of pandemic may benefit from documenting in detail why the borrower stopped paying interest. Likewise, why it was in the interest of the lender to agree to the deferral or waiver of interest payments (from the perspective of a lender, not a shareholder) and details of any publicly disclosed behaviour by third parties in similar circumstances may also be noted.

Real estate investors that are seeking to refinance existing debt or incur new debt during this period might consider contemporaneously documenting the rationale for their financing decisions. While many major central banks have cut base interest rates in response to the economic impact of the pandemic, credit margins above base interest rates have generally increased, particularly for relatively risky below investment grade obligors. Indeed, some heavily leveraged borrowers have found it difficult to raise any debt capital.

However, from a borrower's perspective, the future remains uncertain and the borrower may value the benefits of obtaining locked-in liquidity, even at an increased interest rate, during this period. Again, it may make sense to document contemporaneously credit market evidence of the prevailing financing environment, the financing needs of the borrower, the financial condition, and the alternatives considered by the borrower and the lender in arriving at a particular financing decision, particularly if the amounts involved are material.

Non-financing transactions

Allocation of costs

Managers, developers and owners of real estate on a cross-border basis commonly seek to allocate centrally-incurred costs across jurisdictions in order to reduce aggregate expenditure and apply common systems and procedures across jurisdictions. During economic downturns, these allocated costs may invite particular scrutiny from tax authorities.

This may also occur in respect of REITs within a domestic context as well. For example, for many US REITs, there are certain components of operating properties that result in non-customary activities that could rise to bad income (i.e. income that results in a risk to a REIT's tax-exempt status) for the REIT. Examples of these activities include the operation of a cafeteria within an office building for tenants or providing ancillary services to warehouse customers.

REITs often decide to provide these services through a TRS where the TRS charges the REIT an arm's-length margin above its costs or otherwise targets a certain level of commercially justifiable return. These margins earned by the TRS are certainly an area to revisit in light of the economic impact of COVID-19. After all, should the REIT bear all the risk of operating a cafeteria for office tenants who are likely to be working from home for the foreseeable future? A reduced margin for the TRS or even allowing the TRS to operate at a temporary loss likely makes more commercial sense in a pandemic environment. These are questions real estate investors should be asking their service providers.

Inter-company leases

Within the REIT context, inter-company leases are common in the healthcare and hospitality sectors, whereby a TRS operates the property through an eligible independent contractor (EIK) and pays rent to the REIT for the privilege of property management operations.

For hospitality REITs, the economic impact of COVID-19 has certainly been drastic. If REITs decide to do nothing, many TRSs will find themselves operating with large losses that result in risk for REITs. In the aftermath of the 2008 financial crisis, the Internal Revenue Service (IRS) challenged many inter-company leases as failing to meet the arm's-length principle due to the significant losses resulting in the TRSs where five to 10-year leases were established in the bubble years of 2005 and 2006 with projections that promised profits after rent payments.

It may be that with the concessions offered by property owners or regulated by Congress that the IRS may expect REITs and their TRSs to revisit their inter-company leases. REITs should revisit the force majeure clauses and other provisions of their inter-company lease agreements to confirm the IRS has no footing to suggest such a change. REITs should also consider making sure ample TP documentation and analyses are performed contemporaneously with the establishment of their inter-company leases in order to support their positions.

For healthcare REITs, addressing challenges around the safety and security of their residents may result in both an increase to operating costs and result in a decrease in future revenue potential as seniors and families reconsider the attractiveness and viability of such living arrangements going forward. Many inter-company leases include an automatic escalator that may result in significant decreases to TRS profitability in what are otherwise relatively stable revenue generating properties. Although economic impacts on healthcare REITs are different to those in hospitality, the same risk of re-determined rent penalties remains if leases were not established with TP documentation or otherwise the parties cannot prove they acted at arm's-length.

Service transactions

Finally, for many participants in the real estate sector, the economic impact of a global shutdown to business could be so drastic as to change the nature of how the leasing business operates, including how inter-company services may need to be structured. Not only may there be the need to revisit allocation methodologies among REITs and its subsidiaries, there may also be room to reduce the cost mark-ups earned on service charges.

For cross-border service transactions, while a reduction in the margin paid by the tax jurisdiction receiving the service may not be challenged, the tax jurisdiction of the service provider will require proof that a reduction in margin is consistent with the results of a TP analysis. Similar justification will be expected where the TRS is a service provider in a domestic transaction. In the US, these reductions may even result in certain services qualifying for the low-margin exception for taxpayers subject to the base erosion and anti-abuse tax (BEAT) in the US on such charges.


Changes to consumer demand, commercial tenant behaviour, and working practices will continue to impact the real estate sector as the world recovers from the pandemic. The transfer prices for cross-border real estate financing, real estate management and operating services, and lease rights to real estate will need to change as well.

Pundits have a saying: "don't let a good crisis go to waste". As the use of retail and commercial space changes with the recovery, real estate firms have a unique opportunity to revisit finance contracts, lease pricing, service agreements, and more generally the real estate operating model with both customers and related parties to adjust to a post-pandemic economy.

Click here to read the entire 2020 Deloitte/ITR Financial Services Guide

Bill Yohana


Managing director

Deloitte US

T: +1 212 436 5578

Bill Yohana has been providing clients with TP advice for more than 22 years, with a focus on addressing financial transactions TP issues across industries. This experience includes the pricing of related-party loans, setting terms for intra-group cash pooling arrangements, pricing credit guarantees, the development of global loan and guarantee pricing policies and the evaluation of thin capitalisation issues.

Bill also advises on financial services TP issues, as an advisor to commercial and investment banks, asset managers, finance companies, real estate investment firms and insurers. In addition to advising clients in the US, he gained 10 years of TP experience in Australia.

Before beginning work in TP, Bill worked in US, international and emerging-market equity investment management and in interest rate derivative structuring. Bill received an MBA degree from Cornell University's Johnson Graduate School of Management, an AB in Economics from the University of Chicago, and is a CFA Charterholder.

Chad Lusted


Senior manager

Deloitte US

T: +1 404 227 0510

Chad Lusted is a TP senior manager with Deloitte US. He has experience in coordinating and managing global and regional planning, restructuring and documentation projects, including global TP projects for establishing and implementing policies for intangible property, cost sharing arrangements, services and financial transactions.

Chad has more than 10 years of experience in providing TP services to multinational corporations, focusing on industries such as industrial and consumer products, aerospace, telecommunications, real estate and financial services. He has also served as the co-chair for Deloitte's national team of professionals focused on best practice and client service improvement and the related initiatives for the practice.

Chad graduated from the Georgie Institute of Technology with a bachelor of science degree in global economics. He also obtained a Master of Business Administration (MBA) degree from the Goizueta Business School at Emory University.

Stan Hales



Deloitte Australia

T: +61 2 9322 5500

Stan Hales is a TP economist and tax partner at Deloitte Australia. With more than 20 years of experience in Australia, US, and Brazil, he specialises in the financial services industry collaborating with banks, insurers, investment managers, and private equity investors for TP matters between related parties.

Stan has several years of experience in tax valuation, TP controversy, negotiations of advance pricing agreements (APA) with revenue authorities, and TP documentation. Over the years, he has published articles covering TP topics in publications including ITR and Euromoney. He has also commented on tax and TP legislation and/or guidance and draft rulings submitted to the IRS, the Australian Taxation Office (ATO), and the OECD.

Stan has taught university-level courses in economics, statistics, money and banking and TP. He was a doctoral fellow at the Rheinische Friedrich-Wilhelms-Universität Bonn and earned MA and PhD degrees in economics from the Ohio State University of Columbus, with a primary focus on the valuation of foreign currency futures options.

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