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Broker's take: DBS Group Research maintains 'buy' on Manulife US Reit amid worries on upcoming US tax rulings

ANALYSTS at DBS Group Research have maintained their "buy" call and target price of US$0.97 on units in Manulife US Reit, despite news reports suggesting that unfavourable tax rulings on the back of US tax reforms in 2017 could result in a 30 per cent cut in the Reit's (real estate investment trust) distribution to unitholders.

Units in the Reit fell by more than 7 per cent this week, but are now trading up S$0.025 or 3.5 per cent on the day at S$0.735.

DBS Group Research said in a research note on Thursday: "The fears over the cut in distribution per unit (DPU) arises from the US tax authorities potentially ruling that its Barbados entity which is used to repatriate cash from the US to Singapore is deemed as a 'hybrid entity'."

A hybrid entity is one that is classified differently in the US and another jurisdiction, and as a result of the differences in classification, no tax is paid in either the US or the foreign jurisdiction.

The analysts said: "Under the new US tax laws, we understand that should there be a hybrid entity within a tax structure that conducts a transaction, the Reit is unable to claim an interest tax deduction."

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Manulife US Reit invests in properties in the US through special purpose vehicles (SPVs) that are wholly owned subsidiaries of the parent US Reit and organised so as to qualify as US Reits.

In the case of Manulife US Reit, this will prevent the parent US Reit which holds Manulife US Reit’s properties from claiming a tax deduction on interest expenses arising from the Singapore financing SPV that provided a shareholder loan to the parent US Reit, DBS said.

"To mitigate against the risk that the Singapore financing SPV is being deemed a hybrid entity, a decision was made by Manulife US Reit to stream this cashflow via Barbados entities earlier this year."

As the Barbados entity pays corporate tax, it avoids one of the criteria for being a hybrid entity. However, uncertainty remains as "US tax authorities have not provided any rulings or guidance on the validity of the use of Barbados entities since the start of the year and there is no clarity on timing on when this may happen," analysts said.

Manulife US Reit estimates suggest that in the worst-case scenario, the impact on DPU would be about 15 per cent. In this case, the DBS analysts expect that Manulife US Reit would "trade close to 6.5 per cent yield, slightly below its historical average yield of 7.1 per cent".

The Reit will also explore other potential structures and other jurisdictions that may reduce its effective tax rate.

The analysts said: "Given the current weak market sentiment, we believe it is natural for investors to fear the worst, jump at shadows and place more emphasis on risk factors that have been present all along.

"However, with greater clarity provided from Manulife US Reit’s management on its tax structure and better understanding by investors, subject to a final determination by the US tax authorities, investor confidence in Manulife US Reit should be restored over time."

The Reit is due to report its Q3 results on Nov 5.

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