Land Bill: A ‘no investment in Sri Lanka’ message?

Wednesday, 24 September 2014 00:00 - - {{hitsCtrl.values.hits}}

By a Special Correspondent The Land (Restrictions on Alienation) Bill, which was recently placed before Parliament for debate, appears to have gone beyond its initial mandate and intentions.

It will be recalled that President Mahinda Rajapaksa, proposed, during his Budget Speech in November 2011, that “foreigners” be not allowed to purchase State land on a freehold basis. This was administratively widened, subsequently, to include both, State and privately-owned land. It is the general view that the widening was aimed, primarily, at creating an “affordable” playing field to Sri Lankan nationals wishing to purchase residential property.

Whilst the freehold purchase of both commercial and residential property by “foreigners” was abolished, it is doubtful that the President ever intended for the required legislation to unduly hinder the flow of Foreign Direct Investment by organisations or persons wishing to participate in Sri Lanka’s economic development via the lease of industrial and commercial land. Investigations and enquiries reveal that the business community in Sri Lanka acknowledges, and is supportive of, the need to control the purchase of residential properties by non-Sri Lankans and also appreciates the need to manage and monitor long-term leases of a capital nature (de-facto substitutes for freehold title), entered into by non-Sri Lankans. However, they are desirous of this happening without any significant damage to Sri Lanka’s drive for Foreign Direct Investment (FDI), Foreign Institutional Investment (FII) and in making Sri Lanka attractive for investment in terms of her ‘Ease of Doing Business’. Unfortunately, the Bill, which is proposed to be effective retrospectively 1 January 2013, falls far short of these aspirations and has created great confusion. The confusion and consternation have been exacerbated by the Bill being significantly different to the various Administrative Circulars which have been in force since November 2012. If made retrospective, the Bill nullifies transactions concluded during the period between the initial Budget Speech and the final Parliamentary approval of the Bill. The conflicts with stated National Objectives, and other concerns, of the Bill, as currently drafted, are summated as follows. Retards the growth of the Colombo stock market and erodes its capital raising capability Sections 2.1 and 2.2 of the Bill 1. Notwithstanding any provision to the contrary in any other written law, the transfer of title of any land situated in Sri Lanka, shall be prohibited if such transfer is— a. to a foreigner; or b. to a company incorporated in Sri Lanka under Companies Act where any foreign shareholding in such company is fifty per cent or above; or c. to a foreign company, unless exempted as provided in section 3. 2. a. For the purpose of maintaining the legal validity of a transfer of land to a company incorporated in Sri Lanka under the Companies Act, with less than fifty per cent of foreign shareholding, the foreign shareholding of such company shall remain less than fifty per cent, for a minimum period of consecutive twenty years from the date of such transfer. b. Where the company referred to in paragraph (a) increases its foreign shareholding up to fifty per cent or above contrary to paragraph (a), the transfer of land referred to therein shall be null and void with effect from the date of increasing of the foreign shareholding. Rendering land transfers “null and void” if foreign shareholding rises beyond a pre-determined threshold will create great uncertainty regarding the value of listed companies and will retard the growth of the Colombo Stock Exchange. Other points of note are;

Companies use land as an asset in creating value for their customers and society and in contributing to the GDP of Sri Lanka. In order to sustain and grow their businesses, companies need to acquire land and buildings. If a movement in its shareholding on the stock market causes a Listed Company to lose a key asset such as land (and the building thereon), this would be viewed as a tremendous risk by companies and more importantly by its investors.

Foreign Institutional Investment (FII) through the stock market is an important source of capital inflow for listed companies.
Access to FII is also crucial for local entrepreneurs and many such entrepreneurs list on the Colombo Stock Exchange for the purpose of accessing such foreign capital.
The current provisions regarding the impact of foreign shareholding on the ownership of land will :

Retard the growth of existing listed companies because if they exceed a foreign shareholding threshold they will lose the land they have already acquired for development.
Foreign shareholders will refrain from investing in listed companies through the stock market because of the uncertainty of the status of the assets which may leave the subject company if the foreign shareholding in such company was to exceed 50%.
Local entrepreneurs will be discouraged from listing on the Colombo Stock Exchange as the probability of attracting foreign shareholder investment will be very low.

A stock market with high liquidity and high public participation attracts more capital. The proposed provisions are contrary to the intentions, and objectives, of increasing the public float of listed companies which catalyses the aforesaid requirements and is a goal pursued by the Securities Exchange Commission and the Colombo Stock Exchange.
The provisions as stipulated will result in the free-flow of the stock market being impaired and will also give rise to a host of impracticalities.
As stated before, the proposed provisions will result in an overnight reduction of assets of a company. This will have serious accounting consequences for company ratios and solvency, including “serious loss of capital” and would have a serious impact on the securities obtained by banking institutions in providing debt facilities

Ease of Doing Business in Sri Lanka, cost of doing business in Sri Lanka and loss of business confidence Section 5 of the Bill (1) Notwithstanding any provision to the contrary in any other written law, the leasing of a land— (a) to a foreigner; or (b) to a company incorporated in Sri Lanka under Companies Act where any foreign shareholding in such company is fifty per cent or above; or (c) to a foreign company, shall be effected subject to the payment of the Land Lease Tax imposed under section 6: Provided however, the maximum tenure of any such lease shall not exceed 99 years. It has been accepted that Sri Lanka requires Foreign Direct Investment (FDI) to facilitate her targeted economic growth. The Ease of Doing Business in Sri Lanka and the consistency of regulation are paramount in attracting such FDI. The fruits of what Sri Lanka has sown in the form of massive infrastructure development in the past few years will come to naught in the absence of FDI, and as explained before, FII. Much of day to day business, and day to day life, are in the form of short rental agreements, the methodology and cost of which should be eased without compromising the long term intention of protecting land ownership. The business community is of the view that the Land Lease Tax should not be applicable to day to day routine operational and “living” transactions such as short term rentals of office space for use of businesses, shops and commercial spaces in malls for trading, entertainment, restaurants and homes to live in etc. It must apply only to long term leases which are more capital in nature (i.e., de facto substitutes of freehold title). It should also be noted that:

There are no taxes on leases which are not of a long term and capital nature in comparative countries such as Singapore, Thailand, Malaysia, India, Indonesia and Philippines.

Further investigations reveal that Singapore allows foreigners to lease/purchase commercial land on an unrestricted basis, provided that the purchaser/lessee produces a development plan to the relevant authority. These development plans have to be implemented within specified periods. However, Singapore does not allow foreigners to purchase Restricted Residential Property without the permission of the relevant authorities. Such prohibition also applies to companies which have any foreign shareholding. Other negative matters include:

The requirements in the Bill of obtaining valuations and confirmations of shareholding prior to transfers/leases will hinder day to day commercial operations, discourage new investment and will increase the cost of business operations. Needless to say, these additional costs will result in an increase in prices to the ultimate consumer.
The commercial viability of several large shopping malls, office development, apartment complexes and other developments which are aimed at making Sri Lanka a premier tourist destination and regional commercial capital through the attraction of international brands and other world renowned organisations, tourists sought facilities and attractions will be significantly eroded. The current Bill imposes both financial and operational hurdles in how these large developments will operate.

As stated at the outset, the leasing of land in Sri Lanka was carried out, since November 2012, as per the Administrative Orders issued by the Ministry of Finance and Planning. The proposed Bill varies these orders with retrospective effect, by the imposition of regulations which were never indicated, nor signalled, in the Administrative Orders. This manner of “change of rules” will result in a loss of business confidence and a further slowdown of FDI. E.g. the imposition of a 7.5% Land Lease Tax on companies where 50% of its shares are held by more than one foreign shareholder whereas the Administrative Order dated 27 March 2013 issued by the Ministry of Finance and Planning only captured companies which had a single shareholder owning more than 50% of its shares and even so, exempted such companies from the payment of any Land Lease Tax if they had been in operation for more than 10 years. All in all, it is the consensus of the business community that the national benefits pursued by the Bill will be far outweighed by the costs which arise out of a decline in the ‘Ease of Doing Business’ and loss of business confidence due to the inconsistent of application of the law. Several contradictory clauses and clauses which conflict with other national objectives There are several instances of contradiction and conflict in the Bill which bring uncertainty to the legal regime governing transactions. The Bill needs reworking to bring it in line with the objective of the articulated intention of the government, viz introducing safeguards on transfer of freehold title of land in Sri Lanka and in managing long-term leases which were used as de-facto substitutes for freehold title: An example: Section 7 (1) & b of the Bill 1. The Land Lease Tax payable under section 6, shall not be applicable on the lease of— (b) a Condominium Parcel situated on or above the fourth floor of a building specified under the provisions of the Apartment Ownership Law (excluding the Ground level floor and floors which accommodate any common element or elements within the meaning of Apartment Ownership Law) where the period of lease is thirty five years or above and the lease rental for the full period of lease is paid through inward remittance of foreign currency on or before the date of the execution of the relevant indenture of lease;

The current exemptions to the prohibition on transfer stipulate that a floor cannot contain a common element. All floors in a Condominium Property will contain Common Elements such as corridors, lift lobbies, maintenance ducts etc. These are all classed as Common Elements by law. The previous direction (Gazette Extraordinary No 1530/16 dated 1st January 2008) which dealt with exemptions from the 100% tax excluded any floors where more than 50% was a common element in the calculation of the number of floors. Also the arbitrary exclusion of the ground floor will cause difficulty for smaller residential condominium developments. It is believed that this is an error and needs correction. If the current wording is enacted into law, sale to foreigners of any condominium properties will not be possible and would thereby affect the viability of condominium projects which have commenced basing reliance on the Administrative Circulars which were in force. Needless to say, these will impact growth projections for the country.

Other areas which need review, clarification and/or amplification and corrections are;

The definition of Citizen to include corporate entities incorporated in Sri Lanka.
The role of the Registrar of Companies in ensuring compliance with the restriction on transfer of land with the role appears to be misconceived. If the Bill attempts to obtain an endorsement by the ROC in relation to shareholding (particularly in Listed Companies), it will delay and frustrate many commercial transactions such as back to back mortgages etc. It also fails to take into account that ROC registers are not up to date.

Section 11(1) & (2) of the Bill (1) Any land transferred or leased to a person or a company referred to in section 2(1) or 5(1), prior to January 1, 2013, shall not for any purpose be mortgaged or pledged to any bank licensed under the Banking Act, for a period of five years with effect from the execution of the relevant instrument of transfer or lease. (2) Any mortgage executed in contravention of subsection (1), shall be void.

Prohibition on the mortgage of State land transferred prior to 1st January 2013 and making such mortgage void is inexplicable. This provision is unclear as to whether it has retrospective application, and if so, would put the banking sector in disarray. What would happen to the mortgages that have been effected since 1 January 2013? Further, nullity of land transactions undertaken from 1 January 2013 contrary to the bill (but in compliance with Administrative Circulars) would result in all mortgages getting cancelled! The question which arises is: “What is the method of recovery for a bank that has monies owing to it?”

Conclusion The anomalies and the contradictions inherent in the Bill, as currently drafted, indicate that very little consultation has been had by the architects of the Bill with important institutions such as the Board of Investment, Colombo Stock Exchange and the Registrar of Companies, just to name a few. Judging by the reactions of the business community, it appears that they too have been left out of the consultative process. It is also worrying to see legislation being introduced with retrospective effect. One could accept such retrospection if the final legislation is consistent with Administrative and Public Notices/Circular released in the interim. Finally, the need to have a coherent National Policy which recognises the right balance of the various objectives pursued by the Government needs no emphasis. This can only happen if the architects of policies of this nature are willing to listen to the views of stakeholders.