REITs & InvITs: Retail investors get ready
A relatively new instrument that is slated to emerge in the retail investment segment is the Real Estate Investment Trust or REIT. These Trusts are structured like MFs, except that they are related purely with real estate.
Some of them (REITs) vie for capital gains by buying, developing and selling real estate. Others (InvITs) generate rental income by building and leasing out assets. Both are designed to give the retail investor a return he would receive as if he owned the property directly, but in the ratio of his contribution vis-a-vis the total.
The sponsors (AMC) call for investments from retail investors, enabling them to take exposure to real estate without the need to make the normal large ticket investment. Therefore, a REIT is also an Alternate Investment Fund (AIF) for the real estate industry directly tapping into individual and household savings. This leads to lower costs for realtors, who must otherwise raise money at extremely high interest rates. REITs may be listed and traded like an MF or an ETF.
The existing tax regime provides that —
- i) The listed units of a business trust, when traded on a recognised stock exchange in India, would be liable to STT and therefore, the LTCG is exempt and the STCG is taxable @ 15%.
- ii) Sec. 47(xvii) specifies that exchange of shares in Special Purpose Vehicle (SPV), being an unlisted company through which units of the business trust are held indirectly by the business trusts, is not to be treated as a transfer. The tax on capital gains is to be levied when units are disposed by the sponsor as per item (i) above. However, the preferential capital gains regime (consequential to levy of STT) available to other unit holders is not available to the sponsor at the time of their transfer.
iii) For computing capital gain, the cost of these units is considered as cost of the shares to the sponsor. The holding period of shares is included in computing the holding period of such units.
- iv) The pass-through is provided in respect of income by way of interest received by the business trust from SPV i.e., there is no tax and consequently no TDS on such interest income.
- v) However, withholding tax @5% in case of payment of interest component of income distributed to Non-Resident unit holders, and @10% in respect of payment of interest component of distributed income to a Resident unit holder is required to be effected by the trust.
- vi) The dividend received by the trust is subject to dividend distribution tax (DDT) at the level of SPV and is exempt in the hands of the trust, and the dividend component of the income distributed by the trust to the unit holders is also exempt.
The deferral of capital gains provided to the sponsor of business trust places such a sponsor at a disadvantage vis-a-vis direct listing of the shares of the SPV.
For the sake of parity, the recent Finance Act 2015 has now provided that —
- i) the sponsor would get the same tax treatment on offloading of units under an IPO on listing of units as it would have been available had he offloaded the underlying shareholding through an IPO;
- ii) STT shall be levied on sale of such units of business trust which are acquired in lieu of shares of SPV, under an IPO at the time of listing of units of business trust on similar lines as in the case of sale of unlisted equity shares under an IPO;
iii) the benefit of concessional tax regime of tax @15% on STCG and exemption on LTCG shall be available to the sponsor on sale of units received in lieu of shares.
Further, in case of REITs, the income is predominantly in the nature of rental income. This rental income arises from the assets held directly by REIT or held by it through an SPV. The rental income received at the level of SPV gets passed through by way of interest or dividend to the REIT. The rental income directly received by the REIT is taxable at REIT level and does not get pass-through benefit.
In order to provide pass-through status to rental income arising from real estate directly held by it, now it is provided that —
- i) any income of a business trust, being a real estate investment trust, by way of renting or leasing or letting out any real estate asset owned directly by such business trust shall be exempt;
- ii) the distributed income or any part thereof, received by a unit holder from the REIT, which is in the nature of income by way of renting or leasing or letting out any real estate asset owned directly by such REIT, shall be deemed to be income of such unit holder and shall be charged to tax;
- iv) no deduction shall be made under section 194-I of the Act where the income by way of rent is credited or paid to a business trust, being a real estate investment trust, in respect of any real estate asset held directly by such REIT.
But there are heavy dampeners. If the asset is held through a SPV and not directly, DDT will be applicable. The industry was clamouring for removal of DDT, but this wish has not been granted. Worst, there is no clarity on the minimum alternate tax (MAT). Internationally, there is no MAT or DDT. When assets are transferred to a REIT, holding companies attract MAT on 100% notional gains. The exemptions on capital gains become irrelevant, since the MAT liability is triggered twice — once at the sponsor level, when shares are transferred to a REIT and also when the units of REIT are transferred.
Fortunately, just before the budget proposals were passed by the parliament, a new clause has been inserted to compute the gains from transfer of the units when traded on a recognised stock exchange in India for the purpose of MAT. The gain shall be computed by taking into account the cost of shares exchanged with units or the carrying amount of the shares at time of exchange where such shares are carried at a value other than the cost through P&L account.
Accordingly, notional loss arising from transfer of asset or notional loss arising from change in carrying amount of the units and actual loss from their transfer shall be added back to the book profit for computation of MAT.
by A N Shanbag
Source :- The Free Press Journal
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