Pass-through status for REITs comes with riders

Written by Shubhra Tandon | Mumbai | Updated: Jul 12 2014, 19:16pm hrs
Real EstateREITs are set up as trusts as per the provisions of the Indian Trust Act, 1882 and has trustees, sponsors, managers and principal valuers as parties.
The real estate industry cheered the so-called pass through status that was given to Real Estate Investment Trusts (REIT) that was announced by finance minister Arun Jaitley in his Budget speech in Parliament on Thursday. However, details in the explanatory statement accompanying the Budget show the tax incentive given to REITs comes with certain riders.

REITs are investment entities where the funds drawn from investors are invested primarily in completed, rental income-yielding real estate assets. A part of the income generated from such real estate is distributed among investors as dividends. The structure is similar to that of mutual funds that can be listed and traded on exchanges. REITs are set up as trusts as per the provisions of the Indian Trust Act, 1882 and has trustees, sponsors, managers and principal valuers as parties. The sponsor, which is usually a developer or a private equity fund sets up the REIT.

REIT may hold real estate properties either directly or through a special purpose vehicle (SPV). The REIT raises capital by securing funds from investors either by way of equity of debt and issuing units in lieu of their investment. The REIT, which receive equity investment, have to be listed on stock exchanges.

The pass through treatment is essentially accorded in the case where REITs are acting as a debt-raising instrument. For instance, if a sponsor or SPV has formed a REIT to raise funds either in foreign or domestic markets through bonds or loans, the trust will deduct a witholding tax, before repatriating the interest income to investors. While the tax is paid by the trust, the tax liability is that of the investor, and not the SPV or the REIT. The special tax regime says that no tax is levied on interest income received from the SPV in the hands of the trust and no withholding tax is levied at the level of SPV. Withholding tax is levied in case of payments of this interest income to unit holders at 5% in case of non-resident unit holders and at 10% in case of resident unit holders," explains Pranay Bhatia, partner at consulting firm BDO India LLP.

However, in case where an SPV is distributing dividend on equity to the trust (which in turn will repatriate to the investor), it will be subject to dividend distribution tax (DDT) at the level of the SPV, but exempt in the hands of the trust and eventually the unit holders.

Also, REIT units when traded on the stock exchanges would attract similar tax treatments as equity shares, and will be liable to levy of Securities Transaction Tax. While these units will be exempt from the levy of long term capital gains, they will attract short term capital gains tax at the rate of 15%.

REIT itself will only be taxed in case the assets it holds are transferred to another REIT. "Capital gains at the time of sale of assets by the business trust will be taxable in the hands of the trust at the applicable rate, Bhatia said. If such capital gains are distributed, then the component of distributed income attributable to the capital gains would be exempt in the hands of the unit holder."

Despite the riders, the real industry has given a thumbs-up to the instrument as it will bring in much needed liquidity to the cash-starved sector.

"We expect the entry of this much awaited investment instrument to provide alternative funding channels to the realty sector, Anshuman Magazine, chairman and managing director of property consulting firm CBRE South Asia Ltd said. Going forward, it will also act as a key enabler for capital markets in the country, and provide investors with exit options. I perceive this announcement as the single most consequential reform witnessed in the sector in recent times."