Real estate developers like DLF, Parsvnath and Omax have finally got a favourable tax regime on Real Estate Investment Trusts (Reits), but analysts feel only institutional investors with deep pockets and patience rather than retail investors will queue up for the asset class due to a slump in the real estate market.
Developers usually form individual companies or special purpose vehicles (SPVs) to execute specific real estate projects. For a Reit with diversified real estate assets which could be listed, developers need to exchange shares of several such companies with the units of the newly formed Reit at a price that reflects the market price of these assets. Finance minister Arun Jaitley on Thursday had exempted Minimum Alternate Tax (MAT) on the developer at this stage. Tax on capital gain arising from such swap was exempt even earlier.
Experts say the government finally has appreciated the fact that the potential liability of MAT at this stage was blocking the commercial viability of Reits. They said the exemption will push sponsors to take next steps of setting up a Reit.
Hemal Mehta, senior director, Deloitte in India, said investor interest in Reits would depend on the actual returns offered by them compared with other investment avenues. “Globally, Reits offer a pre-tax return of about 8-10% and it is likely that foreign institutions may show more appetite for Reits in the initial years rather than retail investors considering the current market conditions,” he said.
The push that the Modi governments is planning to give to the urban development and smart cities is likely to give a boost to the real estate sector, which is mainly driven at present by investors rather than consumers. Home sales have slowed down in the recent years in metros due to a surplus inventory, while developers were confronted with huge debt burden. Reits, if takes off well, would provide a new source of capital to the developers, while giving investors the opportunity to participate in the sector without actually buying homes or commercial properties. Analysts also welcomed the exemption of gains arising on sale of units of Reit on stock exchange from MAT.
Ajit Krishnan, tax partner with EY India, said Reit is likely to be successful in the country since it provides a new source of funding to the real estate sector, which currently has a debt-overhang. “Traditional sources of funding are now minimal in the real estate sector. With sales being tepid, funds that were earlier available from banks and private equity sectors have also reduced substantially. In such a case, Reit will provide the sector a new funding source,” said Krishnan.
A few procedural changes are also essential to make Reits a success. These include changes in the Foreign Exchange Management Act (Fema) rules to provide for automatic approval of FDI in Reits. Full foreign direct ownership is allowed in real estate, subject to certain riders.
The finance Bill approved by Lok Sabha extended MAT exemption not only to foreign portfolio investors (FPIs) but also to foreign companies, PE funds, debt funds and venture capitalists who earn interest, royalty and fee for technical services which is currently taxed below the MAT rate of 18.5%. Capital gains earned in India by these foreign entities are also exempt from MAT prospectively.
Sameer Gupta, Tax Leader for Financial Services, EY India, said a major demand of debt FPIs was the exclusion of interest income from MAT liability. The concessional rate of 5% introduced two years ago would have become redundant if MAT was to apply. “Now, the finance minister has provided relief and that is a welcome step,” said Gupta.
Jaitley also extended the tax breaks available to units in backward areas of Andhra Pradesh or Telangana set up after April 1 to those in Bihar and West Bengal, too. Both states would enjoy the additional depreciation at the rate of 35% instead of 20% in respect of actual cost of new machinery or plant (other than ship and aircraft) acquired and installed on or after 1 April 2015 but before 1 April 2020, said a KPMG note on the amended Bill.