The budgetary amendments, which allow sponsors/developers to monetise their assets by tapping capital markets, could give a boost to real estate and infra sectors.
If you are an investor and looking for a new investment opportunity—offering tax-free returns in the form of dividend and capital gains—the Budget FY17 has opened up doors for the launch of the Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InvIT). REIT/InvIT is a structured business trust model facilitating entrepreneurs and corporates to monetise their capital locked in assets through issue of units to investors at large.
In India, generally an investor expects a yield of 8-9% tax-free in long-term savings plans or government bonds, or a similar yield if invested in debt mutual funds. Further, an investor could look at a higher yield of about 11-13% (taxable) by investing in unsecured non-convertible debentures (NCDs) or debt instruments of corporates and now units of REITs/InvITs.
So, what is REIT/InvIT?
REIT is an investment vehicle that allows both small and large investors to acquire ownership in real estate assets through purchase of units. Similarly, InvIT is an investment vehicle for owning undivided interest in other classes of assets such as hospitals, hotels, warehouses, shopping malls, roads, ports, etc. The capital markets regulator—Securities and Exchange Board of India (Sebi)—had already enacted REIT/InvIT regulations in September 2014, broadly covering a few aspects.
Units of REIT/InvIT are listed on stock exchanges in India;
Sponsor (developer/promoter) to hold at least 25% units in the business trust to start with;
Prescribed minimum asset size of R1,000 crore for REIT and R500 crore for InvIT;
Compulsory distribution of 90% of post-tax income arising from assets held under REIT/InvIT;
Minimum investment ticket size of R2 lakh for REIT and R5 lakh for InvIT by an investor.
As an investor, such units not just accrue dividend; however, from an India perspective, one could also look at appreciation in value of units, which could potentially arise out of value enhancement in assets in a longer term. Whether this holds true for certain other classes of assets like roads and ports is anybody’s guess at the moment. To give wings to this popular international concept, finance minister Arun Jaitley has done his best to roll-out certain tax benefits in previous as well as in the current Budget.
How does a sponsor/developer unlock value in assets?
A sponsor/developer is required to swap (non-cash) its holdings in real properties or in shares of SPVs (holding assets) to a business trust in consideration of units of such a trust. Such units are offered to public, as a result of which liquidity is generated in the hands of the sponsor/developer. Such a fund-raising model has become popular due to its benefits of raising fresh liquidity of funds, and at the same time, the sponsor/developer continues to control and manage the property. While the swap of shares in an SPV is exempt from capital gains or minimum alternate tax (MAT)—irrespective of the period of holding—the transfer of real property held directly by sponsor/developer to a business trust remains a taxable event.
Further, such a transfer of real property directly to a trust would be chargeable with stamp duty at a rate prevailing in respective states. On the other hand, the sale of units by the sponsor/developer would also remain exempt from capital gains if the same is long term under the Income-tax Act and sold on the floor of stock exchange; however, subject to MAT (applicable in case of companies). The accompanying table shows tax incidence in the hands of a business trust.
What if you are a unit-holder?
The Union Budget 2014 paved way for capital-gains tax exemption on the sale of long-term units, but the concept didn’t take off primarily due to applicability of dividend distribution tax (DDT) on dividends distributed by SPV (holding assets) resulting in lower yield. This concern has been addressed in the current Union Budget by amending Section 115-O of the Act. As far as a non-resident unit-holder is concerned, the investment in REIT/InvIT becomes more attractive in light of a very low tax cost of 5% on income earned as interest from the business trust. The table shows the summary of tax incidence for unit-holders.
In a nutshell, the current budgetary amendments could give the much required boost to the beleaguered real estate and infrastructure segments, as these allow the sponsors/developers to monetise their assets by tapping capital markets. For non-resident investors, there is a silver-lining of lower tax cost of 5% on interest income stream, but they should factor in the foreign exchange fluctuation risk while computing expected yield, as against the average dollar yield of approximately 7% in similar securities in a few other countries. This is a big picture and could be a game-changer for Indian players in the segment.
Hemal Uchat is partner and Bhavin Vora is associate director, Tax & Regulatory Services, PwC