Foreign portfolio investors (FPIs) are hopeful that the upcoming Budget may provide the much-needed clarity on the tax to be paid on interest income earned from investments in real estate investment trusts (REITs) and infrastructure investment trusts (InvITs).
Several FPIs have taken a conservative view and have been paying a higher tax of 20% for such income. This is because of the amendment in the definition of ‘securities’ in the Securities Contracts Regulation Act (SCRA) with effect from April 1, 2021, which now extends to the units of REITs and InvITs as well.
Interest income distributed by a business trust to non-resident unit holders attracts a tax of 5% plus applicable surcharge and cess under section 115A of the Income Tax (I-T) Act. The objective of introducing a specific tax regime for business trusts, said experts, was to boost investment in vehicles such as REITs and InvITs. Hence, this section provides for grant of a concessional tax treatment.
Section 115A of the I-T Act provides for tax rates on specified incomes for a general category of taxpayers (all non-residents). Section 115AD provides for rates applicable to a specific category of non-residents, namely FPIs. Section 115AD applies to income in respect of securities in general, while section 115A has a specific provision for a type of income under consideration – income by way of interest from a business trust.
The amendment in the SCRA has led to the interpretation that tax on interest income received by FPIs from business trusts could be taxable as interest in securities, according to Yashesh Ashar, partner, Bhuta Shah & Co. “Clearly, the specific provisions relating to business trusts should be applicable instead of provisions relating to the FPIs in general,” he said.
The legislative intent behind the introduction of clause (iiac) in section 115A(1)(a) and section 194LBA(2) of the Act was to accord a concessional tax treatment to all non-resident unit holders of the business trust. There is nothing to suggest that the amendment to the SCRA was made with the intention of denying the above benefit under section 115AD of the Act, said experts.
“The government’s intention doesn’t seem to be to tax FPIs at a rate higher than other non-residents. This is an unintended consequence of the amendment to the definition of securities under SCRA. A clarificatory amendment under section 115AD would put things beyond doubt and mitigate the possibility of any litigation,” said Sunil Badala, partner and head, Financial Services, Tax, KPMG.
REITs and InvITs typically pay out at least 90% of their net cash flow to unit holders in the form of dividends and interest.
“The conflict between two independent provisions of the Act must be clarified to provide clarity and certainty. On the one hand, provisions enacted to deal with REIT/InvIT taxation provides that non-residents shall be taxed at 5% on distributions in the nature of interest, whereas FPIs are taxable on income from investments under section 115AD at 20%. As a point of principle, the more beneficial of the two provisions should apply but without an explicit carve-out, the controversy can’t be eliminated,” said Subramaniam Krishnan, partner, Private Equity Tax, EY India.
Last year, the RBI allowed FPIs to invest in debt securities issued by REITs and InvITs with the objective of providing capital and liquidity to the two asset classes. This was to enable raising debt at competitive rates from foreign investors and wider participation by institutional investors.