World over, Real Estate Investment Trusts (REIT) have become a successful instrument for pooling investments...
World over, Real Estate Investment Trusts (REIT) have become a successful instrument for pooling investments and, thereby, spurring growth in infrastructure and construction sectors.
Seven years after it was mooted in India, Sebi notified the REIT regulations in September 2014. In this year’s Budget, finance minister Arun Jaitley provided for certain incentives for REITs.
The industry, however, was not happy and there was a general consensus that without certain key tax issues being resolved, India’s REIT ambitions would remain a ship holed up below the waterline. The industry had a number of reservations on capital gains tax, dividend distribution tax (DDT) and minimum alternate tax (MAT).
The Budget has sought to assuage the concerns of the industry by proposing the following changes:
Transfer of shares of a Special Purpose Vehicle (SPV) into the REIT was exempt from capital gains tax, but the transfer of units of REIT by the sponsor wasn’t. Now, subject to levy of Securities Transaction Tax (STT), the REIT units are exempt from long-term capital gains tax, while, in the case of short-term capital gains, the tax rate of 15% will apply.
REIT’s income is predominantly in the nature of rental income. This arises from assets owned by the REIT itself or through an SPV. Currently, rental income received at the level of the SPV gets passed through by way of interest/dividends to the REIT. However, the rental income directly received by the REIT is taxable at the REIT level and does not get the pass-through benefit.
It is now proposed that such income shall be exempt in the hands of the REIT and any distributions by the REIT shall constitute taxable income in the hands of the recipient unit holders. The REIT shall withhold taxes at 10% in the case of resident unit holders, while, in the case of non-resident holders, tax shall be withheld at the rates in force.
While the proposed amendments have been welcomed by the industry, a number of gaps have been left, which are needed to be filled before REIT becomes a potent tool.
The industry had been clamouring for removal of DDT on REIT, the application of which is prohibitive. Dividends paid by an SPV to the holding REIT attract DDT of 15%. Subsequent distribution of income by the REIT, in turn, will be subject to TDS at the rate of 10% for resident unit holders and 5% for non-resident unit holders. Further, such income will be taxable in the hands of the individual unit holders as well. The aggregate tax effect shall be considerably high, resulting in low yield. This may act as a deterrent to investment in REITs. The government would have done well to keep REITs out of the ambit of DDT, especially when an REIT is required to distribute 90% of its lease rental income to the unit holders.
Another bone of contention has been the applicability of MAT on exchange of units against shares of SPV. While Budget 2015 has addressed the capital gains aspect for such a transaction, MAT shall continue to apply. This does not stand to reason because the gain is notional and there is no cash generated in the transaction. MAT is triggered again when units of an REIT is sold. This cascading effect of MAT should have been avoided by the government if it wanted to let the REITs work as intended.
By Rakesh Nangia
The writer is managing partner Nangia & Co. With inputs from Rahul Jain