The uncertainty over the taxability of capital returned to unitholders of real estate investment trust (REITs) and infrastructure investment trusts (InvITs) has spooked investors in these vehicles.
The proposed amendment in the Finance Bill 2023 seeks to tax repayment of debt to such unitholders as ‘income from other sources’ under Section 56(2)(xii) of the IT Act, which may not be appropriate under law, said experts.
REITs and InvITs own a portfolio of income-generating real estate and infrastructure assets. These assets can be held through special purpose vehicles (SPVs), where REIT/InvITs hold shares, interest-bearing loans, or debt instruments.
Income from other sources is a residual head and deals with incomes otherwise not covered under any other provisions of law.
The Finance Act 2021 amended the definition of securities to include units issued by business trusts. All securities whether listed or not are capital assets u/s 2(14) of IT Act.
Accordingly, investments by unitholders in REITs/InvITs are ‘securities’ and ‘capital assets’. Any return of capital by the business trust to the unit holder should be first allowed to be set off against the cost of capital assets in the hands of the unitholder and the excess offered to tax.
Whats is more, extension of debt by REITs or InvITs to their SPVs is a transaction on capital account, and the refund, repayment or redemption of the principal amount does not constitute income under the IT Act.
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“The return of capital to the unitholders by REITs/InvITs, which arises out of the repayment of debt by the underlying SPVs, is essentially in the nature of capital receipt. At best, it can be taxed as capital gains and not income from other sources, and that also only when the payment exceeds the cost of unit capital put in by the investors,” said Punit Shah, partner, Dhruva Advisors.
Shah added that appropriate amendments would need to be made in the capital gains provisions of the IT Act to avoid any ambiguity in future.
“When you invest under a security for a long time, it is treated as capital asset. Post the amendment in the Budget, even the return of investment in a capital asset will be charged to tax as other income. Secondly, if you are earning more than what you invested in a listed product, it is always treated under capital gains regime, not under income from other sources,” said Nitan Chhatwal, managing director-investment manager, Shrem InvIT.
InvITs as an asset class has started taking off in the last two years and domestic investors would be wary of putting money in such assets because of the arbitrary taxation, added Chhatwal.
Investments under InvITs amount to less than Rs 1 trillion at present and is projected to grow to Rs 10 trillion by 2030.
“Taxing of repayment of loans in the hands of unitholders of business trusts as income from other sources puts unitholders at a greater disadvantage and will impact yields,” said Anish Sanghvi, partner, Pricewaterhouse & Co.
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Also, there are a lot of practical difficulties that need to be ironed out. For instance, how does the business trust deal with buying units when a distribution entails redemption of partial units (in the absence of face value concept), Sanghvi said.
Sebi laws do not have the concept of face or par value of units as in the case of shares. The laws may have to be amended to allow for partial redemption of REIT/InvIT units so that there’s no tax liability until cost of capital gets exhausted, said experts.