This is a three-part series demystifying Infrastructure Investment Trust (InvIT), a relatively new asset class that is slowly gaining popularity among high networth individuals (HNIs), and even among retail investors. InvITs provide investors an opportunity to participate in India’s growth story at a time when the Central government and various state governments across India are building roads, ports and better connectivity. InvITs give a chance to investors to participate in a new asset class through small-ticket investments. However, thanks to its multiple sources of income, InvIT is a complex instrument. Besides, InvITs are listed instruments. This piece explains the recent changes brought in through Budget 2023 for debt repayment income ― one of the many streams of income for an InvIT (and thereby its unitholders) ― and the way it is taxed and its impact on unitholders.
Beginning April 1, 2024, investors in Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) will have to pay more tax. The government proposes taxing the revenue that business trusts like InvITs distribute to unitholders in the form of debt repayment.
Before delving deeper, it's important to understand the many kinds of payments that an InvIT makes to its unitholders.
· Dividend
· Interest
· Repayment of the principal amount of a loan from a Special Purpose Vehicle (SPV)
· Any other income (interest on fixed deposits (FDs), capital gains, etc.)
· A combination of any of the above
Unitholders or investors are currently taxed on their dividends, interest, and other income at the applicable income tax rate. Also, depending on the holding term, the profits or losses on sales of InvIT units will be taxed as capital gains or losses.
Also read | How the Finance Bill 2023 amendment will affect debt mutual fund investors, after April 1, 2023
Yet, neither InvITs nor the unitholders are currently subject to tax on debt repayment. That is what the current Budget is attempting to achieve by stating that loan repayments in the hands of unitholders should be taxed as "income from other sources" at the investor's income tax slab rate.
On February 1, the Budget had proposed taxing unitholders' the full amount of debt repayment distributions at applicable tax rates.
But there is good news: under the amended laws (as of March 24, 2023), only a "specified sum" or portion of such payments will be taxed. The specified amount is determined after subtracting the acquisition cost from the distribution amount.
I'll give you an illustration: Assume that an InvIT had a Rs 100 issue price and disbursed Rs. 10 towards debt repayment. There would be no tax on this sum because it is less than the issue price, which is Rs. 100. The original plan was to tax without deduction. The InvIT pays out almost every quarter, therefore the trust will keep paying off the debt in subsequent instalments. However, any further contributions shall be subject to unitholder taxation after it has paid a total of Rs. 100.
Three stakeholders
There are basically three stakeholders:
· The trust
· Special purpose vehicles (SPVs)
· Unitholders
Investors buy units in the trust, which in most cases invests the money by lending though SPVs. The main SPVs that earn income pay interest or dividends to the trust. Because the trust lends money to the SPV, there is also a provision for repaying the loan or debt. Ninety percent of the revenue received by the trust is distributed to the unitholders. For unitholders, the share that was received as capital or debt repayment was not currently subject to taxation.
Would this tax deter investment in InvITs?
The appeal of these trust funds as a vehicle that generates a higher income than other debt instruments, while being less risky than equity investments, has been affected. InvITs had gained in popularity in recent years, particularly among HNIs. But, if you observe closely, the repayment portion of the most recent income distributions made by an InvIT was small compared to the other income distributions. If this is going to be the case, then the impact will be significantly less than it would be otherwise and shouldn't deter investors from investing in InvITs.
Example
About 18 InvITs are registered with the Securities and Exchange Board of India (SEBI). Only three of these are publicly traded ― IndiGrid InvIT, IRB InvIT and PowerGrid InvIT (PGInvIT).
Let’s take a real life example of a recent income distribution from PGInvIT, which announced a dividend of Rs 3 per unit on January 24, 2023. This was PGInvIT's third disbursement in fiscal year 2022-23.
I've already covered a similar example of PowerGrid's second income distribution in Part 2 of the InvIT series, and you can see that the repayment portion has changed slightly in the third income distribution series.
Here is a breakdown of their most recent distribution of Rs 3 per unit:
· Rs 2.01 in interest
· Rs 0.43 in taxable dividend
· Rs 0.25 in tax-exempt dividend
· Rs 0.30 by way of repayment of SPV debt, and
· Rs 0.01 in treasury income in the unitholder's hands
The portion of this distribution revenue that represents the "loan payback," or the repayment of the SPV's debt of Rs 0.30 per unit, will be taxed, going forward. InvIT investors will be required to pay this additional tax, but under the recently changed law, only the portion over the cost of acquisition, or the issue price, will be taxed, as stated in the example above.
What should investors do?
The main reasons for investing in Real Estate Investment Trusts (REITs) and InvITs were to help investors diversify their portfolios into a new asset class that has the potential to perform better than the other debt and hybrid products, to gain exposure to infrastructure projects, and to benefit from the three-in-one returns that these investments offer: capital gains, dividends, and interest.
One should not redeem or come out of the InvIT investments because of this additional tax burden, as the underlying premise to invest in this asset class still holds true. Do not rush out. Continue your investments at least for the next two quarters and evaluate the tax impact. The prices of these listed InvITs may also show an upward trend whenever interest rates start reducing.
If you are a new investor, as suggested earlier, try out a small allocation and check the returns in the next few quarters. Once you understand this slightly complicated structure, you can increase your investment.
