Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) now constitute a new asset class available for investors, allowing investors to invest in completed real estate and infrastructure assets with a low ticket size and adequate liquidity.
On July 30, markets regulator Securities and Exchange Board of India (SEBI) reduced the minimum application value of REITs and InvITs, and revised trading lot to one unit for these emerging investment instruments to make them attractive for retail investors.
Last month, the minimum application value for retail investors of REITs and InvITs was reduced by SEBI within the range of Rs 10,000-15,000 (from Rs 50,000 for REIT and Rs 1 lakh for InvITs) at the time of listing with a revised minimum trading lot of one unit. The move is expected to enhance the liquidity of the asset class in addition to providing the depth to the market.
REITs allow pooling of money from multiple investors into a single trust which is professionally managed by a manager and invests in immovable and rent yielding properties or special purpose vehicles (SPVs) holding such kind of properties.
It is common for REITs to hold assets through SPVs rather than directly. As per the regulations framed by the SEBI for REIT, 80% of investments made by an REIT need to be in commercial properties (can be held through SPVs) that can be rented out to generate income. The remaining assets of the trust (up to the 20% limit) can be held in the form of certain stocks, bonds, cash, or under-construction commercial property.
At least 90% of the rental income earned by the REIT has to be distributed to its unit holders. Listing of REIT is mandatory and till now three REITs have been listed – Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust. There have been news reports of other developers evaluating REIT for their commercial real estate portfolio.
Similar to REITs, InvITs enable companies to monetise their infrastructure assets and provide a channel for investors to buy a stake in infrastructure projects. Money raised through an InvIT can be utilised only to buy infrastructure assets – or invest in equity or debt instrument of SPVs holding such infrastructure assets.
Similar to REITs, it is common for InvITs to hold assets through SPVs. Of the total assets, a listed InvIT is required to invest at least 80% in completed and revenue generating infrastructure assets (can be held through SPVs). The rest can be invested in under-construction infrastructure assets or securities of infrastructure companies.
Further, like REITs, listed InvITs are also required by SEBI to distribute 90% of its income to unit holders. However, unlike REITs, SEBI regulations also allow private and unlisted InvITs. Till now the infrastructure assets which have been monetised through the InvIT route have been roads, telecom towers, power transmission grids and gas pipeline assets.
Taxation for REITs / InvITs and investors
The Income-tax Act, 1961 provides separate tax provisions for ‘business trusts’ i.e. REITs and InvITs. These provisions are applicable irrespective of the business trust’s public or private status or whether such trusts are listed or unlisted. The business trust receives from SPVs, income in the nature of dividend and interest, and has further cash flows on repayment of capital invested in the SPVs.
Taxation of SPVs
The SPVs pay tax on their respective taxable income, which is computed after deducting all allowable expenses (including interest paid to the REIT/InvIT) from the business income. For companies, such tax may be the normal rate of 25% plus surcharge and cess, or the concessional rate of 22% plus surcharge and cess (for newly incorporated companies engaged in production of energy the corporate tax rate is 15% plus surcharge and cess).
Taxation of REITs / InvITs
The interest and dividends received by REITs/ InvITs from the SPVs is exempt from tax as per the specific provisions applicable for business trusts. A business trust would however have to pay tax on any capital gains from sale of assets / SPVs and other interest and investment income, other than income earned from the SPVs. As business trusts are meant to be perpetual asset holding platforms, sale of assets is usually not contemplated. Hence, in effect, the business trusts are given a ‘tax pass through’ status.
Taxation of unit holders
The investors receive distributions from the business trusts on a periodic basis. These distributions received by the investors will constitute income of the investors, though a portion of the distributions received could also constitute repayment of unit capital.
The business trust is required to intimate the unit holders of the income component in the distributions, which is taxable for the investors, as well as separately identify any distributions in the nature of repayment of capital which is not taxable for the unit holders to the extent of amounts invested. The business trust is also required to deduct taxes at the rate of 10% (for Indian tax resident unit holders) on the income distributed which is taxable in the hands of the unit holders.
The characterisation of the income in the hands of the unit holders is dependent on and takes the same nature and proportion as the income of the business trust. For example, say the business trust receives 75 of interest from the SPVs, 20 of dividend and five of capital (e.g. loan) repayment from the SPVs totalling to 100, and distributes the 100 to the unit holders.
The income of 95 received by the business trust is exempt in its hands because of its ‘tax pass through’ status. Of the 100 received by the unit holders, 95 constitutes income, of which 75 is deemed to be interest income and 20 is deemed to be dividend income in the hands of the unit holders. Such income would ordinarily be taxable for the unit holders at their respective applicable tax rates and credit would be available for taxes withheld by the business trusts on distribution of income to unit holders.
In respect of dividend income of unit holders, there is an exemption available to unit holders if the SPVs held by the business trusts have not elected for the concessional corporate tax regime. This would be fact specific and if exemption is applicable, the business trust would communicate the extent of dividends which are exempt in the hands of the unit holders.
The capital gain tax rate on transfer of listed units of InvIT and REIT in case of resident unit holders is 10% (plus surcharge/cess) for long term gains (held for more than three years), and 15% (plus surcharge/cess) for short term gains.
As the Indian economy starts recovering, listing of REITs/InvITs is expected to gather steam, as a common platform for both developers looking to monetise their assets and for investors who realise the need to participate in small amounts in large capital-intensive sectors.The author is a Partner, International tax and transaction services- Real estate sector, EY India