Infrastructure Investment Trusts (‘InvITs’) and Real Estate Investment Trusts (‘REITs’) together called as ‘Business Trusts’ are pooling vehicles which raise long-term funds from investors; use such funds to acquire stable yielding infrastructure and real estate assets; manage such assets, and compulsorily distribute the cash-flows from such assets to the investors.Unlike a listed company which has an operating business and provides returns based on growth, Business Trusts provide long-term and stable yields. Typically, the assets that go into a Business Trust include commercial yielding real estates such as offices, malls, power plants, roads, ports, gas pipelines, gas distribution networks, transmission lines, telecom towers, and optic fibre cables among others which exhibit the following features:
If one were to look at the universe of investors, inter alia, there are equity investors and yield investors. Equity investors are interested in growth up-side, high IRRs and willing to take high-risk while yield investors are interested in long-term and stable yields with low-risk.
Typical yield investors are pension funds, insurance companies, sovereign wealth funds, and family offices. The hypothesis is that once an asset is stabilised and is giving regular yields, there is no potential for significant growth in future and hence equity investors would no longer value such an asset. As against this, a yield investor would be interested in owning such an asset.
Similarly, if one were to look at developers, asset developers identify and conceptualise the opportunity, undertake greenfield development of asset (or brownfield acquisition), stabilise the asset and its revenue streams and then exit such assets to investors interested in yield providing assets.
The funds and resources which the developer blocked for acquisition or development of the asset gets released (with an embedded return) on exit and gives the developer the ability to recycle capital and develop more assets. Business Trusts were introduced in India in 2014 to address this funding gap and attract long-term global capital to fund real estate and infrastructure assets in India.
The Business Trust is a trust registered under the Indian Trusts Act and owns the shares and debt of the special purpose vehicles (SPVs) which in-turn owns the infrastructure/real estate asset. There can be multiple such SPVs (each owning a separate asset) under a Business Trust. The sponsor is akin to a promoter in a company.
The governance is undertaken through a combination of unit-holders, trustee, investment manager and documents governing the Business Trust. The SPV is mandatorily required to distribute 90 percent of its free cash-flows to the Business Trust which in-turn is also mandatorily required to distribute 90 percent of its free cash-flows to its unit-holders. The units are listed on a stock exchange and are freely tradable.
Globally such vehicles and their investors are subject to a single layer of taxation based on the rationale that the tax in the structure should be equal to the tax, had the asset been owned by the investor directly rather than through the structure. USA, UK, Japan, Australia and Singapore have a developed capital market for Business Trusts and in all these jurisdictions, tax is only levied once – when the unit-holder (i.e. investor) gets returns from the Business Trust. In other words, there are no taxes at the asset level or through the chain of distribution to unit-holders.
In India, the tax landscape on Business Trusts has been evolving since 2014. In 2014, a tax deferral was provided to Sponsors for transferring the shares of SPV to Business Trusts in consideration for units.
The point of taxation was deferred until the date of sale of units. In 2015 inter alia (i) a similar deferral for minimum alternate tax (MAT) was introduced and (ii) capital gains on the sale of units was accorded a beneficial tax regime akin to listed shares. In 2016, the dividend distribution tax exemption was provided at the SPV level.
With the changes in 2016, the Indian tax system for Business Trusts became largely consistent with the global system of levying single layer of tax i.e. corporate tax or MAT at the SPV level (asset level) and then the distributions were not subject to tax either through the chain of distribution or in the hands of the unit-holders where the same was in the nature of dividend.
Post-2016, India has seen hectic activity and more than Rs 24,000 crore has been raised through five listed InvITS and one listed REIT. Last few months have seen several new announcements, such as a renewable energy trust by Piramal Group and Canada Pension Plan Investment Board, road InvIT by Cube Highways, REIT by Raheja Developers and telecom asset InvIT by Reliance Industries. Large public sector utilities (PSUs) such as PowerGrid Corporation (PGCIL), Bharat Sanchar Nigam (BSNL) and the National Highways Authority of India (NHAI) are also at advanced stages of exploring/setting up InvITs for raising large amounts of capital.
However, the recent finance bill proposes to introduce a tax on dividends declared by a Business Trust at the unitholder level, creating two levels of taxation and jeopardising any new fundraise by infrastructure and real estate companies. Assuming 100 of PBT, the yield to an investor in the existing tax regime is 74.83, which in the proposed tax regime, will reduce to 42.85 in case of a resident individual, 56 in case of a resident company and 58.49 in case of a foreign company.
This takes away the very attractiveness of such Business Trusts. The objective of the Business Trust (unlike a company) is to make sure that annuity income is distributed to investors. To enable this, a tax exemption on dividends was accorded to Business Trust, subject to conditions. By taking away the exemption on tax on dividends, the Business Trust is being treated at par with the company and will no longer be attractive for yield investors to hold infrastructure and real estate assets.
Any change with the tax regime at this stage would send a very negative signal to global and local investors. It would create a perception of India having an uncertain policy regime – introducing a concept and then moving the goal-post in four to five years when the concept has just started gaining popularity.
This is even more so since investors have already made significant investments and commitments. It is important to keep in mind that these are long term patient investors with a horizon of 20-25 years or more. Therefore, if India wants to attract long-term and patient global capital, then it should have a stable and certain policy regime which supports the same.
From a timing perspective, we are at the cusp of attracting a significant amount of capital through Business Trusts into real estate and infrastructure assets in India. There are successful precedents available and the global investor community has become comfortable with the concept. All the factors are perfectly poised for Business Trusts to become a very successful story for India.
In the interest of making India competitive and attractive for long-term global equity capital, enhancing the depth of India’s capital markets and helping the Government achieve its target of making India a $5 trillion economy, the industry requests that the government restores the tax exemption on dividend income in case of unit-holders of Business Trusts.
The author is a Tax Partner – Real Estate practice, EY IndiaDisclaimer: Views expressed are personal