Taxation Regime for Real Estate Investment Trusts (REIT) and Infrastructure Investment Trusts (Invit)
Recently, I have written article on taxguru.in on “Concept of Business Trust in India” and “Taxation of Business Trust in India”. In India, Business Trust operates as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs); Central Board of Direct Taxes issued CIRCULAR NO. – 19 /2015, DATED 27th NOVEMBER, 2015 giving Explanatory Notes to the Provisions of the Finance Act, 2015. This circular also contains amendments at a glance relating to taxation of Real Estate Investment Trusts (REIT) and Infrastructure Investment Trusts (Invit). In this article, I am incorporating relevant extracts of circular explaining Taxation Regime for Real Estate Investment Trusts (REIT) and Infrastructure Investment Trusts (Invit). These amendments are enumerated in below points-
1. The Finance (No.2) Act, 2014 had amended the Income-tax Act to put in place a special taxation regime in respect of business trusts. The business trust as defined in section 2(13A) of the Income-tax Act before amendment by the Act, included a Real Estate investment Trust (REIT) and an Infrastructure Investment Trust(InviT) which is registered under regulations framed by Securities and Exchange Board of India (SEBI) in this regard.
2. The said tax regime for the business trust and their investors as contained in different sections of the Income-tax Act, inter alia, provided that:-
(a) The listed units of a business trust, when traded on a recognized stock exchange, would be liable to securities transaction tax (STT), and the long term capital gains shall be exempt and the short term capital gains shall be taxable at the rate of 15%.
(b) In case of capital gains arising to the sponsor at the time of exchange of shares in Special Purpose Vehicle (SPV), being the unlisted company through which income generating assets are held indirectly by the business trusts, with units of the business trust, the taxation of gains is deferred.
(c) The tax on such gains is to be levied at the time of disposal of units by the sponsor.
(d) However, the preferential capital gains regime (consequential to levy of STT) available to other unit holders of business trust, is not available to the sponsor in respect of these units at the time of their transfer.
(e) For the purpose of computing capital gain, the cost of these units is considered as cost of the shares to the sponsor. The holding period of shares is included in computing the holding period of such units.
(f) The pass through is provided in respect of income by way of interest received by the business trust from SPV i.e., there is no taxation of such interest income in the hands of the trust and no withholding tax at the level of SPV.
(g) However, withholding tax at the rate of 5 per cent in case of payment of interest component of income distributed to non-resident unit holders, and at the rate of 10 per cent in respect of payment of interest component of distributed income to a resident unit holder is required to be effected by the trust.
(h) The dividend received by the trust is subject to dividend distribution tax at the level of SPV and is exempt in the hands of the trust, and the dividend component of the income distributed by the trust to the unit holders is also exempt.
3. The deferral of capital gains provided to the sponsor of business trust had placed such a sponsor at a disadvantageous tax position vis-a vis direct listing of the shares of the SPV. In case the sponsor holding the shares of the SPV decides to exit through the Initial Public Offer (IPO) route, then the benefit of concessional tax regime relating to capital gains arising on transfer of shares subject to levy of STT is available to him. The tax on short term capital gains (STCG) in such cases is levied @ 15% and the long term capital gain (LTCG) is exempt under section 10(38) of the Act. However, the benefit of concessional regime was not available to the sponsor at the time it offloads units of business trust acquired in exchange of its shareholding in the SPV through Initial offer at the time of listing of business trust on stock exchange.
4. In order to provide parity, it has been provided that,-
(a) the sponsor would get the same tax treatment on offloading of units under an Initial offer on listing of units as it would have been available had he offloaded the underlying shareholding through an IPO.
(b) Chapter VII of the Finance (No. 2) Act, 2004 has been amended to provide that STT shall be levied on sale of such units of business trust which are acquired in lieu of shares of SPV, under an Initial offer at the time of listing of units of business trust on similar lines as in the case of sale of unlisted equity shares under an IPO.
(c) the benefit of concessional tax regime of tax @15 % on STCG and exemption on LTCG under section 10(38) of the Act shall be available to the sponsor on sale of units received in lieu of shares of SPV subject to levy of STT.
(d) MAT deferral at the time of exchange of shares of SPV with units of business trust has also been provided-
(i) The Finance (No.2) Act, 2014 inserted clause (xvii) in section 47 of the Income tax Act to provide tax neutrality /deferment in respect of exchange of share of a special purpose vehicle with the units of business trust, however, no neutrality/deferment of Minimum Alternate Tax (MAT) liability under section 115JB of the Income-tax Act has been provided. The liability under MAT may arise due to recording of exchange of shares with the units at fair value by a shareholder, being a company in compliance with the provisions of Accounting Standard – 13 prescribed under the Companies Act, 2013 as per rule 7 of the Companies (Accounts) Rules, 2014. The recording of said exchange at fair value may result into inclusion of notional gain or loss in the book profit of the company for the purposes of levy of MAT under section 115JB of the Income-tax Act. Inclusion of these notional amounts especially notional gain in the book profit for levying MAT may result into cash flow problem for the company.
(ii) In order to provide tax deferment/ neutrality for MAT purposes, at the stage of the said exchange of share with the units of business trust, the provisions of section 115JB of the Income-tax Act have been amended to provide that notional gain or loss on transfer of a capital asset, being share of a special purpose vehicle to a business trust in exchange of units allotted by that trust referred to in clause (xvii) of section 47 of the Income-tax Act shall not be taken into account for computation of book profit for the purposes of levying MAT under section 115JB of the Income-tax Act.
(iii) It has been further provided that notional gain or loss resulting from any change in carrying amount of the said units shall also not be taken into account for the purposes of levy of MAT. The actual gain or loss on transfer of the units by taking into account the cost of shares exchanged or the carrying amount of such shares at the time of exchange where such shares are carried at a value other than the cost through profit or loss account, as the case may be, shall be included in the book profit of the year of transfer of units for the purposes of levying MAT under section 115JB of the Income-tax Act. These amendments are explained by way of the following illustration:-
§ Company ‘A’ is holding 100 shares of Special Purpose Vehicle (SPV) which are carried at Rs.2000 in the books of the company as on 1st April, 2015. During the financial year 2015-16, these 100 shares are exchanged with the 100 units of Business Trust (BT) and the same is recorded at the fair value of Rs.3000 resulting into a notional gain of Rs.1000. At the end of financial year 2016-17, the carrying amount of the units has been recorded at Rs.2500 resulting into a notional loss of Rs.500. During the financial year 2017-18, these units are sold for Rs.4000.
§ In the above illustration, the notional gain of Rs.1000 shall be excluded from the book profit of the financial year 2015-16. Similarly, the notional loss of Rs.500 shall be excluded from the book profit of the financial year 2016-17. For computation of book profit for the financial year 2017-18, the actual gain of Rs.2000, computed by taking into account the carrying cost of shares i.e. Rs.2000 and the actual sale price of unit i.e. Rs.4000 shall be included in the book profit of financial year 2017-18 for the purposes of levying MAT under section 115JB of the Income-tax Act.
5. Further, in case of a business trust being a REIT, the income is predominantly in the nature of rental income. This rental income arises from the assets held directly by REIT or held by it through an SPV. While the rental income received at the level of SPV gets passed through by way of interest or dividend to the REIT, the rental income directly received by the REIT was being taxed at REIT level and did not get pass through benefit.
6. In order to provide pass through to the rental income arising to REIT from real estate property directly held by it, it has been provided that :-
(a) any income of a business trust, being a real estate investment trust, by way of renting or leasing or letting out any real estate asset owned directly by such business trust shall be exempt;
(b) the distributed income or any part thereof, received by a unit holder from the REIT, which is in the nature of income byway of renting or leasing or letting out any real estate asset owned directly by such REIT, shall be deemed to be income of such unit holder and shall be charged to tax.
(c) the REIT shall effect TDS on rental income allowed to be passed through. In case of resident unit holder, tax shall be deducted @ 10%, and in case of distribution to non-resident unit holder, the tax shall be deducted at rate in force as applicable for deduction of tax on payment to the non-resident of any sum chargeable to tax.
(d) no deduction shall be made under section 194-I of the Income-tax Act where the income by way of rent is credited or paid to a business trust, being a real estate investment trust, in respect of any real estate asset held directly by such REIT.
7. These amendments take effect from 1st April, 2016 and will, accordingly, apply in relation to the assessment year 2016-17 and subsequent assessment years.