Taxation of REITs and InvITs under Section 115UA

Taxation of REITs and InvITs under Section 115UA: Assessing the tax framework for Real Estate Investment Trusts and Infrastructure Investment Trusts and its impact on investment flows

Introduction

One of the most ambitious attempts at institutionalising the channelling of institutional capital and retail capital into commercial real estate and infrastructure through Indian capital markets is the Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). These vehicles require an efficient, transparent and investor-aligned tax regime to succeed. In order to create a pass-through/conduit model, India added Section 115UA to the Income-tax Act, to exempt income at the trust level, and tax at the hands of unitholders, none of which changes the nature of original income. However, with time, structural arbitrages, particularly the utilisation of debt repayments by the SPVs, which are considered as tax-free capital receipts, undermined the purpose of the regime.

The Government took a step to shut this loophole in the 2023 Union Budget to require that such residual distributions be taxed as income in other sources in the hands of unitholders as of AY 2024-25 and beyond. In more recent changes, the Finance Bill 2025 has made proposals to amend Section 115UA(2) to expressly refer to Section 112A and therefore provide a concessional 10 per cent long-term capital gains rate in listed REIT/InvIT units effective AY 2026-27. A combination of these changes can be seen as a transition of a pure incentive-based tax model to the equilibrium between revenue objectives and attractiveness to investors.

This paper makes an in-depth examination of the evolving tax structure of REITs/InvITs under 115UA, a comparison of the pre- and post-amendment regimes, and an evaluation of the impacts of these changes on incentives and capital flows. We evaluate the impacts on yield-sensitive retail investors, institutional pools, and foreign portfolio investors, and recommend some improvements to enhance the tax equity without compromising the growth direction of the trust ecosystem.

Legal & Fiscal Framework under Section 115UA

The legal nexus of taxing business trusts in India, i.e. REITs and InvITs, is found in Section 115UA of the Income Tax Act, 1961, the pass-through structure which makes the unit-holders subject to direct income taxation on the income earned by Special Purpose Vehicles (SPVs) (interest, dividends, and rental income). According to Sub-section (1) of Section 115UA, any income that is paid out to the unit-holders of a business trust shall be considered to be of the same nature and proportion as was paid by the trust. Therefore, SPVs, dividends or rent involve the earning of interest which is not taxed at the trust level, but is subject to taxation as income of the unitholder.

Exemptions in 10(23FC) and 10(23FCA) are to be added to 115UA. Section 10(23FC) has an exemption on the income of a business trust regarding interest or dividends received by SPVs, but Section 10(23FCA) does not have such an exemption on rental or leasing income received by real estate assets held by a business trust (in the case of REITs). These exempt incomes are therefore exempted at the trust level, and they are subject to taxation upon their distribution to unitholders.

Section 194LBA will provide a TDS liability on business trusts that pay income under 115UA that is based on the type of income included in 10(23FC) or 10(23FCA). In the case of resident unit-holders, a rate of 10 per cent is considered normal. In the case of non-residents, various rates are charged depending on the nature of income, e.g., 5% on specified interest of SPVs, 10% on dividend income in specified cases and other rates in force as per available Double Taxation Avoidance Agreements (DTAAs). The liability to deduction occurs earlier of the date of credit to the account of the unit-holder, or the actual payment.

Amendments to the budget level have been made recently in order to make this structure clear and also to make it more refined. To provide an example, the Finance Bill 2025 suggests the addition of the reference to Section 112A (concessional long-term capital gains rate) to Section 115UA(2), which will enable listed business trust units to enjoy the 10% LTCG rate. Also, uncertainties in relation to residual distributions (e.g. SPV debt repayments) are being resolved to avoid non-taxation on top of non-taxation.

2023 Budget Amendment: Closing the Debt-Repayment Loophole

One of the major arbitrage in the REIT/InvIT tax regime prior to 2023 was that debt repayments by SPVs to the business trust, then passed on to the unitholders, were characterised as a capital receipt and therefore free from taxation. These receipts were not categorised as interest, dividend or rent (which are taxed at a rate of pass-through) or taxed at the trust level and therefore, they passed through taxation, producing a situation of double non-taxation.

To seal this loophole the Finance Act, 2023 revised the tax code by introducing a new clause (xii) in the section 56(2) of the income tax act which states that: any amount paid by a unitholder of a business trust and which is not a like dividend, interest or rent under Section 10(23FC)/10(23FCA) would be taxed under the head Income from Other Sources.

Nevertheless, the amendment was moderated: not all such repayments are brought to the tax net, but only a given amount (i.e. that amount which is not a part of the original issue price or cost base) is subject to tax. When there is unit redemption, the cost of redemption is deducted (so far not exceeding the amount received) from the amount taxable.

Concurrently, the Bill presents the insertion of Section 115UA(3A) that exempts such “specified sums” from the deeming provisions of pass-through of Sections 115UA(1)-(3). In such a way, allocations that qualify under clause (xii) are de-embraced by the 115UA regime to be taxed differently.

Its economic impact is two-fold: first, it limits tax arbitrage since residual streams of distribution are now taxable, and second, it presents a yield headwind to unitholders who were formerly accustomed to receiving large cash streams tax-free. However, it also adds complexity to the computation and compliance since it needs cumulative distributions and cost base adjustments to be tracked.

2025 Amendment Proposal: Section 112A Introduction

The Government has made a landmark change in the taxation of business trusts in the Finance Bill, 2025, through Section 115UA, by stating that Section 112A is specifically included in its scope of action. The current law states that the total income of any business trust is liable to taxation at the highest marginal rate under the following sections: 111A (the short-term capital gains tax on the investment assets as equity) and 112 (the long-term capital gains tax on the investment assets as assets other than equity). Nonetheless, since Section 112A (which imposes a concessional 10% rate on long-term capital gains realised on the disposition of listed equity shares, mutual fund and business trust units) is not provided at all, gains on the transfer of REIT/InvIT units will not, at the current rate, be subject to the concessional rate of 10%.

The amendment (Clause 25 of the Bill) aims to substitute the phrase “sections 111A and 112” in Clause 115UA(2) with the phrase sections 111A, 112 and 112A, effective as of 1st April, 2026 (i.e. assessment years 2026-27 onwards). On coming into effect, this change would allow gains on transfer of units of listed business trusts (REITs/InvITs) to be taxed at the preferential 10 per cent (including any surcharge and cess) instead of at the highest marginal rate.

This congruity would have a number of results. First, it increases the tax equality of business trust units and equity shares/equity mutual funds, which is a structural disadvantage of REITs/InvITs. Second, it offers more certainty and predictability of exit taxation, and therefore, these vehicles are more appealing to long-term investors. Third, this concession can partially offset the negative effect on yield that the 2023 amendment (widening taxation of residual distributions) has. Lastly, simplicity in treating the capital gains is bound to make the secondary markets of the trust units more active and liquid.

With this said, it would only benefit listed business trusts that meet the requirements of Section 112A (e.g. STT payment, holding period, etc.). Further, although this amendment enhances investor alignment, residual ambiguity as to the categorisation of mixed distributions or non-listed transfers of trust is not resolved by this amendment, which might have to be addressed by additional rulemaking practices or regulatory clarity.

Comparative Regime Analysis: Before vs. After Reform

Until the amendment of 2023, Section 115UA taxation of REITs/InvITs permits some structural arbitrage. Repayment of debts by SPVs to business trusts when distributed to unitholders was mostly considered as a capital receipt and was tax-exempt. The flows, which were tax-free to investors, increased after-tax yields. In the meantime, capital gains on the transfer of trust units were taxed by Section 112 (in the case of long-term gains) or Section 111A (in the case of short-term gains), but at the non-concessional rate of Section 112A in the case of business trust units, which applied to listed equity shares / mutual funds in some circumstances. Section 115UA(2) also failed to specifically address Section 112A; consequently, even listed REITs/InvITs were not subject to the reduced LTCG rate of 10 per cent under Section 112A.

The debt-repayment loophole was sealed with the government’s 2023 amendment to the budget. Since AY 2024-25, payments made by SPVs from debt repayment that is not included in interest/dividend/rent are taxed as Income of Other Sources in the hands of the unitholders. The latter expansion of the taxable base and the narrowing of the yield of investors who once relied on such tax-free receipts. But cost base adjustments were also put in by the amendment, such that the cost base adjusts only to the extent that it exceeds the issue price/cost, which gives a relief. Empirical reaction incorporated the issues of compression of yields and a slight decline in investor sentiment.

A concessional regime of listed business trust units is brought about by the proposal to amend the 2025 proposal to amend Section 115UA(2) to expressly refer to Section 112A. The long-term capital gains on listed units above 112A will be subject to income tax at the rate of 10 (including surcharge and cess) in the qualifying transfer, providing income tax parity with equity shares/equity mutual funds. The anticipated advantage modifies part of the drawback of the 2023 amendment to the investors who are capital gain-oriented. In addition, recent modifications in Section 112A (as of July 2024) increased the exemption threshold from 1 lakh to 1.25 lakh and the rates from 10% to 12.5% of listed equity/units consisting of business trusts.

Effects on Investment Flows & Market Dynamics 

The new tax and regulation changes in the REITs and InvITs in India are already changing the nature of investment flows and the market dynamics in quantifiable and expected ways. A significant rise in the mobilisation of capital has been one of the results. The RBI data indicate that REITs and InvITs have collected about Rs. 1.3 lakh crore in FY2020-24. Particularly, fundraising increased to approximately Rs. 17,116 crore in FY2023-24 as compared to a low of approximately Rs. 1,166 crore in FY2022-23. This steep increase indicates increasing investor confidence as well as the regulatory changes that have reduced entry barriers and enhanced visibility of yields.

One more significant indicator is liquidity: the trading volumes of the REITs and InvITs have grown sharply. As an example, trading in the public REIT units grew from approximately 3,273 lakh in FY23 to 16,350 lakh in FY25; the value traded also increased significantly. This means that the number of players in the secondary markets is increasing and liquidity risk is lower, and exit options are improved. Retail participation has also increased (unitholders have increased by an estimated 8.2% YoY).

Tax reforms have been met by investor sentiment. The Finance Bill 2023, which made repayments of debts liable under the title Income from Other Sources, although restricted in some cases to taxable income after cost adjustments, at first raised some apprehension among those holding such distributions yield-sensitively. However, it is later realised that this tax overhang is being consumed, partly due to compensating benefits like greater transparency in the cost basis, a more foreseeable tax rate and a hope of positive future reforms (including adding Section 112A).

These are being magnified by regulatory classification changes. The recent re-characterisation of the REITs as equity instruments as opposed to InvITs as a hybrid under the mutual fund rules by SEBI permits the mutual funds to count the REIT exposures as equity allocations in their investment products, enhancing the feasibility of their institutional demand and the incorporation of such exposures into equity-based investment products. Together with this are suggestions to increase the eligibility of strategic investors such as pension funds, insurance companies, and foreign institutional investors and increase the exposure of mutual funds to REITs/InvITs, which would further broaden the investor base.

Looking forward, it is expected to be bullish. According to a Knight Frank survey, InvIT AUM is estimated to grow approximately 3.5x, moving USD 73.3 billion in FY25 to USD 258 billion in 2030, assuming a continued regulatory favour, availability of asset pipeline, and investor satisfaction with the tax regime also, Indian REITs crossed Rs. 1 lakh crore in market capitalization, which has been a milestone of further maturity and an indicator of increased confidence.

Policy and Design Recommendations  

First, it is possible to increase the investment flows by relaxing the mutual fund exposure limits to REITs and InvITs. In April 2025, SEBI suggested doubling the total limit of equity and mixed schemes to 20 per cent of the NAV of REIT/InvIT units and lifting the cap of 5 per cent to 10 per cent of a single issuer. The changes would enable the mutual funds to diversify more vigorously into real assets, to enhance the liquidity of trust units and to minimise the concentration of risk. Nevertheless, these growths should be criticised with a sound risk evaluation, particularly for debt-based plans, which still carry an upper limit with perpetual and liquidity risks.

Second, the fact that SEBI has decided to regulate REITs as equity instruments according to the Mutual Fund Regulations is a good move. This will enable the allocation of REIT units to be included in equity exposure and allow it to be included in equity indices. This aligns the incentives of investors and makes classification easier, and would probably encourage more institutional involvement. However, there is a need to be clear on the application of the same treatment to InvITs, or in what circumstances.

Third, there must be better norms of disclosure and transparency. The newer rules by SEBI mandate REITs and InvITs that issue offer documents or follow-on offers to publish the audited financial statements of the previous three years and a stub period, where applicable. Further, trusts must be obliged to report the nature of received amounts (interest/dividends vs. principal repayments vs. residual income), the expense of acquiring the unit-holders, and the effects of taxation. This would decrease information asymmetry, assist investors in approximating after-tax yields more precisely and decrease tax arbitrage.

Fourth, it will reduce the entry barriers and regulatory friction that will ensure that the investor base is expanded. To illustrate, the making of REITs/InvITs accessible will be facilitated by the reduction of minimum investment requirements to private InvITs, streamlining of KYC and tax withholding requirements to small/retail unitholders, and withholding (TDS) regimes that are not over-onerating. Despite the fact that certain suggestions of these reforms are not so evident in the recent sources, the issues of liquidity, investor education and complexity in tax compliance have been referred to by the stakeholders.

Conclusion

The changing taxation of REITs and InvITs under Section 115UA is an would-be turning point: the 2023 budget amendment has sealed a large debt-repayment loophole, and the 2025 proposed addition of Section 112A will ensure more capital gains parity. Collectively, these changes realign incentives, yield-oriented to long-term capital gain, but offer more certainty on taxes and less arbitrage. Compression of yield can put some investors off in the short term, but structural transparency and equity alignment can trigger new inflows, more liquidity and increased engagement on the part of institutions.

In the future, policy measures that are complementary to this regime are needed: transparent disaggregation of distributed incomes, rollover or reinvestment holidays, treatment in the same way, and mechanisms of TDS. When done effectively, the REIT/InvIT model in India can transform into a strong, mainstream real-asset class, the mobilisation of massive sums of capital into infrastructure and property, and the foundation of Indian growth aspirations in market-based, sustainable financing. In addition to that, ex-post studies will be essential in empirical analysis, cross-jurisdictional benchmarking, and investor response surveys will be essential in polishing the regime as time goes by.