Taxation of Real Estate Investment Trusts (REITs)

Article explains What is a Real Estate Investment Trust (REIT), Criteria which REITs need to adhere for their qualification as per SEBI guidelines 2019, Taxability of REITs under the Act, Taxability of REIT in the hands of Unit Holders and Future of REITs in India.

What is a Real Estate Investment Trust (REIT)

-REIT is a business trust (not a trust formed u/s 11 and 12 of the Act) which owns and operates income generating real estate assets through direct or indirect holding in SPVs (Special Purpose Vehicles).

-REITs own many types of commercial assets ranging from office spaces to hospitals, shopping centers, hotels and warehouses.

-There are two main types of REITs – Equity REITs and Mortgage REITs. The concept of REIT originated in United States in 1960s. Since then many countries have come up with REITs to provide investors an opportunity to invest in large scale Real Estate Assets via REIT.

REITs in India

SEBI (Securities and Exchange Board of India) came up with guidelines on REIT in 2007. SEBI regulates all the provisions relating to REITs in India including the rights of Sponsors, Trust and the Unitholders.

Criteria which REITs need to adhere for their qualification as per SEBI guidelines 2019

REITs need to adhere to the below criteria for their qualification as per SEBI guidelines 2019:

• The company must have an asset base of at least 500 crores.
• For an Asset to qualify as SPV (Special Purpose Vehicle), REIT shall hold controlling interest and at least 50 percent of the total nominal value of equity in that SPV.
• 90 percent of net distributable cash flow shall be distributed to unit holders in the form of interest/dividend.
• 80 percent of the investment must be made in income generating assets and only 20 percent of the total investment can be made in under construction assets.

Taxability of REITs under the Act

• REITs have been given a pass-through status u/s 10(23FC) w.r.t interest received or receivable from an SPV or dividend referred to in section 115(O)(7) of the Act.

The expression “SPV” (Special Purpose Vehicle) means an Indian Company in which business trust holds controlling interest and not less than 50 percent of the nominal value of equity.

• The total income of a business trust may include interest and dividend income from SPVs, Rental income if it holds rent generating assets, investment income from funds/fixed deposits where surplus money is parked, capital gains under section 111A and 112.
• Any income of a business trust by way of renting or leasing of any real estate asset directly owned by the trust does not form part of total income u/s 10(23FCA).
• Subject to the provisions of section 111A and 112, the total income of a business trust shall be charged to tax at maximum marginal rate (MMR= 30 percent+ applicable surcharge and cess).
• As per section 115(O)(7), no tax shall be chargeable on dividends declared by a specified domestic company to a business trust out of its current income on or after specified date.

“Specified domestic company” means a company in which business trust holds whole of the nominal value of equity share capital.

“Specified Date” means the date of acquisition of aforesaid holding by the business trust.

• No tax shall be chargeable if the dividend is declared, distributed or paid by the specified domestic company out of its accumulated profits and current profits up to the specified date.
• A new section 115BBDA has been inserted by Finance Act, 2016 w.e.f. 01-04-2017 which is applicable to a “specified assessee” resident in India where total income includes income by way of dividends declared, distributed or paid by a domestic company. The amount of income tax calculated on such income by way of dividends in aggregate exceeding ten lakh rupees shall be at the rate of 10 percent.

“Specified Assessee” means a person other than a domestic company or a fund or an institution or trust referred to in section 10(23C) or a trust registered under section 12A or 12AA.

• In case of REIT, section 115(O)(7) has to be read with section 115BBDA to establish taxability of dividends received form SPVs.

SPV in which REIT holds entire nominal value of equity share capital and dividend is distributed by such SPV out of current profits after specified date; then no tax is chargeable under section 115BBDA.

In all other cases, section 115BBDA is applicable on dividends received exceeding 10 lakh rupees.

Taxability of REIT in the hands of Unit Holders

• Taxability of unit holders is governed by the provisions of section 115UA of the Act.
• As per section 115UA of the Act, Income distributed by business trust to its unit holders shall be treated of the same nature and in same proportion as it is received by the trust.
• If in any previous year, any income is distributed by the trust to unit holders which it receives as interest or dividend shall be treated as income of the unit holder for that previous year subject to provisions of the Act.
• Whereas if principal is repaid to unit holders by the trust, it shall be treated as capital receipts in the hands of unit holders and not “income” since section 56(2)(x) read with section 115UA implies that the income received without consideration shall be taxable under section 56(2)(x) and section 115UA contains the words “income distributed by a business trust”.
• Since unit holders are the beneficiaries of units held by them in the trust , amount of principal
  received for units is not without consideration; henceforth section 56(2)(x) shall not apply.
• Section 115UA shall not apply since distribution of principal to unit holders is not income and capital receipt in their hands whereas section 115UA contains the word “income”.

The word “Act” stated aforesaid refers to the Indian Income Tax Act 1961.

Future of REITs in India

• Indian Market welcomed its first REIT in April 2019. It was cheered by investors and saw a subscription of about 2.5 times.
• In the upcoming two years as well, marquee real estate players in India are looking to mop up billions via REITs.
• Since India’s first REIT offering garnered a whopping amount of Rs.4750 crores, this is a sign that investors have a positive outlook on Indian Real Estate Market – primarily in commercial real estate.

Disclaimer

The aforesaid write up is author’s sole discretion on the subject under discussion. The author has relied upon the provisions of Indian Income Tax Act,1961 and SEBI regulations on REIT,2014 and amended regulations,2019.

It is imperative that any subsequent changes in law may impact the aforesaid stated provisions and tax positions. No assurance is given that a position contrary to the above cannot be asserted by any authority or court.

No person shall be entitled to conclude any tax position on the basis of the aforesaid write up without the prior consent of the author.

For any related queries , Author can be reached at [email protected]