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Contrary to a promise made in the Budget for 2014-15, the proposed real estate investment trusts (Reits) might not get a full pass-through status.
Reits are listed entities investing in income-producing real estate assets, the earnings of which are mostly distributed to shareholders.
While Budget 2014-15 had announced pass-through status for these trusts, the Securities and Exchange Board of India (Sebi) announced the guidelines for Reits late last month.
Pass-through status means taxes on the income distributed by Reits to unit holders will be paid by unit holders and not the Reits. This was one of the major demands of those interested in coming out with Reits.
However, tax experts say a complete pass-through status has not been given to the trusts for the purpose of taxation. Provision for tax on Reits is contained in the Finance Bill, 2014.
Hemal Mehta, senior director, Deloitte India, explained the Sebi norms allow Reits to either acquire the shares held in a special purpose vehicle (SPV) by the developer or acquire the real estate asset directly under the trust.
If a developer transfers shares held in an SPV to a Reit, capital gains tax would not be immediately applicable. The developer would be liable to pay when he sells units of the Reit to investors, which may be retail investors on a stock exchange. At this time, capital gains tax would be payable by the developer on sale price of units minus indexed cost of holding of shares in the SPV.
Now, on these units held by investors, different kinds of income can be generated, which will be passed on by Reits to unit holders. These may be dividend, interest or capital gains.
If it is interest on units, then the SPV will pass it to the Reit, which will cut the withholding tax - 10 per cent in case of resident Indians and five per cent in case of non-residents. The unit holders will pay tax on such interest depending on their income slab and take credit of withholding tax. Non-resident will pay according to rules in his country, but nothing further in India. In this case, it is a some sort of a pass-through.
| The lowdown on Reits |
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If the SPV, on behalf of the developer, distributes dividend to the Reit, which in turn pays it to unit holders, then the SPV will pay dividend distribution tax (DDT) at the rate of 17 per cent, which turns out to be approximately 20 per cent after cess and surcharges. This is not a pass-through.
Now if shares held by the Reit are sold and the capital gain is made, which is distributed by Reit to unit holders, then Reits will pay tax on such capital gains and not unit holders, said Mehta. In this case as well, there is no a pass-through.
Had it been a complete pass-through status, investors would have been able to net the capital gains with capital loss from other sources, which Reits may not be able to do so. Besides, if an investor is from a country with which India has double taxation avoidance agreement, such as Mauritius, he would have got the benefit of tax treaty and not paid capital gains tax. However, under the current tax regime, he will have to receive less income to the extent of capital gains tax paid by the Reit as the tax falls on the trust.
Earlier, it was given to understand that a 'pass-through' status means the income generated would be taxed in the hands of the investor, and that the Reits or SPVs themselves would not have to pay tax on the same.
Instead of Reits acquiring shares held in SPV, the trust can also acquire real estate and give units to the SPVs. In such a scenario, the capital gains tax would arise in the hands of the concerned SPV, which would be required to be discharged by them at the time of transfer of real estate assets.
In this case, since the real estate assets would be housed in the Reit itself, the income of the Reit is the business income from real estate assets and not the interest or dividend from shares in SPVs. Any capital gains to the Reit on the transfer of the real estate assets subsequently would be subject to tax in the hands of the Reits and exempt in the hands of the unit holders, explained Mehta. This is also not a pass-through.
It is only when unit holders sell their units and get capital gains that the tax would be paid by unit holders. In that sense, it would be a pass-through, said an analyst.
When contacted, a finance ministry official said there is an issue relating to DDT for a pass-through status, but not capital gains tax. He said no further tax incentives are likely for Reits.
Neeraj Bansal, partner and head (real estate and construction) at KPMG in India, said the finance ministry should consider exempting capital gains arising to the sponsor on exchange of shares of SPV or real estate assets in lieu of units of Reit.
In order to bring clarity in provisions, he said the Reit should be made a complete pass-through vehicle. The current provisions allow such pass-through only with respect to interest income from SPV, which is taxed in the hands of the investors directly, while other income is taxed at Reit level.
Yogesh Bhatt, a fund manager at ICICI Prudential AMC, said there is no clarity on Reits. "The way it is worded currently can be interpreted differently."
According to Sebi rules, only commercial properties such as office buildings can be part of a Reit, and all Reits have to be listed on a stock exchange.
To be eligible for listing, the value of the assets owned or proposed to be owned by a Reit should be worth at least Rs 500 crore.
Reits will be required to distribute not less than 90 per cent of their net distributable cash flows to investors every six months.
According to the rules, at least 80 per cent of the value of the Reits' assets must be in properties that are completed and are generating revenue. This means, a Reit can invest only 10 per cent of the value of its assets in properties that are under construction. Reits can also invest a small portion in other securities such as mortgage-backed securities and money market funds.
