[This guest
post is contributed by Yashesh Ashar and
Swati Adukia. They are tax professionals and specialize in
mergers and acquisition tax. Please note that the views are personal]
post is contributed by Yashesh Ashar and
Swati Adukia. They are tax professionals and specialize in
mergers and acquisition tax. Please note that the views are personal]
I. Introduction
The
Securities and Exchange Board of India (“SEBI”) notified the SEBI (Real Estate Investment
Trusts) Regulations, 2014 (“REIT Regulations”) on September 26, 2014 , governing
the real estate investment trusts (“REITs”) in India. REITs would:
Securities and Exchange Board of India (“SEBI”) notified the SEBI (Real Estate Investment
Trusts) Regulations, 2014 (“REIT Regulations”) on September 26, 2014 , governing
the real estate investment trusts (“REITs”) in India. REITs would:
(i) Invest primarily in completed, revenue
generating real estate assets;
generating real estate assets;
(ii) Be professionally managed; and
(iii) Distribute a major part of their earnings to
their investors.
their investors.
REITs
are closed ended funds set up as trusts and registered with SEBI, just like
mutual funds, with investment primarily in completed and revenue-generating real
estate / infrastructure assets. The units of REITs are required to be
mandatorily listed and freely traded on a recognized stock exchange in India. The
income earned from properties will be distributed to the investors in the
trusts. In long term, REITs are expected to complement the growth and cater to the
financing needs of both sectors, drive the development of capital markets,
provide retail investors with less risky, fixed income investment avenues and provide
exit options for financial investors as well as developers.
are closed ended funds set up as trusts and registered with SEBI, just like
mutual funds, with investment primarily in completed and revenue-generating real
estate / infrastructure assets. The units of REITs are required to be
mandatorily listed and freely traded on a recognized stock exchange in India. The
income earned from properties will be distributed to the investors in the
trusts. In long term, REITs are expected to complement the growth and cater to the
financing needs of both sectors, drive the development of capital markets,
provide retail investors with less risky, fixed income investment avenues and provide
exit options for financial investors as well as developers.
Effective
April 1, 2015, a new tax regime for REITs (also referred to as “business trusts”
or “BTs”) had come into effect to provide tax certainty in the hands of BTs as
well as investors and to provide for a single of level taxation. Some of the
salient features of this tax regime are discussed below.
April 1, 2015, a new tax regime for REITs (also referred to as “business trusts”
or “BTs”) had come into effect to provide tax certainty in the hands of BTs as
well as investors and to provide for a single of level taxation. Some of the
salient features of this tax regime are discussed below.
II. Dividends
Dividends
distributed by a special purpose vehicle (‘SPV’) being a company, into which a
BT invests, will be subject to a dividend distribution tax (“DDT”) at the rate
of 15%[1] on
gross up basis; such dividends will be exempt from tax in the hands of the BT
as well as the investors in the BT.
distributed by a special purpose vehicle (‘SPV’) being a company, into which a
BT invests, will be subject to a dividend distribution tax (“DDT”) at the rate
of 15%[1] on
gross up basis; such dividends will be exempt from tax in the hands of the BT
as well as the investors in the BT.
III. Interest
Interest
received by a BT from an SPV, enjoys a complete tax pass through; such interest
will be taxed in the hands of the investors in the BT. However, the BT is
required to withhold tax (“WHT”) at the rate of 5% (for non-residents
investors) and 10% (for resident investors) on distribution of such interest income
to the investors.
received by a BT from an SPV, enjoys a complete tax pass through; such interest
will be taxed in the hands of the investors in the BT. However, the BT is
required to withhold tax (“WHT”) at the rate of 5% (for non-residents
investors) and 10% (for resident investors) on distribution of such interest income
to the investors.
IV. Capital Gains
The
BT will be taxed on any capital gains realized on disposal of its assets
(including shares held in an SPV) at the applicable tax rates, depending on
whether the gains are short term (“STCGs”) (i.e. assets are held for 36 months
or less) or long term (“LTCGs”) (i.e. the assets are held for more than 36
months). Further, the capital gains component of the income distributed by the
BT to its investors will be exempt from tax in the hands of the investors.
BT will be taxed on any capital gains realized on disposal of its assets
(including shares held in an SPV) at the applicable tax rates, depending on
whether the gains are short term (“STCGs”) (i.e. assets are held for 36 months
or less) or long term (“LTCGs”) (i.e. the assets are held for more than 36
months). Further, the capital gains component of the income distributed by the
BT to its investors will be exempt from tax in the hands of the investors.
V. Capital Gains Realized by BT Investors on Transfer of their
BT Units
BT Units
Investors
in a BT will be liable to pay securities transaction tax (“STT”) on sale of
their units in the BT. LTCGs realized by such investors on sale of their units
in the BT will be exempt from tax in their hands, while STCGs realized by such
investors on sale of their units in the BT will be taxable at the rate of 15%.
in a BT will be liable to pay securities transaction tax (“STT”) on sale of
their units in the BT. LTCGs realized by such investors on sale of their units
in the BT will be exempt from tax in their hands, while STCGs realized by such
investors on sale of their units in the BT will be taxable at the rate of 15%.
VI. Tax Implications for a Sponsor[2]
on Exchange of its Shares in an SPV for Units in a BT
on Exchange of its Shares in an SPV for Units in a BT
The
exchange of shares of an SPV for units in a BT will be exempt from tax in the
hands of a sponsor.
exchange of shares of an SPV for units in a BT will be exempt from tax in the
hands of a sponsor.
LTCGs
realized by such sponsors on sale of their units in the BT will be exempt from
tax in their hands, if the aggregate period of holding of the SPV shares and
REIT units together exceeds 36 month, subject to payment of STT. STCGs realized
by such sponsors on sale of their units in the BT will be taxable at the rate
of 15%, subject to payment of STT.
realized by such sponsors on sale of their units in the BT will be exempt from
tax in their hands, if the aggregate period of holding of the SPV shares and
REIT units together exceeds 36 month, subject to payment of STT. STCGs realized
by such sponsors on sale of their units in the BT will be taxable at the rate
of 15%, subject to payment of STT.
The
tax implications discussed above are summarized in the following table:
tax implications discussed above are summarized in the following table:
|
Entity
|
Streams of Income and its Distribution
|
||||
|
Dividend
|
Interest
|
Capital
Gain |
Other
income |
||
|
On
transfer of assets by BT |
On
Transfer of Units of BT |
||||
|
SPV
|
DDT
@ 20.36% on gross up basis |
SPV
exempt from withholding tax on interest paid to BTs |
N/A
|
N/A
|
N/A
|
|
BT
|
Exempt
|
Exempt
BTs
liable to WHT at 5% (for residents) and 10% (for non-residents) |
Taxable
at 20% and 30% for LTCG and STCG, respectively
No
withholding obligation on BTs |
N/A
|
Taxable
@ 30%
No
withholding obligation on BTs |
|
Investors (including sponsors)
|
Exempt
|
Taxable
at 30% (subject to credit of tax withheld by BT) |
Exempt
|
In
case of sponsors for exchanged units: Exempt, subject to payment of STT (as equity shares) and STCG at 15%
In
case of other units: LTCG – exempt and STCG at 15% |
N/A
|
The
above provisions were the first welcome move on the part of the Indian
government as it lays down a basic framework for one-level taxation and thereby,
provided much needed clarity on the tax implications for BTs and their investors.
However, considering the international experience, tax efficiency is critical
to the success of BTs. As the law stands today, there are several taxation and
regulatory challenges which need critical evaluation and amendment to make the
regime of BTs successful in India. Some of the key challenges that need to be
addressed in the Budget 2016 at various levels of the BT structure are discussed
below.
above provisions were the first welcome move on the part of the Indian
government as it lays down a basic framework for one-level taxation and thereby,
provided much needed clarity on the tax implications for BTs and their investors.
However, considering the international experience, tax efficiency is critical
to the success of BTs. As the law stands today, there are several taxation and
regulatory challenges which need critical evaluation and amendment to make the
regime of BTs successful in India. Some of the key challenges that need to be
addressed in the Budget 2016 at various levels of the BT structure are discussed
below.
VII. Tax Challenges
A. Transfer of Assets to BTs by Sponsors
Though
SEBI has permitted BTs to hold assets directly, the benefit as regards exchange
of the shares of the SPV by the sponsors have not been extended to exchange of
assets by sponsors in lieu of units of BTs. Accordingly, such an exchange of
assets for units of BTs would be treated as a taxable transfer liable to tax. Further,
direct transfer of assets to BTs would have stamp duty implications for the
purchasing BT in the range of 5% to 11% on the market value of the assets as
determined under stamp duty laws. This would make any direct transfer of assets
commercially unviable for sponsors as well as BTs. Jurisdictions such as
Singapore provides specific remission of stamp duties to REITs. Similar
remission/exemption may also be provided to BTs to contain the transaction costs
on direct purchase of assets by BTs.
SEBI has permitted BTs to hold assets directly, the benefit as regards exchange
of the shares of the SPV by the sponsors have not been extended to exchange of
assets by sponsors in lieu of units of BTs. Accordingly, such an exchange of
assets for units of BTs would be treated as a taxable transfer liable to tax. Further,
direct transfer of assets to BTs would have stamp duty implications for the
purchasing BT in the range of 5% to 11% on the market value of the assets as
determined under stamp duty laws. This would make any direct transfer of assets
commercially unviable for sponsors as well as BTs. Jurisdictions such as
Singapore provides specific remission of stamp duties to REITs. Similar
remission/exemption may also be provided to BTs to contain the transaction costs
on direct purchase of assets by BTs.
B. Partial Pass-Through only for Interest
Income
Income
The
REIT Regulations (or “BT Regulations”) permit foreign investors to make
investments in BTs. However, in the absence of pass through for the capital
gains and incomes other than interest income earned by BTs, the foreign
investors would not be eligible to claim the benefits of exemption or concessional
rates provided under the tax treaties entered into by India with the relevant
jurisdiction.
REIT Regulations (or “BT Regulations”) permit foreign investors to make
investments in BTs. However, in the absence of pass through for the capital
gains and incomes other than interest income earned by BTs, the foreign
investors would not be eligible to claim the benefits of exemption or concessional
rates provided under the tax treaties entered into by India with the relevant
jurisdiction.
As
regards domestic investors, non-pass through for capital gains and other
incomes (other than interest) would result in investors not eligible to set-off
losses from other activities against income earned from units in BTs.
regards domestic investors, non-pass through for capital gains and other
incomes (other than interest) would result in investors not eligible to set-off
losses from other activities against income earned from units in BTs.
C. Expense Deductibility for BTs as well
as Investors
as Investors
As
per the Indian tax laws, expenditure attributable to earning exempt income is
not allowed as deduction. This would lead to BTs not able to claim expenditure
incurred in the form of management fees, interest on monies borrowed against
interest income. Also, the investors would not be able to claim deduction for any
interest paid on borrowings against capital gains and other income (other than
interest) received from BTs. Moreover, generally, under Indian tax laws,
management fees would not be allowed as a deduction to BTs from capital gains
income. Thus, a complete pass-through for the BTs may allow the investors to
claim the deduction, to the extent permissible, for the expenditure incurred in
making investments in BTs against capital gains and other income (other than
interest income) as well.
per the Indian tax laws, expenditure attributable to earning exempt income is
not allowed as deduction. This would lead to BTs not able to claim expenditure
incurred in the form of management fees, interest on monies borrowed against
interest income. Also, the investors would not be able to claim deduction for any
interest paid on borrowings against capital gains and other income (other than
interest) received from BTs. Moreover, generally, under Indian tax laws,
management fees would not be allowed as a deduction to BTs from capital gains
income. Thus, a complete pass-through for the BTs may allow the investors to
claim the deduction, to the extent permissible, for the expenditure incurred in
making investments in BTs against capital gains and other income (other than
interest income) as well.
D. Use of a Limited Liability
Partnership (“LLPs”) as SPV
Partnership (“LLPs”) as SPV
LLPs,
a globally popular business entity structure, are gaining popularity even in
India since their introduction in 2008. LLPs enjoy a tax advantage over
companies, as LLPs are not subject to DDT on any income distributed to its
partners. Such income is exempt in the hands of BTs as partners to the LLPs. Unfortunately,
unlike interest income from companies as SPVs, interest income from LLPs as
SPVs have not been given pass through status and therefore, would be taxable at
BT level at 30%. Thus, in order to allow a widespread use of the more flexible
LLP vehicle, the pass through status for BTs should be extended to income from
LLPs as well.
a globally popular business entity structure, are gaining popularity even in
India since their introduction in 2008. LLPs enjoy a tax advantage over
companies, as LLPs are not subject to DDT on any income distributed to its
partners. Such income is exempt in the hands of BTs as partners to the LLPs. Unfortunately,
unlike interest income from companies as SPVs, interest income from LLPs as
SPVs have not been given pass through status and therefore, would be taxable at
BT level at 30%. Thus, in order to allow a widespread use of the more flexible
LLP vehicle, the pass through status for BTs should be extended to income from
LLPs as well.
VIII. Regulatory Challenges
Recently,
the Reserve Bank of India had allowed foreign investments in BTs subject to
certain conditions. Further, BTs are also added as eligible borrowers for the
purpose of raising external commercial borrowings.
the Reserve Bank of India had allowed foreign investments in BTs subject to
certain conditions. Further, BTs are also added as eligible borrowers for the
purpose of raising external commercial borrowings.
However,
compared with the regulations covering REITs in other jurisdictions, BT
Regulations are more stringent with regard to form of entity, initial offer
size, minimum number of investors, minimum distribution norms, disclosure and
governance requirements, sponsor commitment and lock-in requirements etc., to
achieve the dual objective of permitting only serious players to BT and
protection of investors. However, BT Regulations miss out on providing the
flexibility to listed entities to transition to BT model, investments in
overseas assets and flexibility for BTs to launch open ended schemes which are
available to REITs in other comparable jurisdictions.
compared with the regulations covering REITs in other jurisdictions, BT
Regulations are more stringent with regard to form of entity, initial offer
size, minimum number of investors, minimum distribution norms, disclosure and
governance requirements, sponsor commitment and lock-in requirements etc., to
achieve the dual objective of permitting only serious players to BT and
protection of investors. However, BT Regulations miss out on providing the
flexibility to listed entities to transition to BT model, investments in
overseas assets and flexibility for BTs to launch open ended schemes which are
available to REITs in other comparable jurisdictions.
IX. Conclusion
The Indian regulators have decided to adopt a
cautious approach towards the BT Regulations and therefore, the BT Regulations
and the associated tax regimes are at best in ALPHA mode. The successful
implementation, operation and development of the BT market in India will depend
heavily on the key challenges identified above. The structural reform process
in India is usually a lengthy process. However,
considering the heavy reliance being placed by the regulators as well as
investors on BTs to further develop the capital markets for the real estate and
infrastructure sectors in India, hopefully, the regulators will act swiftly to
remove the inflexibilities in regulations and inefficiencies in tax laws in the
upcoming Budget 2016.
cautious approach towards the BT Regulations and therefore, the BT Regulations
and the associated tax regimes are at best in ALPHA mode. The successful
implementation, operation and development of the BT market in India will depend
heavily on the key challenges identified above. The structural reform process
in India is usually a lengthy process. However,
considering the heavy reliance being placed by the regulators as well as
investors on BTs to further develop the capital markets for the real estate and
infrastructure sectors in India, hopefully, the regulators will act swiftly to
remove the inflexibilities in regulations and inefficiencies in tax laws in the
upcoming Budget 2016.
– Yashesh Ashar & Swati Adukia
[1] All the tax rates mentioned in this post will be
required to be increased by applicable surcharge and education cess under
Indian tax laws.
required to be increased by applicable surcharge and education cess under
Indian tax laws.
[2] Sponsor is a person/persons who set up the REIT and satisfies
conditions relating to minimum net worth and minimum experience and sound track
record. The sponsors are also required to meet certain minimum commitment and
lock-in requirements.
conditions relating to minimum net worth and minimum experience and sound track
record. The sponsors are also required to meet certain minimum commitment and
lock-in requirements.