Wednesday, 1 April 2015

Budget 2015 Brings REITs Closer to Realty

REIT regulations expected to bring much-needed relief to cash-strapped developers

Introduction of REIT regulations has been lauded as one of the most important reforms in the real estate sector as it is expected to bring relief to the cash-strapped developers. It is expected to free up cash for developers of commercial assets, who have been facing liquidity issues with limited options for raising funds.

REITs are essentially trusts or companies that raise capital by issuing units or raise debt from investors, invest directly or through a special purpose vehicle (SPV) into revenue-generating real estate assets such as; shopping centres, offices, commercial spaces, etc. The income thus generated from assets of REITs is distributed among its unit holders.

Finance Act 2014 paved the way for introduction of REITs in India. It introduced specific provisions regarding taxation which was one of the key factors for the success of REITs. It was accorded a ‘tax pass-through’ status which means that income earned by the trust would be taxed in the hands of unit-holders and not trust, avoiding double taxation on the same income.

However, there were some issues that the industry felt were not adequately addressed by the finance minister in the last budget. From a taxation standpoint, there were some issues regarding sponsor taxability and some of the provisions being highly tax-inefficient vis-a-vis the sponsors. There were certain gaps on the pass-through front, concerns about levying dividend distribution tax or DDT at the SPV level, the stamp duty on contribution of assets to REIT, etc., which needed to be addressed.

Against this backdrop, the real estate sector was hoping that Budget 2015 would address some of the issues and provide the much-needed impetus to the sector.
The finance minister in his Budget speech acknowledged the need to give a boost to REIT listing in India as its success could play a pivotal role in reviving activity in the sector. Budget 2015 amendments have now brought the sponsor at par with the investor by allowing him to avail of the benefit of concessional tax rate on transfer of units of a REIT that have been subject to security transaction Tax (STT). Thus, short-term capital gains arising thereof would be subject to tax at the rate of 15%t and tax exemption has been provided in respect of long-term capital gains, a welcome step that puts the sponsor’s REIT units at par with other listed securities as far as the tax rates are concerned.

Further, rental income received by REIT for directly owned assets, has been given a pass-through and is not subject to withholding on distribution to the REIT. Such leasing income will be taxable only in the hands of the REIT investors and is subject to withholding on distribution by REITs to unit holders. The withholding is at a 10% rate for resident unit holders and at the applicable rate of tax for non-resident unit holders. It is yet to be seen whether non-resident unit holders will be allowed concessional rates prescribed under the applicable tax treaties.

However, some key areas including exemption from levy of DDT for the SPVs, applicability of minimum alternative tax or MAT on the sponsor at the time of contribution to the REIT have still not been addressed. Though passthrough status has been provided for rental income received by the REIT, no such amendment was made in respect of other revenue streams such as maintenance income received by REIT, making the structure possibly inefficient.

The policy is still silent on tax treatment in case of direct transfer of immoveable assets to the trust and while the Budget addressed concerns regarding transfer of shares of SPV by a sponsor providing them with a concessional tax rate, the holding period of three years for REIT units to qualify as long-term capital asset still does not put them at par with listed equity shares for which such period of holding is only 12 months.

Allowing foreign investments in REITs can be critical for its successful implementation. Amendments in foreign exchange management act or FEMA regulations for permitting foreign portfolio investors or FPIs and NRIs to invest in units of REITs without any cap or restrictions would be a welcome move. Modifications in the external commercial borrowings or ECB regulations should also be made so that REITS can leverage foreign debt.
Another issue that requires attention is applicability of stamp duty on transfer of asset by a sponsor to a REIT. Such charges etc render this model as highly cost-inefficient.

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