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Globally REIT is well developed phenomena, serving dual purpose of providing investor with alternative investment avenue, being real estate properties and providing developer or private equity fund avenues of exit, thus enabling them to utilise their existing funds in other projects

In India, there is imperative need for development of real estate sector commensurate with growth in other sectors of economy. Being highly capital intensive and limited capacity of existing financial institution to provide necessary capital for real estate sector, there is impressing requirement of alternative means of finance for real estate sector

In India, road map has been laid out to make REIT a reality. Firstly SEBI has come out with draft regulation for REIT and secondly Finance bill 2014(2) has provided light on Direct taxation aspects of REIT.

Hereinafter, attempt has been made to summarise the Direct Tax Proposal on REIT and scope for further clarity on the same. The underlying principle on Direct Tax Proposal appears to facilitate the additional finance for real estate sectors.

In order to properly appreciate the taxation aspect of REIT, it is necessary to understand the concept of REIT, as under:-

1.  Investors Holding units in REIT

2.  REIT will invest either in Real Estate Properties Directly or through Special Purpose Vehicle

3.  Special Purpose vehicle will make investment in Real Estate Properties

The above only gives brief description of Model of REIT. Further SEBI has mandated that UNITS of REIT shall be listed on Stock Exchange.

Among other things SEBI’s draft regulation contains the conditions regulating the investments of REIT. At this stage, it is necessary to summarise the investment regulations of REIT to properly appreciate the possible nature of income in the hands of REIT.

Investment Regulations

1. The investment by REIT shall only be in securities or properties (other than vacant land or agriculture land) in India.

2. Investment Proportion:-

a. Not less than 90% of value of REIT asset shall be invested in completed and rent generated properties

b. Not more than 10% of value of the REIT asset shall be invested in :-

- Developmental Properties

- Listed or unlisted Debt of Companies

- Mortgage backed securities

- Listed Equity shares of the companies, which derive not less than 75% of their revenue from Real Estate Activities

- Government Securities

- Money Market Instruments or Cash Equivalents

Investment in Properties

a. REIT can invest in Properties directly in its own name

b. REIT can invest in properties through Special purpose Vehicle (SPV), if following conditions are satisfied:-

i. Such SPV hold not less than 90% of their asset directly in Properties

ii. The REIT shall hold controlling interest and not less than 51% of equity share capital of SPV

Income Proportion – Not less than 75% of the Revenues of REIT, other than gains arising from disposal of Properties, shall be from rental, leasing and letting real estate assets at all times.

Based on above the investment avenues proposed for REIT, its income can be comprised of the following:-

1. Rental Income from Direct Investment in Real Estate Properties

2. Capital Gains on sale of Real estate properties.

3. Dividend Income from equity Investment in Special purpose vehicle

4. Interest Income from loans advanced  to Special purpose vehicle

5. Interest/Dividend/Capital Gains from other Investment (10% of REIT assets)

The taxation proposal can be categorised at two levels

a. REIT level

b, Investor Level

REIT Level taxation Proposal

Nature of Income

Direct Tax Proposal

Remarks

Dividend from SPV

Exempt u/s 10(34) (Existing Provision)

Interest from SPV

Exempt u/s 10(23FC) (New Provision)

Rental Income

Taxable @ 30% 115UA(2) (new Provision)

  1. There are specific Provision for computation of Income from House property and Capital gain
  2. Whether expense incurred by REIT can be claimed as business expenditure and can be set-off against Income other heads of income, since Income under the head Business or profession will be rarely in REIT
  3. Whether deductibility of such expenses can be restricted by application of section 14A, since part of income of REIT is exempt?

Short term Capital gain (STCG)

Taxable @ 30%, other than STCG on listed shares traded on stock exchange, which are taxable @ 15% u/s 111A

Long term Capital Gain (LTCG)

Taxable @ 20% u/s 112, other than LTCG on listed shares traded on stock exchange, which are exempt u/s 10(38)

Other Interest Income

Taxable @ 30% u/s 115UA(2)

Investor Level taxation Proposal

1. In respect of Distributed Income from REIT, the nature of Income in the hands of Investors shall be in same proportion as in the hands of REIT as per section 115UA.

2. For all practical purpose, Units in REIT (which are listed on stock exchange) is treated at par with listed shares as under:-

a. Securities Transaction tax (STT) – Units are subject to STT

b. Short Term Capital gains – Taxable u/s 111A

c. Long term capital gains – Exempt u/s 10(38)

d. Tenure for Long term capital assets- Section 2(42A) is amended to provide that for security listed on stock exchange, holding of 12 month is required to classify them as long term capital asset. Security is defined as per section 2(h) of Securities Contract Regulation Act as under:-

i. shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate

ii. Derivative

iii. Units or any other instrument issued by any collective investment scheme to the investor in such scheme.

From said definition of Security, it is not aptly clear that whether UNITS of REIT will be covered under existing definition or needs amendment.

If UNITS of REIT are not covered above, the holding period of same will be 36 months or more to be classified as Long term capital asset.

Need clarity in this aspect

Other Proposal at Investor level is as under:-

Nature of Income

Direct Tax Proposal

Remarks

Distributed income from REIT

  1. Interest from SPV component is taxable.
  2. Any other component of Income exempt u/s 10(23FD)

For Interest from SPV in the hands of REIT, there is Pass through Mechanism i.e interest income is made exempt in the hands of trust and made taxable in the hands of investor of trust.

Capital gain on conversion of shares to Units and subsequent sale of units

  1. Capital gains on conversion of Shares in SPV by sponsor (Developer of project) into units of REIT are exempt u/s 47(xvii).
  2. The holding period of Unit will include the holding period of Shares in SPV u/s 2(42A)
  3. The cost of units will be cost of shares u/s 49(2AC)
  4. Sale of such converted units will be taxable either STCG or LTCG depending upon holding period

Short Term capital gain on sale of units by normal investor (Other than sponsor specified above)

Taxable @ 15% u/s 111A, if sold on stock exchange.

Long term capital gains on sale of units by normal investor (Other than sponsor specified above)

Exempt u/s 10(38), if sold on stock exchange.

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