Real Estate Investment Trust – REITs:
The introduction of the Real Estate Regulation Bill, which foretells the government’s desire to promote the real estate sector, will abort the torment of Indian real estate.
Globally REIT is well developed phenomena, serving dual purpose of providing investor with alternative investment avenue. Initially it was introduced in the US in the 1960s.
Rationale of REITs:
REITs will be the new funding mechanism for rental assets. A REIT is a company that, in most cases, operates income producing real estate properties by pooling in money from several investors and it gets a status of pass-through entity which does not have to pay corporate tax, hence avoiding double taxation.
Stepping stone for REITs:
India’s real estate sector has witnessed rapid growth in recent years underlined by robust economic growth in the country. The growing scale of operations of the corporate sector has increased the demand for commercial buildings and space including modern offices, warehouses, shopping centres, conference centre’s, etc. For such rapidly growing industry, it is crucial that investment vehicles such as Real Estate Investment Trusts (REITs) evolve in the country.
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. Dependence of developers on bank funding is likely to come down as REITs will enable them to get access to cheaper funds compared to debt which is costly.
Need for REITs:
The objective of REITs to be registered as trusts with SEBI will be:
a. To organize, operate and manage collective investments.
b. To launch REITs schemes, these trusts will have to float a real estate investment management company.
c. All REITs schemes, to begin with, will be close-ended real estate investment schemes that will invest in property with the aim of providing returns to unit holders. The returns will be derived mainly from rental income or capital gains from real estate.
Finance Bill 2014 Hand over:
Encouragement is sought to be provided to real estate and infrastructure sector funds by clarifying the basis of taxation in the hands of the Trusts/Funds and investors.
In this Budget, the Union Finance Minister had announced REITs as a pass-through entity and other incentives for it, including exemption from long-term capital gains tax. These trusts would raise capital by way of issue of units to be listed on a recognized stock exchange. The income bearing assets would be held by the trust by acquiring interest in an Indian Company (SPV) from the sponsor.
Taxation of real estate investment trusts and infrastructure investment trust (business trusts)
In order to understand the taxation aspect of REIT, it is necessary to understand the concept of REIT:-
Investors Holding units in REIT:
• REIT will invest in Real Estate Properties Directly
• REIT will invest through Special Purpose Vehicle.
• Special Purpose vehicle will make investment in Real Estate Properties.
The SEBI has proposed draft regulations relating to two new categories of investment vehicles, namely:
• REIT; and
• Infrastructure Investment Trust.
(Both the above entities referred to as “business trust” hereinafter). REITs have been allowed to invest in the properties directly or through special purpose vehicles, wherein such special purpose vehicles (SPV) hold not less than 90% of their assets directly in such properties. However, in such cases, it has been mandated that REITs shall have not less than 51% control over the SPV so that the interest of the investors of the REITs are not jeopardized. It is proposed to introduce a specific taxation regime for business trusts and investors in such a business trusts in a manner that there is no double taxation
The key features of such regime are as under:
The business trust is taxable on any capital gains earned by it on disposal of any assets at the applicable rate (depending upon whether the gains are short or long term)
Capital gains on transfer of units of the business trust by investors;
Listed units of business trust when traded on stock exchange would attract STT and long term capital gains would be exempt while short term capital gains would be taxable at 15%
1. Dividend received by the Business Trust from SPV shall be exempt as it would be subject to dividend distribution tax at the level of SPV. Hence, Dividend is exempt in the hands of the business trust.
2. Dividend component of the income distributed by the business trust is treated as such in the hands of the unit holder and therefore is exempt in their hands. This amendment shall take effect from 1 October 2014.
1. Interest income of the business trust from SPV is accorded pass through treatment in the hands of the Business Trust and no withholding tax at the level of SPV. Hence, Interest from SPV is not taxable in the hands of the business trust.
2. Interest distributed by business trust is taxable in the hands of unit holders.
3. Business trust will withhold tax on the interest component of the distributed income payable to the unit holders at the rate of 5 per cent for any non-resident unit holder and 10 per cent for a resident unit holder.
Tax implications in the sponsor’s hands on disposal of SPVs’ shares with business trust units;
1. In case of capital gains arising to the sponsor at the time of exchange of shares in SPVs with units of the business trust, the taxation of gains is now been deferred and taxed at the time of disposal of units by the sponsor.
2. However, at the time of ultimate disposal of the units of the business trust, the sponsor shall not be entitled to avail the concessional STT-based capital gains tax regime. Further, the acquisition cost of the units to the sponsor shall be deemed to be the acquisition cost of the shares in the SPV. The holding period of the shares would also be included in reckoning the holding period of the units.
REITs has been established for regulation and promotion of the real estate sector and to ensure sale of plot, apartment or building, as the case may be, in an efficient and transparent manner and to protect the interest of consumers in the real estate sector. It will bring the much needed respite to the commercial real estate sector and enable developers sitting on assets to both unlock value and create liquidity.
It uses investors' money to buy real estate assets for rental and capital gains. These help buyers benefit from real estate price appreciation without the hassles associated with buying and maintaining properties. As REITs invest a large pool of money in multiple properties, the investment risk is also diversified.
SEBI has mandated that UNITS of REITs shall be listed on Stock Exchange.
a. For coming out with initial offer, it has been specified that the size of the assets under the REIT shall not be less than Rs. 1000 crore which is expected to ensure that initially only large assets and established players enter the market.
b. Further, minimum initial offer size of Rs. 250 crore and minimum public float of 25% is specified to ensure adequate public participation and float in the units.
c. The REIT may raise funds from any investors, resident or foreign. However, initially, till the market develops, it is proposed that the units of the REITs may be offered only to HNIs/institutions and therefore, it is proposed that the minimum subscription size shall be Rs. 2 lakhs and the unit size shall be Rs. 1 lakh.
Conditions regulating the investments of REITs.
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 (Maximum upto 10 % of REIT assets).
The investment by REIT shall only be in securities or properties (other than vacant land or agriculture land) in India.
1. Not more than 10% of value of the REIT assets shall be invested in:
a. Developmental properties; Provided that such investment shall only be in properties which shall be held by the REIT for not less than three years after completion and shall be leased out;
b. Listed or unlisted debt of companies;
c. mortgage backed securities;
d. Equity shares of companies listed on a recognized stock exchange in India which derive not less than 75% of their revenues from Real Estate activity;
e. Government securities;
f. Money market instruments or Cash equivalents;
2. Not Less than 90% of the value of the REIT assets shall be in completed revenue generating properties.
REITs have been on the wish-list of the Indian real estate sector for long. They are expected to bring in globally-accepted practices to real estate funding and revive the interest of both global and domestic investors in the sector.
The decision to allow listing of REITs in India as an investment product will boost the liquidity situation of cash-starved developers, which are struggling to find funds for their construction activities.
REITs will be a sign of the maturity of the Indian real estate market. REITs reduce individual speculation in real estate assets and allow for more professional investment and management in the sector.
Written By: Sandeep Gupta
Tags Income Tax