MUMBAI: The Securities and Exchange Board of India (Sebi) has written to the government seeking easier tax rules for Real Estate Investment Trusts (REITs) to help the product category pick up. The capital markets regulator has recommended abolishing capital gains tax and minimum alternate tax (MAT) for sponsors of REITs and investors as several real estate players are holding back their plans to raise funds through this new investment route citing stiff taxes.
Last year, Sebi had put in place the regulations after the government, in the 2014-15 Budget, gave REITs the ‘pass through’ status for the purpose of taxation to attract long-term foreign and domestic investors, including nonresident Indians. But, industry trackers said taxation rules for REITs have been the biggest dampener, making the product appear less lucrative to both sponsors and investors.
“Many players are holding back their plans to raise funds through REITs due to the taxation rules,” said Dinesh Kanabar, CEO of tax advisory firm Dhruva. The government is expected to give some tax sops in the Budget, say industry trackers. REITs provide investors an investment avenue that is less risky than investing in under-construction properties and also a regular income.
It also provides the sponsor avenues of exit, thus providing liquidity and enabling them to invest in other projects. Although last year’s Budget introduced provisions providing for tax deferral to owners at the time of a cashless transfer of assets to REITs in exchange of its units, such transactions could attract MAT, tax experts said. “There could be a potential MAT liability on such transfer, and the industry has asked for an exemption from the potential MAT liability as well on such cashless transfers, since there is no change in the ultimate economic owner of the asset,” said Gautam Mehra, partner, PricewaterhouseCoopers.
Some leading real estate developers and private equity investors are eager to tap this new route. Generally, for commercial reasons, REITs may prefer to hold real estate assets through a corporate SPV(special purpose vehicle) and not directly. Since REITs are required to mandatorily distribute almost the entire annual income as dividends to unit holders, the underlying SPV would necessarily have to suffer the DDT (dividend distribution tax) liability when it distributes income to the REIT. “This results in a multiple layer of tax, since the SPV would suffer this DDT levy in addition to corporate income tax on its taxable income. Accordingly, the post-tax returns to investors are likely to get significantly reduced since the aggregate tax liability would be in excess of 40%,” Mehra said.
Rajesh H Gandhi, partner – tax, Deloitte Haskins & Sells said while from a corporate tax perspective, direct ownership of the real estate asset by the REIT is preferable, the higher stamp duty on direct transfer of the asset to the REIT would make this less favorable. Rules also mandate listing of units for all REITs after raising funds through an initial offer.
“Exit through a REIT listing entails the levy of capital gains tax (20% in case of long-term gains) to the asset owner at the time when the owner sells the units of the REIT, typically in an IPO. However, there is no tax liability if an owner has a similar exit through the IPO of a company that lists on the stock exchange. Hence, tax parity should be provided for exit through a REIT IPO as well, such that the REIT exit is at par with an IPO exit,” Mehra said.
The regulator feels easier taxation rules could provide a fillip to the product as a lot of global capital is looking at new investment opportunities. Besides, players would also not explore offshore listing for raising capital.
In the last couple years, rental income from Indian commercial and retail properties has not been more than 5% to 6%, which is less than the rate a retail investor could fetch from a fixed deposit scheme or government securities. “So why should an investor take the risk of investing in a REIT if the returns are taxed?” asks Gandhi of Deloitte Haskins & Sells. He said while REITs will also get the benefit of capital appreciation on the properties they own, it may be difficult to quickly monetize such benefits.
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