Residual income from REITs and InvITs now covered under section 56 of Income-tax Act.
– Kaushal Shah, Executive | kaushal@vinodkothari.com
Background
Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are two of the most important investments in the real estate and infrastructure sectors. REITs provide investors with a way to invest in real estate without having to own physical assets, while InvITs allow investors to invest in infrastructure projects without taking on the risk associated with owning physical assets. Both REITs and InvITs offer investors an opportunity for diversification, income generation, and capital appreciation and also provide them with the option of liquidity. As per recent trends, they are becoming increasingly popular among both institutional and retail investors looking to diversify their portfolios.
One of the key aspects which make REITs & InvITs is the tax transparency they provide owing to their structure. The ‘pass-through’ status means that the income generated would be taxed in the hands of the unit holders, and that the business trust will not be liable to pay any tax on the same.
As per the extant provisions the taxation of REITs as a business trust shall be as per the following:
As can be seen from the above diagram, any other income distributed by the business trust to the unitholders is currently exempt in their hands. Thus, with the intent of increasing the tax base, the Budget 2023-24 has proposed amendments regarding the same.
Changes proposed
With Infrastructure and Investment being one of the seven priorities, it is important to also address the issues of REITs and InvITs. Various measures have been taken to encourage the development of REITs and InvITs in the Indian markets, such as reducing the trading lot and the minimum investment amount, etc
In accordance with current tax rules, income (aside from dividends, interest & rent which are already subject to taxation) received by unit holders is not taxable at their individual level, and capital gains are taxable at the fund level.
Plugging this gap, amendments to section 56 of the Income Tax Act, 1961 are notified wherein u/s 56 (2) a clause shall be inserted which provides that any sum received by the unit holder from a business trust which is not an income of the business trust as defined under section 10(23FC) or 10 (23FCA) and is not chargeable to tax under section 115UA (wherein it is provided that distributed income of the business trust shall be deemed to be the income of such unit holders) shall be charged as income from other sources in the hands of the unit holders.
Therefore, any income other than (a) dividends, (b) interest, (c) rent, (d) long-term and short-term capital gains, will be charged to tax under this section 56(2)(xii) at the time of distribution of such income, with effect from 1st April 2024.
In this regard, it may be worthwhile to note that leaving apart the four categories of incomes above, there will be hardly any source of income which can fall under this section. Nevertheless, this section will act as a charging section for any residual income.
Also, on the time of redemption, the amendment also provides that the sum so received shall be reduced by the cost of acquisition of such units to such extent that it does not exceed the sum received on such redemption
Developments since last year’s Budget
The Economic Survey[2] of 2022-23 also highlighted under Chapter 3 Fiscal Developments: Revenue Relish, the Department of Economic Affairs (DEA) has laid out the Measures undertaken to curb tax evasion & facilitate the widening of the tax base wherein the concept of bonus stripping was made applicable to the units of REITs, InvITs and AIFs[3].
Further, As stated in the JLL’s The Global Real Estate Transparency Index 2022[4], India’s Real Estate Market transparency is amongst the top 10 most improved markets globally and has an overall rank of 36, and falls under the category of ‘SEMI’ on transparency level.
The report while quoting India as one of the top global performers mentioned aspects like institutional investors and the growth in the number of REITs that have aided the increase in the market data and has lead to the professionalization of the sector to some extent. On the other hand, the regulatory initiatives like the Model Tenancy Act, and digitization of land registries, such as through the Dharani and MahaRERA platforms have contributed in placing India on a higher pedestal.
After all of this has been discussed, it is difficult to determine the impact of the Budget proposals and the reaction of the concerned market until these amendments are implemented in order to gauge their impact.
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[1]Guide to Structured Finance, Second Edition 2023 by Vinod Kothari
[2]https://www.indiabudget.gov.in/economicsurvey/
[3] Refer page number 71 of Chapter 3 Fiscal Developments: Revenue Relish of Economic Survey-2023-24 Measures undertaken to curb tax evasion & facilitate the widening of the tax bas
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