With a view to incentivizing the Indian real estate and infrastructure markets, a framework for Real Estate Investment Trusts and Infrastructure Investment Trusts (collectively referred to as ?Business Trusts? in this piece) was put in place by the SEBI through the SEBI (Real Estate Investment Trust) Regulations, 2014 and the SEBI (Infrastructure Investment Trust) Regulations, 2014. The Business Trust framework would allow for an asset backed investment mechanism where an Indian trust is set up for the holding of real estate or infrastructure assets as investments, either directly or through an Indian company set up as a Special Purpose Vehicle (SPV). Please click here for our article providing further details on the Business Trust taxation framework in light of last year?s budget.
Further, the Government sought to provide clarity on the tax treatment of Business Trusts through the introduction of a specialized regime in the Finance Act, 2014, enacted into the ITA following last year?s budget. However, these measures did not offer much encouragement either to the sponsor (the developer who sets up the Business Trust by transfer of property or shares of SPV) or the unit holders (investors in units of the Business Trust). The Bill proposes to make amendments to the ITA to rationalize the tax provisions governing Business Trusts as below:
1. Sponsor taxation:
Under the existing provisions of the ITA, capital gains tax exemption is provided to the sponsor on transfer of shares of an SPV to the Business Trust. However, the sponsor is liable to capital gains tax on the difference between the sale price of the Business Trust units and acquisition cost of the SPV shares at the time of divestment of the Business Trust Units. Further, even though the initial transfer of shares of the SPV is not subject to capital gains tax, there is a levy of MAT that applies on the total book profits in the year of transfer, in addition to deferred capital gains tax later at an appreciated value on sale of Business Trust units. The extant regime also provides for no exemption from capital gains tax or stamp duty for the sponsor transferring real property directly into the Business Trust.
The Bill proposes to modify the extant regime by making capital gains completely exempt in the hands of the sponsor in ordinary cases. For this purpose, the Bill has introduced an amendment allowing for the long term capital gain exemption and beneficial 15% rate on short term capital gains on the sale of Business Trust units by the sponsor as part of an offer for sale at the time of initial listing or by way of subsequent sale on the stock exchanges.
However, no exemption has been provided in respect of MAT liability on the sponsor entity. As per the Bill, the sponsor has been given capital gains exemptions both on transfer of SPV shares to the Business Trust and on later sale of Business Trust units, although both events would substantially increase the book profits of the sponsor. Therefore, MAT would most likely be applicable on the total book profits in both financial years despite the exemptions.
While tax implications on sale of Business Trust units by the sponsor is justified owing to realization of gains, imposing MAT at the point of transfer of SPV shares results in unjust tax burden for the sponsors since it is only a notional profit. Therefore, an exemption from / deferral of MAT liability at the point of transfer of SPV shares to the Business Trust would have been desirable and the lack of the same makes the Business Trust structure less desirable for a developer.
Further, a larger issue raised by the developer community was that the present regime does not provide a capital gains or stamp duty exemption for the sponsor where property is directly transferred into the Business Trust. The Bill has not made any revisions to this position and this position remains unchanged.
2. Taxation of Business Trust income
Under the existing regime, a pass-through has been provided only for income up-streamed by way of interest on debt infused into an SPV by the Business Trust. No pass-through was allowed for income up-streamed by way of dividends distributed by the SPV or for rental income of the Business Trust, from real property directly held by it, being up-streamed to the investors.
The Bill proposes to add to this by allowing a pass-through for rental income earned by the Business Trust from real property directly held by it as well. Further, tenants paying the rental income to the Business Trust are not required to withholding any tax on the rental payments, thereby increasing the cash available for payout by the Business Trust. To this extent, the Bill proposes that in case of distributions of rental income by the Business Trust to the domestic investors, there is no tax in the hands of the Business Trust and the domestic investors have to pay tax on such income. In respect of distribution of rental income by the Business Trust to non-resident investors, there is a withholding tax which will be applied on such income at the rates in force, which can go up to 40%. Such withholding tax paid in India under this provision should be creditable in the jurisdiction of residence of the investors. From a foreign investor point of view, a direct holding of assets by the Business Trust may not be tax efficient.
Most importantly, in the absence of capital gains and stamp duty exemptions being accorded to the sponsor for direct transfer of property, the pass-through that has been given for rental income would remain largely ineffectual since developers would be unwilling to transfer property into the Business Trust after incurring such significant costs. Further, since no pass-through in respect of dividend distribution by the SPV, the pass-through accorded to Business Trusts remains partial and not in line with investor expectations.
Although developers and investors alike have largely been expectant of a mass iron-out of the tax framework for Business Trusts, the proposals made in the Bill in respect of taxation of Business Trusts still leave un-addressed tax issues. All in all, the proposals fall short of expectations and further revisions would be required for the Indian Business Trust structure to become a success story.
About the author
This article is written by Nishith M. Desai