A Real Estate Investment Trust ("REIT") is a trust that uses pooled capital of investors to purchase and manage income property ("Equity REIT") and/or mortgage loans ("Mortgage REIT"). REITs offer several advantages to people who do not have sufficient money to invest in real estate but desire to own property. Other than Unit Holders/Investors, the other primary players in REITs constitute the Trustee, Sponsors, Managers and Principal Valuer.
The Securities and Exchange Board of India ("SEBI") has vide a notification dated September 26, 2014 notified the SEBI (Real Estate Investment Trusts) Regulations, 2014 ("SEBI REITs Regulations") towards regulating investments in REITS. The SEBI REITs Regulations, inter alia, set out the registration requirements, procedure of registration, and eligibility requirements of REITs as well as that the primary players. The key highlights of the SEBI REITs Regulations are set out below:
Eligibility Requirement for REIT: A REIT must be a trust set up under the Indian Trust Act, 1882 and registered under the SEBI REITs Regulations. The trust deed of a REIT has to be duly registered, is required to set out that its main objective is to undertake the activity of REITs and should also include the responsibilities of the Trustee. There should not be any disciplinary action taken by the SEBI or any other regulatory authority against the REIT or any related party. The parties to the REIT should be fit and proper persons as per in Schedule II of the SEBI (Intermediaries) Regulations, 2008. Further, multiple classes of units of REIT are not allowed.
Investments through a SPV: REITS may invest either directly or through a SPV. Where the investment is through a SPV, it is required to hold controlling interest and not less than 50% equity in such SPV. Also, the SPV is required to hold 80% equity in the REIT assets. Multilayer SPV structure may not be permitted and multiple schemes under REIT are not permitted.
Dividend Distribution: SEBI REITs Regulations prescribe mandatory distribution of at least 90% of the net distributable cash flows to investors on a half yearly basis and at least 90% of the sale proceeds from sale of assets to unit holders, unless reinvested in another property.
Foreign Investments in REITs: The RBI has vide a circular dated April 21, 20161 permitted foreign investments in REITs without any approval requirements. NRIs and FPIs have also been allowed to invest in REITs units.
The said circular also provides that downstream investment by REITs will be regarded as foreign investment if either the Sponsor or the Manager is not Indian 'owned and controlled' as defined in Regulation 14 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000. In case the sponsors or managers are organized in a form other than companies or LLPs, SEBI would have the power to determine whether the sponsor or manager or investment manager is foreign owned and controlled.
Open for high net worth entities: Till the market develops, REIT unit can be offered only to high net worth individuals/institutions with a proposed minimum subscription size of INR 2 Lakhs and unit size of INR 1 Lakh each. All unit holders are given equal voting rights. Also, voting by related parties for any unit holder's approval is not taken into consideration.
Valuation Requirements: SEBI REITs Regulations prescribe a mandatory requirement for full fledged valuation of all REIT assets on a yearly basis through a registered valuer. Semi-annual updation is also mandatory. Net Asset Value is required to be declared within 15 days from the date of valuation/ updation of valuation of assets. Any acquisition/ transfer of REIT Assets are required to meet the prescribed valuation guidelines.
Listing Requirements: After registration, REITs are required to raise funds through an initial public offer and subsequently through follow on offers, rights issues and qualified institutional placements, e. In this regard, SEBI Regulations prescribe the following:
- Detailed disclosures are required in case of a follow on offer, rights issue, qualified institutional placement, etc.
- REITs units have to be in dematerialized form and are mandatorily required to be listed on recognized stock exchanges in India and continue to be listed unless delisted as per the SEBI Regulations..
- The minimum IPO asset size of REITs is prescribed as being INR 500 Crore and the minimum offer size is prescribed as INR 250 Crore.
- A minimum of 200 subscribers are required to form a REIT (excluding related parties) and the minimum public share in an initial offer should not be less than 25% of the number of units of the REIT on post issue basis.
- The procedure for delisting of REITs has also been provided under the SEBI Regulations.
REIT Investments: At least 80% of the value of REITs Assets is required to be invested in completed and rent generating properties. Specific conditions are prescribed for investing the balance funds in other assets. Further, REITs are required to invest in at least two projects and investment in any one project should not exceed 60% of the value of assets owned by the REIT. REITs are permitted to invest only in the assets situated in India. Lastly, a specific list of inclusions (like TDRs, land and any permanently attached improvements to it (whether leasehold or freehold) etc) and exclusions (like Hospitals, Hotels and convention centers with specified conditions, agricultural land, mortgages, units other REITS, etc.) have been provided under the SEBI REITs Regulations.
- Dividend Distribution Tax (DDT): The Finance Budget of 2016 proposes that any distribution made out of income of SPV to REITs and infrastructure investment trusts having specified shareholding will not be subjected to any DDT. It is exempted for unit holders and REIT.
- Capital Gains Tax: (a) Capital Gains earned by REITs on the sale of shares of SPV are taxable for REITs as per the applicable capital gains tax rates; (b) Long Term Capital Gains earned by unit holders on the sale of units of REITs is exempt for the unit holders. Short Term Capital Gains is taxable at the rate of 15%; (c) Capital Gains earned by sponsors on the sale of units of REITs/ swap of SPV shares with REIT units is exempted.
- Interest from SPV: The Interest amount is exempt from tax for REITs and is taxable as income for unit holders.
- Other income: Any other income is taxed at maximum marginal rate for REITs and is exempt for the unit holders.
Way ahead and Recommendations:
Although a lot has been done liberalize investments in REITs, further taxation and regulatory incentives are required to make REITs a real success in India and attract the desired investors. Tax measures governing REITs do not offer much by way of encouragement, neither to the sponsor nor the unit holders. Towards addressing the above, the recent Union Budget proposes relief in the form of exemption from DDT. However it is critical that the government considers further amendments to the Income tax Act to provide a tax efficient and stable regime for REITs in India. Exemption is available only in case of the transfer of shares of the SPV by the sponsor in exchange of REIT units and not direct transfer of the property to the REIT. The lack of exemption to sponsors is likely to deter direct holding of properties by REITs.
Capital gains tax is second biggest hurdle after DDT. When a REIT sells shares of a SPV or assets, the capital gain is taxable at the hands of the REIT. A complete pass-through is what is desired by investors. In the previous Budget of 2015, the government announced capital gains tax exemption at the hands of the sponsor but still it remains an issue at the REIT level where it is still applicable. Suitable exemptions from capital gains incidence (long term as well as short term) should be provided. Also, Minimum Alternate Tax (MAT) applicable on the transfer of shares to REITS should ideally also be exempted.
Apart from the tax challenges set out above, there are several non-tax issues which may hinder the success of REITs in the Indian market, which include the below:
- The transfer of assets at the initial stage of setting-up a REIT could be regarded as a transfer, which may attract stamp duty thereon, which, ranges from approximately 5% to 10% depending upon the state in which the property is located. In this regard, the government ought to consider waiving or reducing the applicable stamp duty on REITs specifically in relation to specified period of years for which REIT holds the property or alternatively, state governments could consider a one-time waiver of stamp duty on transfer of assets to REITs or SPVs owned by REITs to encourage the creation of REITS in this nascent stage.
- Norms of investment by foreign portfolio investors and non-resident Indians should further liberalised. Towards this, there should be no cap or restriction on the units of REITs that can be acquired by these entities.
- The Insurance Regulatory and Development Authority's (IRDA) investment regulations should also be amended to allow insurance companies to invest in REITs e. Similarly, changes should be brought about in the provident fund regime, and REITs should be made as eligible investment in the prescribed pattern of investment.
- Units of REITs set-up as a trust should be included in the definition of 'security' as per the Securities Contract (Regulation) Act, 1956.
- The eligibility requirement of a sponsor having a real estate track record would restrict a lot of non real estate entities like banks and financial institutions from becoming the sponsors in the REITS. Ideally, the track record requirement should only be for the key employee(s) or partners of the sponsor entity and not on the sponsoring entity itself. Further, foreign sponsors should be allowed to acquire units of REITs under the automatic route. In such a case, swap of existing shares of a SPV held by a non-resident sponsor with the units of a REIT should be permitted under automatic rout
In light of the above, it is imperative for the Government to fast track taxation and other regulatory amendments and reforms to promote REITS in India in order for it to have the desired effect on the economy.
1 RBI/2015-16/377, A.P. (DIR Series) Circular No. 63
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