Taxing The Trust: What India’s REIT And InvIT Tax Reforms Mean For Investors

Taxing the Trust:
What India’s REIT and InvIT Tax Reforms Mean for Investors

India’s Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) were designed as tax-efficient ways to invest in income-producing assets through a regulated, transparent structure. That promise remains, but three successive legislative reforms between 2023 and 2026 have changed the tax structure for these business trusts and their investors. The pass-through structure remains, but investors now face higher holding and exit costs, more detailed tax treatment for distributions, and a binding cash-distribution framework imposed by the securities regulator. This article discusses the reforms, their combined effects on investors, sponsors, and managers, and certain outstanding issues.

The Pass-Through Structure: A Quick Primer

A business trust¹ pools capital from unit holders, acquires controlling interests in Special Purpose Vehicles (SPVs), and distributes the income those SPVs generate. The statutory framework treats the trust as a conduit: income flows from the underlying asset to the SPV, from the SPV to the trust, and from the trust to the unit holder, keeping the same tax character at each step.² This principle that income keeps its original character as it passes through is the foundation of the entire system.

Distributed income falls into five categories, each with distinct tax treatment:

Interest: paid by a SPV to the trust passes through and is taxable to the unit holder at applicable rates.³

Dividend: income from the SPV also passes through but may be exempt in the unit holder’s hands depending on the SPV’s corporate tax election.⁴

Rental income: earned by a REIT from directly held properties passes through to unit holders in the same manner.⁵

Other exempt distributions: certain distributed income is exempt at the unit holder level when it does not carry the character of interest, dividend (where conditions are not met), or rental income.⁶

Residual distributions: distributions that do not fit the preceding four categories now follow a separate tax formula, the most significant departure from the original design.

The trust must withhold tax at source on the interest component at 10% for residents and 5% for non-residents.⁷⁸ This ensures tax is collected upfront, even if the unit holder’s final liability differs.

Higher Costs on Holding and Exit

The 2023 amendment introduced a formula to tax distributions that do not fall into any of the income categories above⁹ Earlier, residual distributions often structured as debt repayments by the SPV to the trust were not subject to current tax at the time of distribution. They functioned as a return of capital and only reduced the unit holder’s cost base. The revised framework uses three variables: it reduces the aggregate amount of these distributions by the original issue price of the units and by amounts already taxed under this provision. Any positive balance becomes a “specified sum,” taxed as the unit holder’s income from other sources.

Until the cumulative distributions exceed that threshold, the untaxed portion reduces the unit holder’s cost of acquisition.^[10] When the cost base reaches zero, each later residual distribution creates an immediate tax liability. Effectively, the legislation now treats capital distributions as currently taxable events rather than deferred obligations. Distributions that merely return the trust’s own capital can no longer avoid tax indefinitely.

The higher holding cost compounds further at exit.

The 2024 capital gains reform raised the long-term rate on listed business trust units from 10% to 12.5% and eliminated ¹¹indexation, i.e., the mechanism that previously adjusted cost base for inflation. Short-term capital gains escalated from 15% to 20%.¹² The same reform also reduced the holding period for listed business trust units from thirty-six months to twelve months. The compounding effect is significant: residual distributions reduce the unit holder’s cost base over time, so the eventual gain on sale is larger, taxed at a higher rate, and no longer adjusted for inflation.¹³

SEBI’s Mandatory Distribution Framework

In December 2023, the Securities and Exchange Board of India (SEBI) issued parallel circulars, effective April 2024, establishing a Net Distributable Cash Flow (NDCF) framework for REITs and InvITs. Each business trust must distribute at least 90% of its NDCF to unit holders each financial year. The prescribed formula starts with cash flows from operating activities, adds proceeds from asset disposals (net of reinvestment), and subtracts debt repayment obligations and capital expenditure commitments.

The framework prohibits distributions funded by fresh borrowings. That prevents a trust from using its balance sheet to maintain artificially high yields when operating performance is weak. It links distributions to genuine cash generation and gives investors a more reliable signal of underlying asset quality.

For investors, this means the distribution yield quoted by a trust now reflects genuine cash earnings, not borrowed money a significant improvement in transparency.

SEBI later consolidated and refined the framework in its Master Circulars for REITs and InvITs issued in July 2025. A circular in May 2026 addressed borrowing limits and conditions; another in August 2026 prescribed an updated NDCF methodology for InvITs. Together, these establish the principle, respond to market practice, and tighten the rules where ambiguity has arisen.

Dividend Exemption: Decoupled from the SPV’s Tax Choice

The Taxation and Other Laws (Amendment) Act, 2026, assented on 17 August 2026 and effective from 1 April 2026, changed the unit holder exemption framework.¹⁴ Earlier, dividend income distributed by the trust was exempt at the unit holder level only if the underlying SPV had not opted for the concessional corporate tax regime.¹⁵ This created a conflict: a SPV that chose the lower rate to save entity level tax could inadvertently increase the total tax borne across the SPV-trust-investor chain by disqualifying the dividend exemption.

The 2026 amendment removes that condition. Dividend income distributed by the trust is exempt in the unit holder’s hands whether or not the distributing SPV opted for the concessional regime. SPVs can now pick the lowest corporate tax rate without inadvertently disqualifying the unit holder’s dividend exemption.

The amendment also increases the surcharge for SPVs that opt for the concessional regime from 10% to 25%.¹⁶ This partly offsets the revenue loss from extending the exemption and prevents the concessional regime from becoming an unqualified subsidy when combined with the pass-through architecture. Overall, tax incidence shifts from unit holders to SPVs, approximately preserving revenue neutrality while simplifying the investor’s tax position.

Tax Impact Before and After

The table summarises the key changes affecting business trust distributions and unit holder taxation:

Illustrative Example: Before and After

Assume a hypothetical SPV earns Rs 100 of pre-tax income and, after corporate tax at approximately 25%, distributes Rs 75 to the business trust. The trust allocates Rs 50 to interest income (pass-through) and Rs 25 to debt repayment (residual distribution). The unit holder is a resident individual in the highest tax bracket (30% marginal rate).

Before the reforms: Rs 50 interest component is taxed at 30% or Rs. 15. Rs 25 debt repayment is not taxed and only reduces the cost base. Total tax across the SPV and unit holder chain is Rs. 40 (Rs 25 corporate tax plus Rs 15 on interest), netting the investor with Rs 60 of every Rs 100 earned.

After the reforms: Rs. 50 interest component remains taxable at 30 % (Rs. 15). Once the unit holder’s cumulative residual distributions exhaust the original issue price, Rs. 25 residual component is also taxed at 30 %, adding Rs 7.50. Total tax across the chain rises to Rs 47.50 (Rs. 25 corporate taxes, Rs. 15 on interest, and Rs. 7.50 on the residual component). The investor receives Rs 52.50 of every Rs 100.

Once the cost-base buffer is depleted, the reform adds approximately Rs. 7.50 of current tax per Rs 100 of SPV income. It trades a timing benefit for clearer, more predictable tax treatment.

Impact on Stakeholders

Investors

1. Bear a higher aggregate tax burden, especially after the residual-distribution threshold is exhausted and indexation relief lapses.
2. Gain greater comparability across trusts because standardised NDCF rules and clearer income characterisation make yield comparisons easier.

• Must track cumulative cost-base reductions to anticipate when residual distributions become subject to current tax.

Trusts and Managers

1. Use a clearer, regulator-prescribed method to compute and disclose distributable cash.
2. Lose flexibility to create headline yields through leveraged distributions or creative classification of cash flows.

• Face greater compliance obligations, including prescribed NDCF calculations and Form 64B issuance requirements.

Sponsors

1. Face a higher effective exit tax when disposing of units because rates are higher and indexation is unavailable.
2. Must model after-tax proceeds more precisely when evaluating partial or complete exits from sponsored trusts.

Government

1. Broadens the tax base by bringing residual distributions within the charging framework.
2. Creates a standardised, rules-based framework that reduces arbitrage opportunities and makes revenue more predictable.

• Balances revenue collection with the policy objective of attracting private capital to infrastructure and real estate.

Unresolved Issues

Complexity in classifying distributions: Five income categories — interest, dividend, rental, exempt, and residual require the trust to classify each rupee of every distribution. If a SPV generates blended income streams, the allocation method will determine which unit holders bear tax and at what rate. Disputes are likely, particularly where trusts hold diversified portfolios with overlapping income types.

Non-resident treaty interaction Non-resident unit holders rely on bilateral tax treaties to cap withholding rates on interest and dividend income. The Central Board of Direct Taxes may, in due course, issue comprehensive guidance on how domestic pass-through characterization interacts with treaty source rules. If a treaty limits source country taxation of interest to (for example) 10 % and domestic law imposes withholding at the same rate, the alignment is coincidental rather than structural; future rate changes could create mismatches.

Minimum Alternate Tax transition SPVs moving from the regular corporate tax regime to the concessional regime (or vice versa) face questions about using Minimum Alternate Tax credits and treating accumulated depreciation. Understanding the interplay between the regime change and the higher surcharge will enable trust managers to make more informed distribution decisions.

Form 64B accessibility The trust must issue Form 64B to each unit holder, stating the nature, proportion, and amount of distributed income. Retail investors are a growing part of the unit holder base and need timely, accessible disclosures to file accurate returns. It is unclear whether current systems meet that standard, particularly for investors holding units through multiple demat accounts or beneficial ownership chains.

Outlook

Tax clarity is a necessary foundation for a mature business trust market, but it is not sufficient on its own. Asset quality, governance standards, market liquidity, and the depth of investable assets will be equally decisive. The reforms give investors a more transparent and predictable framework  one that prioritises certainty over the tax-deferral advantages of the earlier regime. Whether the higher tax cost is accepted as a fair price for that certainty, or whether it tempers the flow of capital into REITs and InvITs, is a judgment the market will make in the years ahead.

Footnotes

^{1 Section 2(21) of the Income-tax Act, 2025.}

^{2 Section 223 of the Income-tax Act, 2025 (corresponding to section 115UA of the repealed Income-tax Act, 1961).}

^{3 Schedule V, Table: Sl. No. 3(a) of the Income-tax Act, 2025 (interest from SPV).}

^{4 Schedule V, Table: Sl. No. 3(b) of the Income-tax Act, 2025 (dividend from SPV).}

^{5 Schedule V, Table: Sl. No. 4 of the Income-tax Act, 2025 (rental income).}

^{6 Schedule V, Table: Sl. No. 5 of the Income-tax Act, 2025 (unit holder exemption for distributed income).}

^{7 Section 393(1), Table: Sl. No. 4(ii) of the Income-tax Act, 2025 (TDS at 10% on distributed income to resident unitholders).}

^{8 Section 393(2), Table: Sl. No. 6 of the Income-tax Act, 2025 (TDS at 5% on interest distributed to non-resident unitholders).}

^{9 Section 92(2)(k) of the Income-tax Act, 2025 (specified sum formula for residual distributions).}

^{10 Section 72(4) of the Income-tax Act, 2025 (cost of acquisition reduction).}

^{11 Section 198 of the Income-tax Act, 2025 (LTCG at 12.5% on listed business trust units).}

^{12 Section 196 of the Income-tax Act, 2025 (STCG at 20% on listed business trust units).}

^{13 Section 2(101)(b) of the Income-tax Act, 2025 (12-month holding period for listed units of a business trust to qualify as long-term capital asset).}

^{14 Taxation and Other Laws (Amendment) Act, 2026 (Act No. 21 of 2026), Section 5 (omission of clause (b) of Schedule V Sl. No. 5 conditions).}

^{15 Section 200 of the Income-tax Act, 2025 (concessional corporate tax regime).}

^{16 Taxation and Other Laws (Amendment) Act, 2026 (Act No. 21 of 2026), Section 6 (surcharge increase from 10% to 25% for SPVs under sections 200/201).}

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.