Going forward from last write-up on the Real Estate Investment Trusts (REITs)1, this article entails analysis on how the real estate sector has responded since notification of guidelines, investor expectations and road ahead for REITs in India.

It was vide notification No. LAD-NRO/GN/2014- 15/11/1576 dated September 26, 2014 and in exercise of the powers conferred by section 30 read with section 11 and 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), that the market regulator (SEBI) notified the SEBI (Real Estate Investment Trusts) Regulations, 2014 ("REIT Regulations")2, laying down a framework for REITs in India and registration and regulation thereof. Further, the taxation structure of REITs was incorporated in the Income Tax Act, 1961 ("ITA") by the Finance Act 2014.

In India (similar to other jurisdictions), REITs typically make investments in office complexes, information technology parks, large malls, hotels, resorts, hospitals and residential complexes that have apartments on rent or lease.

It is to be noted that REITs have demonstrate to be efficient and effective investment opportunities across the globe. One of the reasons could be due to their transparency and ease of closure. The success of REITs in any jurisdiction is subject legal regime including economic conditions, regulatory environment and the market acceptance as an attractive investment option by the investors, of such jurisdiction and its ability to supplement the laws / regulations in a manner that augment maximum benefits.

In a nutshell, REITs work on straight forward mechanism of pooling money from investors and invest them in revenue generating rental assets offering the investors a way to branch out their portfolio of investing in real estate. REITs aim to bring in cash liquidity into the real estate sector with support (funding) to the developers facing huge financial debts. Even though the regulations applicable to REITs in various jurisdictions vary to a great extent, albeit there are certain common features:

(i) REITs have to distribute a significant proportion of their taxable income to their investors3

(ii) A substantial portion of a REIT's assets to ought to include income-generating real estate assets, which in case of India has been notified as 80 percent;

(iii) A substantial portion of a REIT's annual income is to be derived from income related to real estate, such as rents from property;4

(iv) REIT ownership has to be diversified, i.e. units of REITs have to be freely transferable securities.

Once introduced, the first glaring aspect relating to REITs was noted as the lack of clarity on taxation and regulatory aspects, particularly in cases of foreign investments. Based on market studies and reports, one could note that in other countries (where REITS have passed the gestation period), REITs have been more successful in markets that have provided an enabling and conducive taxation framework. In this regard, a tax framework which covers income distributions being liable to tax to investors at applicable rates and exempts REITs from tax is considered to be ideal. However, in India Indian taxation framework is less than optimal in this regard.

Under section 115UA (the main section pertaining to "business trusts") of the ITA5, scheme for taxation of REITs and Infrastructure Investment Trust (InvITs) which are required to be listed on a recognized stock exchange is made in accordance with the regulations made under the SEBI Act, 1992. Section 10(23FC), IT Act exempts any income of a business trust by way of interest received or receivable from a Special Purpose Vehicle (SPV)6.

Any interest income received or receivable by the business trust from the special purpose vehicle is proposed to be exempted from the tax under Section 10(23FC). This income exempt in the hands of the business trust is taxable in the hands of the unit holders as per Section 115UA(3) of the newly inserted Chapter XII FA; and the same is reproduced as under:

(3) If in any previous year, the distributed income or any part thereof, received by a unit holder from the business trust is of the nature as referred to in clause (23FC) of section 10, then, such distributed income or part thereof shall be deemed to be income of such unit holder and shall be charged to tax as income of the previous year

As per section 10 (23FD) introduced by the Finance Bill, 2014 any other income received by the unit holder from the business trust is exempt in the hands of the unit holder.

Certain amendments in the ITA will take effect from 1st April, 2015 and will become applicable in relation to Assessment Years 2015-16 and subsequent years, namely:

(i) As per section 47(xvii) proposed to be inserted by the Finance Bill, 2014 there will be no capital gains applicable on the shares allotted by a special purpose vehicle to a business trust in exchange of units allotted by that trust to the transferor as provided in.

(ii) Further, in case the business trust sells the shares of the SPV, the income arising from the sale of shares will be subject to long term capital gains or short term capital gains under section 111A or 112 as proposed to be amended by the Finance Bill, 2014.

(iii) Any other income of the business trust subject to the provisions of section 111A and 112 shall be taxable on maximum marginal rate.

(iv) Income, which is exempt in the hands of the business trust under section 10(23FC), distributed by the business trust to its investors shall be taxable under section 115UA. Such income will be distributed by the business trust after deduction of income-tax at the rate of 10% in case of resident unit holder and at the rate of 5% in case of non-resident holder under newly inserted Section 194LBA (1) and (2) respectively.

Keeping the above in perspective, the income earned by the SPVs will be subject to corporate income tax; additionally, dividend distributions by the special purpose vehicle will be liable for a dividend distribution tax. Although the net income distributions will thereafter suffer no further tax at the level of the REIT or in the hands of investors, the overall tax incidence on income earned from the real estate assets results in a relatively unattractive yield for investors.

From an asset owner's perspective, the REIT Regulations forms basis on a transaction scenario under which the asset owner will contribute his assets (or shares of a special purpose vehicle which in turn holds the asset) in exchange for units of the REITs. Such an exchange will not trigger current tax. However, the taxation framework provides for a tax to be imposed on such units when they are sold by the asset owner at a future date. Significant asset owners contrast this tax outcome with that resulting from a listing of their asset holding company; if they were to pursue a listing, a transfer of their shareholding in the company following a listing would be exempt from tax. A transfer of the shares in a special purpose vehicle held by an asset owner to the REIT will result in a change in the shareholding of the SPV. If the SPV has accumulated tax losses (which may not be an unusual fact pattern where large assets have been developed within the SPV and have started generating rentals relatively recently), such losses are wiped out when the ownership transfer occurs.

It is seen that the sector / market has had great expectations from the 2015 Budget and the hope is that the ambiguities, will be addressed. A more pragmatic approach is required for including separate and/or unambiguous provisions regarding taxation of REITs so that a more comprehensive, coherent framework can be defined.

The real estate sector, in order to make certain that REITs are a successful venture in India, sought more tax incentives in the upcoming union budget on investments made into REITs vehicle. As reported, some of such incentives include:

(i)lower stamp duty on properties under REITs;

(ii) lesser tax levels for domestic investors (such as corporate income tax payable by the sponsor at the entry level followed by a possible tax leakage of 35-40 per cent on normal income, and a capital gains tax on the sale of REIT units by the sponsor at the exit level);

(iii) resolution of issues namely analyst coverage for this instrument in India, initial property valuations, and approvals of large bank loans for the holding trusts etc.;

In order to draw out a reference, recently, Confederation of Indian Industries (CII) sought capital gains tax exemption for REITs and InvITs [being investment products that can be listed on stock exchanges like shares of any company and allow retail and institutional investors to buy or sell those securities] on transfer of shares by the sponsor. Arguably, the Budget 2014-15 notified the norms where REITs / InvITs were provided the 'pass through' status for the purpose of taxation to attract long-term foreign and domestic investors. Later, market regulator SEBI had notified norms for listing of new business trust structure REITs that would help attract more funds in a transparent manner into the realty sector. CII also suggested that sponsors of REITs and InvITs be exempt from levy of Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT) at the special purpose vehicle level; since exchange of shares is being done only to initialize REITs/InvITs with assets, therefore such gains should be exempt from MAT as well as this act of exchange is not a transaction and therefore should not be treated as such. 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 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. Outflow of Corporate Tax and DDT will bring down the earnings for distribution. Hence, SPV should be exempt from DDT on dividend distributed to REITs/InvITs.

The Indian government, based on sector response, had expressed its plans to amend tax provisions as applicable to REITs so as to make this option more financially viable and conducive for investors to take exposure in real estate projects and to make REITs the engines of growth for the fast-expanding commercial real estate sector.


It is noted that no major announcement was made for the sector which has been reeling under massive pressure hit by a demand slowdown in the past few years. As discussed herein above, the industry's expectation list expected grant of an infrastructure status for the sector apart from giving tax clarity on REITs, clarity on DDT, an exemption from capital gains tax, an increase in the threshold for income tax exemption towards interest payment on home loans, the MAT rate for special economic zones (SEZs) to be reduced and a complete exemption from DDT.

In the Union Budget 2015-16, the Finance Minister proposed to rationalise capital gains regime for REITs and InvITs. Further, the Finance Minister proposed to allow tax pass-through for alternate investment funds. Meaning thereby, the rental income from such assets will not have any tax liability when returned to the investors or unit holders. Usually, countries do not do tax payouts by REITs as long as 90 percent of the profits are returned. It was proposed that the capital gains regime for the sponsors exiting at the time of listing of the units of REITs and InvITs, shall be subject to payment of Securities Transaction Tax (STT). The rental income of REITs from their own assets will have pass through facility. Developers own office properties within their main company. The impact of this is seen as in case the developers own office properties within their main company and if they launch REITs, these properties will have to be transferred to a SPV.

In India, real estate holds great importance at the micro and macro levels. It is hoped that REITs shall provide the retail investors with an opportunity of investing in real estate. As it seems, there shall be some more time required for this avenue to pass the test of time, law and expectations.


1. Refer to "Framework of REITs in India" published in Vol VII Issue IX (September' 14) of Indian Legal Impetus

2. h t t p : / /w w w. s e b i . g o v . i n /c m s / s e b i _ d a t a / attachdocs/1411722678653.pdf

3. In India, distribution requirement is 90%

4. 75 percent in India

5. http://www.incometaxindia.gov.in/_layouts/15/dit/pages/viewer.aspx?grp=act&cname=cmsid&cval=121200000000 37843&opt=&isdlg=1

6. SPV means an Indian company in which the business trust holds controlling interest and any specified percentage of shareholding or interest, as may be required by the regulations under which such trust is granted registration (not less than 50% as per the current REIT regulations).

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.