Published Editorial

Building trust in infrastructure funding vehicles

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The Hindu Business Line


Maadhav Poddar
Associate Director – Tax and Regulatory Practice, EY

The Securities Exchange Board of India (SEBI), through a consultation paper released on December 20, 2013, proposed to introduce a framework for Infrastructure Investment Trusts (InvITs) primarily to aid financing/ refinancing of infrastructure projects and enable developers to unlock capital.

The infrastructure space, specifically the public-private-partnership (PPP) sector comprising roads and highways, ports, power and transmission projects, has been facing severe liquidity crunch due to the limited funding options, high interest cost and subdued investor interest. To address these issues, SEBI proposed InvITs to act as funding vehicles.

The market regulator suggested that InvITs could be floated either as a mutual fund or as a trust under a separate structural framework. All InvITs should be registered as trusts in India and should distribute to investors at least 90 per cent of their net distributable income after tax.

Under the MF format, the InvIT shall be set up as a trust, which would acquire stake in the special purpose vehicle (SPV) holding the infra asset. MF InvITs can raise funds from both domestic and foreign investors, and should have a portfolio of pre-commercial operation date (COD) — at least 50 per cent developed, and post-COD cash generating projects. To begin with, MF InvITs should have projects of only one infra sub-sector (such as road sector).

Key norms proposed for mutual fund InvITs:

Listing optional

Investments by non-residents subject to three-year lock-in; however, NR to NR transfers would be permitted

At least 65 per cent of net assets should be invested in equity shares — in line with equity-oriented MFs

No debt gearing limits

InvITs under a separate structural framework should be registered as Category I or Category II.

Category I InvITs should raise funds only from institutional investors (domestic or foreign) by way of private placement and can invest in both completed and under-construction projects. They should invest in infra projects either directly or through SPVs — with at least 51 per cent holding at the SPV level.

Key norms proposed for Category I InvITs:

Listing optional

Minimum subscription size per investor: Rs. 5 crore

Sponsor (that is, infrastructure developers) should hold at least 24 per cent units — no direct equity holding in projects

No debt gearing limits

Where a Category I InvIT is listed, the total project size should be at least Rs. 1,000 crore.

Category II InvITs, on the other hand, should be mandatorily listed, have cumulative project size of Rs.1,000 crore and invest only in one-year post-COD revenue generating infra projects.

Key norms proposed for Category II InvITs:

Listing mandatory

Raise funds from investors through IPO route

Minimum issue size: Rs. 250 crore

Minimum public float: 25 per cent post-issue

Subscription size per investor: Rs. 10 lakh

Minimum trading lot: Rs. 5 lakh

Limit on debt gearing proposed: Ratio of borrowing and deferred payments to net asset value proposed to be capped at 50 per cent.

In the case of Category I and II InvITs, the consultation paper provides for management and control through a trustee, manager and project manager. Further, investors can remove the trustee, manager, principal valuer, auditor, and also request delisting. Related-party transactions should be at arm’s length, and those above certain thresholds require investor approval.

At first look, the MF InvITs seem more efficient as the tax incentives (a critical parameter for the success of new financial products) are already in place. In other words, all tax incentives currently available to an equity-oriented mutual fund scheme should also equally apply to InvITs in the MF format, as it would qualify as equity-oriented MF.

Where the standalone format is adopted, one will have to see whether the Finance Ministry provides any tax incentives for tax efficiency. The standalone regulation option will require a fair amount of amendments to the tax law and could possibly also require a larger timeframe for effective implementation. A key tax incentive needed to make InvITs a success is a one-time tax exemption on the transfer of shares of the SPVs/ infra assets to the InvIT. An upfront tax cost on transfer to the trust could be a deterrent.

Apart from changes in tax law, for InvITs to take off, changes may also be needed in the stamp duty regime, exchange control regulations and laws specific to the infra sector. To a large extent, the consultation paper is in line with global regulations on the business trusts format.

However, SEBI has only released a consultation paper and the detailed regulations are awaited. Readiness and support from the Government machinery (for instance, Finance Ministry support for tax incentives, readiness of agencies such as NHAI and so on) are critical to make InvITs a successful investment product.