Budget 2014: REITs regime will facilitate investment in real estate
Associate Director - Tax & Regulatory Services, EY
A Real Estate Investment Trust (REIT) is a trust that offers units to the public. Generally speaking, REITs are vehicles which raise funds from investors, acquire rent yielding real estate and distribute the income to investors. REITs typically own & manage income producing properties and are required to distribute most (90%) of the profits earned as dividend to unit-holders.
The concept of REITs is prevalent in developed economies such as US, UK, Australia, Germany and Asian countries such as Japan, Singapore & Hong Kong. In India, REITs were first formally introduced by the Securities & Exchange Board (SEBI) in 2007 as draft REIT Regulations. However, due to inherent structural limitations in the draft regulations, the regulations were never finalized & announced. In September 2013, SEBI has released a revised set of draft REIT Regulations for public comments. These regulations are in sync with global regulations and should serve the intended purpose when announced. Relevant comments have been received by SEBI and REIT regulations are expected to be notified soon.
REITs have the ability to attract and effectively manage investments in the real estate sector. There is a case to incentivize investments in real estate through a REIT for the following reasons:
- REITs prevent creation of black money as all transactions would take place through normal banking channels
- Currently, there is lack of a fixed income instrument which also provides for inflation hedged returns or capital appreciation. As a result, savings are channelized into gold and housing which are unproductive savings. A publicly traded REIT will convert such un-productive savings into a productive asset class resulting in reduction of fiscal deficit.
- In order to ease pressure on Indian banking system and encourage channelizing of savings into real estate as an asset class, it is essential to make this investment attractive and viable. Therefore, where a tax pass through status is accorded to this format, there is no tax incentive to take leverage and consequent interest deduction. If a pass through status is not granted, there will be an incentive to take leverage for tax reasons.
To make REITs attractive for investors from various classes (i.e. corporate, individuals etc.), it is essential that REIT format is tax efficient. Therefore, relevant changes would be required in tax laws and foreign exchange laws to ensure that REITs practically take-off in the intended manner. We have outlined some of the key asks below:
Property owned by SPV - (i) no income tax & minimum alternate tax (MAT) on income received by the SPV from the property (ii) no withholding tax or distribution tax when SPV distributes income to the REIT (iii) no income tax & MAT on income received by REIT from its SPVs (iv) owing to fiscal pressures, one could consider levying a distribution tax @ 5% when the REIT distributes income to unit holders (v) no income tax & MAT on income received by unit holders from the REIT
Property owned by REIT - (i) no income tax & MAT on income received by REIT from the property (ii) if forced by economic pressures, one could consider levying a distribution tax @ 5% when the REIT distributes income to unit holders (iii) no income tax & MAT on income received by unit holders from the REIT
- A one-time capital gains exemption under section 47 of Income-tax Act, 1961 should be provided to a sponsor of REIT who transfers assets directly/ indirectly to REIT in exchange for units. Such capital gains exemption should be provided on an unconditional basis without any cap / lock-in on the holding period of REIT units or any other condition. In absence of such exemption, it becomes highly tax inefficient to move existing assets into a REIT structure.
- A one-time exemption from stamp duty levy should be provided in states laws on transfer of assets by sponsor to the REIT.
- Securities Transaction Tax (STT) and capital gains tax implications on sale of REIT units on the stock exchange should be made on par with listed equity shares. In other words, sale of REIT units on the stock exchange shall be subject to STT; long term capital gains on sale of REIT units shall be exempt from income tax and short term capital gains shall be subject to tax @ 15%.
- Participation by foreign investors in REITs should be allowed under the automatic route without any conditions both under FDI as well as FPI routes;
- Further, there should not be any service tax on rental income received by REIT/ SPV owned by a REIT.
The real estate sector contributes significantly to the GDP of the country, but continues to be largely unorganised. High transaction costs, high interest rates coupled with credit crunch are few of the main impediments to the growth of the sector. Despite being a natural hedge against inflation, real estate assets are kept out of the financial market and the common investor is denied the opportunity to share in the gains of this assets class. Introduction of a workable REIT regime will facilitate investment in productive assets and provide much needed funds to the cash trapped real estate sector. Therefore, there is a strong rationale to give an incentive for promoting such investments in real estate through REITs in the form of a beneficial tax regime.
(Views expressed are personal)