Budget 2019 | Reviving real estate market: Here’s how Modi govt can make REITs attractive

union budget 2019

Union Budget 2019: It is that time of the year when every man on the street has high hopes. There are high expectations on what the Government proposes to do with a powerful instrument it has launched to propel growth. The instrument also holds the potential to increase the spending power in the hands of the common man. At the same time, it can also introduce changes to ensure checks and balances in terms of paying the right taxes and contributing to the next generation’s development.

The first budget for Modi Government 2.0 will present its own set of challenges. Amongst various factors, the focus will need to be on boosting economic growth and attracting investments in sectors and assets to bolster employment generation in the economy.

Seen against this backdrop, the Real Estate market and its fluctuating nature in India has always seemed to be an attractive investment destination for savvy investors in India. The Real Estate sector has low correlation with other investment categories and makes for a good portfolio diversifier.

Therefore, the introduction of Real Estate Investment Trusts (‘REITs’) in 2014 by the Securities Exchange Board of India (‘SEBI’), was seen as a welcome move and brought in a lot of hopes, given the overwhelming market response generated by REITs in terms of competitive returns. Like every other new product/offering, the Indian REITs had a difficult time in beginning its journey. The first REIT in the country launched its Initial Public Offer only in March 2019; that too after several tax tweaks and amendments to SEBI’s original REIT Regulations.

Interestingly, the first recent REIT was oversubscribed by 2.6 times which indicates that REITs do have potential in India. Given the investor interest and the fact that the Indian market is still recovering from the NPA crisis, it becomes vital for the Government to generate investor confidence in REITs and infuse a fillip in the capital market.

The maturation of REITs as an attractive source of investment would be determined by the commercial factors in terms of land parcels and the asset size. Key tax considerations the government can mull on to boost REITs in the country could be:

a. Tax pass-through status to all SEBI approved structures:
• SEBI Regulations permit a two-tier structure i.e., REIT SPV Holding Co. SPV and require that REIT should hold at least 50% in the equity share capital in the of the SPV Holding Co/ SPV
• However, only those SPV Holding Co/ SPVs that are wholly and directly owned by REITs are granted exemption from Dividend Distribution Tax (‘DDT’) on the dividends paid to REITs
• There is a legitimate need to amend the existing tax provisions to levy a single-level tax on dividends distributed to REITs to avoid dilution of cash in form of DDT where SPV is under a two-tier structure or is not wholly owned.

b. Uniformity in the Period of Holding REIT units:
• Holding period for REIT units should be reduced from 36 months to either –

i. 12 months to bring parity with other listed securities or
ii. At least 24 months as applicable for immovable properties being land and building, as the underlying assets for REITs are these immovable properties

c. Swap of instruments or assets with REIT units:
• Currently, only swap of shares (held as capital asset) with the units of the REIT is regarded as a tax-exempt transaction
• This exemption should also be extended to other instruments (debentures etc.) and assets

d. Complex nature of taxation for REIT unitholders:
• Unlike mutual funds where the income transforms to whatever form the fund distributes it as income from REIT is taxed in the same nature as that received or accrued to the REITs
• To avoid the uncertainty and complexities for the unitholders, it is essential that all incomes distributed by REITs are taxed uniformly

Last but not least, there is a need to amend the definition of ‘Securities’ in Securities Contract Act, 1956 and align the tax treatment of income from REIT for Foreign Portfolio Investors (‘FPI’) with their existing specific tax regime and also extend the beneficial tax rate of 5% to interest portion of income from REITs.

While some of the above “considerations” may be driven largely and could be overshadowed by commercial factors, the Finance Minister could consider the implementation of the considerations to boost the potential of REITs as an instrument of growth and create an investment-friendly climate to attract much-needed overseas investments.