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Clarity on Tax Treatment Crucial to Get the Best Out of REITs written by Daksha Baxi & Abhay Sharma, published in The Economic Times. July 7, 2014

The announcement of the draft Real Estate Investment Trust (REIT) regime by Sebi last year was widely viewed as a step in the right direction, and a potential saviour for the beleaguered real estate industry. However, for a variety of reasons, principal among them being the lack of clarity on tax aspects, it remains unimplemented.

 

Here’s a highlight of the pain points from a tax perspective and suggestions on the steps that could be taken to provide clarity on tax aspects for REIT regulations to see the light of tax implications in a REIT structure that need to be examined from the perspective of the sponsor, the REIT itself and contributors (investors). The current provisions do not provide any clarity on the tax treatment for these parties. In turn, this could lead to unintended and potentially crippling tax consequences.

 

Take the case of a sponsor who contributes immovable property to the REIT in lieu of units of the REIT, in order to meet his commitment to REIT as is required by the regulations. The contribution would amount to transfer of an asset and trigger capital gains tax incidence for the sponsor. Levy of capital gains tax on the contributor based on specific provision of the I-T Act would result in the sponsor going out of pocket on account of taxes even though he receives no cash for contributing the asset. This contribution by the sponsor is akin to an owner of immovable asset converting it into stock in trade. The I-T Act already provides that in such cases, the conversion results in capital gains but the tax on such gains which are determined on the basis of the fair market value of the immovable property on the date of conversion, are payable upon the actual sale of the stock, i.e. when the taxpayer receives actual income. A provision along these lines for the sponsor would bring a great deal of relief. It should be highlighted here that the sponsor would face similar difficulties whether he actually contributed to the real estate, or the shares of a company which owns the real estate. In both cases, he would be taxed without the asset being monetised.

 

There are no specific provisions governing taxation of a trust formed as a REIT in the current tax laws. Thus, unless a specific tax regime for REITs is prescribed, taxation of REITs would be governed by the general provisions of taxation applicable to trusts. A REIT would likely be regarded as a business trust and its income would be taxed at the rate of 33.99%. Internationally, REITS are exempt from tax provided they distribute a certain percentage of income received from the assets. To the extent a REIT distributes income to the contributors they are taxed directly on the income received. The REIT regimes in the US, Australia, Singapore, South Korea and Malaysia are broadly based on the aforementioned pattern. Adopting a similar tax regime will help provide certainty to REITs.

 

Another stumbling block in getting REITs off the ground is the levy of stamp duty when real estate is contributed to a REIT. Technically, given that there is a transfer of real estate stamp duty is payable.

 

Again, this would be an outgo without the payer receiving cash. This acts as a disincentive to setting up REITs in India.

 

A deferral system of payment of stamp duty would address this concern.

 

Taxation of contributors upon transfer of REIT units also needs to be clear.

 

Currently, there is a favourable capital gains tax treatment for gains arising from sale of listed securities on the stock exchange, i.e., if securities are held for more than 12 months, gains are not taxed. Gains from securities held for 12 months or less are taxed at a concessional rate of 15%. Since REITs have to be mandatorily listed on the stock exchange, it is fair that the above-mentioned beneficial tax treatment be extended to the sale of REIT units.

 

While seeking clarity on REIT taxation may seem like putting the cart before the horse since the REIT regulations have not yet come into force, it is noteworthy that without such clarity REITs would be a non-starter. The tax provisions on REITs can be included in the I-T Act and they can be made effective from the date the REITs regulations are notified and implemented.

 

(Daksha Baxi is executive director and Abhay Sharma is a Principal Associate in the Tax practice at the law firm Khaitan & Co, Mumbai)