The Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InvIT) have seen healthy retail traction of late. Individual retail investors hold 11-16 per cent of the units in each of the three listed trusts. The Securities and Exchange Board of India’s (SEBI) mandate to offer regular payouts to unit-holders of these trusts could be among the reasons for its sizeable retail investor base.
Regulations require that the trusts invest at least 80 per cent in income-generating assets and further mandate distribution of 90 per cent of their net distributable cash flows to unit-holders, at least once in every six months.
Also, a recent tweak in the minimum trading lots has encouraged further retail participation.
The regulator had in April 2019 lowered the minimum trading lot for InvITs and REITs to ₹1 lakh and ₹50,000, respectively, from ₹5 lakh and ₹1 lakh earlier.
If you have invested in the listed REIT and InvITs (trusts), things can get intricate when it comes to taxation.
This is because, the income earned by trusts on their underlying investments (properties, securities, etc) must be distributed to the unit-holders in the same form as earned (capital gains on sale of underlying assets, rent, interest and dividend, etc) and hence, are taxed accordingly.
Add to this, with the 2020 abolishing the Dividend Distribution Tax (DDT) for corporate firms, the confusion only got worse for unit-holders.
Earlier, unit-holders were exempt from paying taxes on dividends (on which DDT has been paid).
With the Finance Bill abolishing DDT, investors of existing listed trusts feared a dent in returns. However, clarity has now emerged in the Finance Act, 2020 on this aspect.
Interest and Dividends
For unit-holders, both the interest and dividends earned from the SPVs (Special Purpose Vehicles) shall be taxable under the head ‘Income from Other Sources’ (IOS).
However, the dividend income is taxable for a unit-holder only if the (dividend-paying) SPV has opted for a lower rate of corporate tax (ie,25.17 per cent under Section 115BAA). Otherwise, the dividend income shall be exempt for a unit-holder.
Let us take an example where a listed trust has two SPVs, A and B, and only SPV A has opted for the lower corporate tax rate of 25.17 per cent (including surcharge and cess).
If a unit-holder of the trust receives ₹10 (₹8 from SPV A and ₹2 from SPV B), the unit-holder shall be required to pay only tax on ₹8 (under the head IOS).
Rules for taxation of rental income or capital gains remain the same.
Rental Income
A unit-holder is required to pay taxes on rental income (under the head ‘Income from House Property’) if the REIT owns the properties directly.
However, all the listed trusts have predominantly invested in the underlying properties (or infrastructure assets, etc) through SPVs.
For instance, Embassy Office Parks REIT (Embassy) owns 11 commercial properties, through 10 wholly owned (directly and indirectly) SPVs and one joint venture SPV (50 per cent stake).
Hence, the income for Embassy (akin to other listed trusts) predominantly comes from interest and dividends being distributed by the SPVs.
Sale of units
Apart from the regular distributions, the appreciation in the price of the units (listed) also adds to the returns from the trusts.
Such gains on the sale of units (listed) shall be taxable for the unit-holder at 15 per cent, if the units of the trusts are held for 12 months or a shorter time.
Else, long-term capital gains beyond ₹1 lakh shall be taxable at a rate of 10 per cent.
For long-term gains on the sale of units, while the benefit of indexation does not apply, applicable cess and surcharge shall be payable.
Other income
Any other income being distributed by the trusts shall be exempt from taxes for the unit-holder.
However, on incomes other than interest or dividend or rent from REITS, the trusts are required to pay taxes, which may dent your returns, indirectly.
This is because the income tax rate applicable for trusts is the maximum marginal rate (currently at 42.74 per cent), except in the case of capital gains.