Arun Jaitley, India's finance minister, announced the budget for fiscal 2015/16 on February 28. The news from one of the world’s biggest emerging economies had been eagerly awaited. Weeks before, ECM bankers told GlobalCapital Asia that they were optimistic about a simplified tax regime that would make the setting up of Reits and InvITs less onerous.
Their gripes included lack of clarity on capital gains tax, the taxing of rental income, a dividend distribution tax and a minimum alternate tax (MAT). The budget has offered some relief.
Jaitley plans to rationalise the capital gains regime for sponsors making their exits at the time of the IPO of a Reit or InvIT. This means that long-term capital gains tax has now been scrapped, while a short-term tax of 15% still applies.
“One of the key differences from earlier is regarding the transfer of shares of the SPV into the Reit,” said Vishal Yaduvanshi, a partner at Indian law firm Luthra & Luthra. “Previously the transfer of shares was exempt from capital gains tax but the transfer of units of the Reit by the sponsor was not.
"Now the Reit units are exempt from long-term capital gains tax, which is a big positive as this was a major dampener for sponsors. They had to structure their Reits in a more complicated way to deal with the tax leakage.”
Single tax layer
India has also tackled the problem of double taxation — where rental income is taxed both at the Reit level and in the hands of the investors. To put the country’s regime more in line with international practices, the government has decided to give Reits true pass-through status.
This status means rental income tax is now only charged in the hands of the unitholder rather than at the Reit level — a move that makes a big difference to sponsors.
“The previous rule was an anomaly,” said a second India-based lawyer. “It was a big impediment for sponsors because they have to pay too much tax. Now it’s the investors that pay up, and while this may appear unfavourable to them, it is something globally accepted and puts India in line with other markets.”
Southeast Asia’s biggest Reit hub, Singapore, ensured in its own budget in February that Reits were exempt not just from rental income tax but also goods and services tax on transferring properties.
Inefficiency remains
The market has welcomed India’s measures, with many saying it will ease the way for companies to list Reits and InvITs. But while the government soothed some concerns, it failed to acknowledge other big impediments.
Jaitley did not mention either the dividend distribution tax (DDT) or withholding tax. At the moment, dividends distributed by an SPV to the Reit face a hefty 15% tax. Meanwhile, resident holders of Reit units face a 10% withholding tax, while non-resident unit holders incur 5%.
The fact that the finance minister failed to tackle these issues — despite having been in discussions with the market for the past few months — is being seen as a disappointment.
“We have a tremendous desire to give the budget two thumbs-up, but in the cold light of day it only deserves a one thumbs-up,” reckons Peter Verwer, chief executive of the Asia Pacific Real Estate Association (APREA).
One reason for this is the minimum alternate tax (MAT), which still poses a big challenge. When a promoter swaps shares for units of the Reit, he is not taxed. But the income he generates in the process is penalised with MAT, which is typically less than 20%.
Add to that the issues around DDT, and the tax regime still looks very inefficient.
“The DDT is a nightmare as it unfairly reduces the returns investors can make on their investment and this makes it difficult to kick-start any dynamic growth in the Indian Reit market,” said Verwer.
Moreover, the Securities Transaction Tax (STT), which is paid to brokerages when shares are sold or purchased on the exchange, still applies. Sponsors have to pay this when exiting from Reits, but lawyers reckon it is less cumbersome than having to pay capital gains tax on top of it.
Big winners
The biggest winners of the tax tweaks will be international investors. Domestic investors are likely to be less interested in investing huge amounts of money into Reits or InvITs, said bankers.
This is because of yield. India’s Reits are expected to pay 9%-10%, or even 11%, depending on the quality of the issuer’s assets. While this may be appealing, domestic investors can get similar returns, without having to pay taxes, simply by putting their money into a fixed deposit. This dims their appetite to invest in Reits.
International investors, on the other hand, will be hungry for yield and eager to pick up shares in Indian Reits. And it will be marquee names, particularly blue-chip companies, that will be the first ones out of the door.
“This absolutely will have a massive effect on the market, because historically many companies have tried to tap business trust markets of Singapore and Hong Kong because India had a lack of avenues to raise funds from,” said Luthra & Luthra’s Yaduvanshi. “Many have been sitting on piles of assets and haven’t been able to sell or get overseas funds, but now that can change.”
More clarity sought
But the ambiguity over DDT and withholding tax means any big change may still be some way off.
“Although sponsors and investors alike have been expecting clarity on a complete tax framework for business trusts, the proposals made in the bill in respect of taxation of business trusts still leave unaddressed tax issues such as lack of clarity on DDT or withholding tax,” said Yaduvanshi. “The lack of clarity on such points may act as a dampener for Reit sponsors until the complete picture is clarified.”
More information may be provided in the middle of 2015 when the finance bill is passed into an act.
Until then, APREA’s Verwer said those in the industry would be holding constant discussions with the government to provide feedback on rules that still pose challenges to the market’s development.
“APREA enjoys a very constructive dialogue with the government and we hope to persuade senior policymakers to remove the remaining barriers to a vibrant Reit market,” he said. “Above all, that means adopting a DDT exemption or look-through provisions for SPV structures in Reit funds.”