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Govt Exempts Capital Gains on REIT Sponsors

Wednesday, March 11, 2015

The government exempted the capital-gains tax on sponsors (which was only deferred earlier) to as and when the sponsor decides to monetize its holdings in an REIT (all other conditions remaining the same and provided the sponsor pays STT). This puts a sponsor on a level-playing field with most promoters’ equity offerings. For any asset/SPV created before FY2014, the sponsors can monetize their shareholding after FY2016

The government clarified the direct holdings of an asset in an REIT. The income will be a pass-through for the REIT. For the resident investor, there will be withholding tax of 10% while for a non-resident investor it will be as per the tax laws of the respective country. On the face of it, this remains a lucrative structure for institutional investors with a minimum tax leakage (provided the REIT takes a stamp-duty hit in stage 1). But one still needs to understand the taxation for FIIs as this falls under income from house property

While the above measures are progressive steps, they still do not address the issues of (1) upfront MAT payments while transferring shares in the SPV to the REIT and (2) direct transfer of an asset to the REIT. In both cases there is upfront cash outflow for the sponsors, without necessarily getting cash. In (2), there is a large stamp-duty consideration, which is governed by local states rather than the cent

We believe direct holding of an asset in a REIT is the most efficient structure in the long term—as the income in the REIT is a pass-through and with little leakage on distribution, we believe this will augment yields

MAT remains the biggest issue

MAT is still applicable during the initial transfer of shares from the SPV to the REIT. In case of asset transfer, the sponsor will have to pay capital gains. However, since in most cases assets are in SPVs, setting off of MAT credit could be difficult.

Stamp duty is another issue in case of an asset transfer. Stamp duty varies 6-9% as per state regulations. In such a transfer, this will also have to be taken into consideration and will affect yields. As in Exhibit 1, considering all other variable are similar, SPV transfer is better.

Sponsors are also seeking dividend distribution tax (DDT) exemptions in case of SPV holding assets and REITs investing in form of equity of debt. We continue to believe this will be hard to change, as the government is not giving exemption to other sectors on this parameter. Further, direct holding and investment through debt bypass the DDT. All said, we believe that one cannot set up a perpetual vehicle (REIT) based on financial engineering.

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