REIT taxation clarity provided

Union Budget 2015 finally provided some clarity on the taxation of REITs. As a brief recap, going into the Budget, there were two primary demands from the industry regarding taxation: 1. Exempt transfer of assets from sponsor to REIT from capital gains as it’s similar to a company doing an IPO; and 2. Exempt the project SPV from Dividend Distribution Tax when paying dividends to REIT. These norms would have incentivized sponsors to put assets into the REIT without undergoing significant tax outgo and also be able to upstream higher dividends from assets to final investors.

On the first demand, partial relief given. Transfer of assets from the sponsor to the REIT is exempted from capital gains tax. There will be a levy of MAT at transfer but this can be offset on other residential business that the sponsor may have. On DDT exemption, no relief has been given as against industry demands. Thus REITs will now need to take out dividends as interest income from the SPV. This, however, attracts withholding tax which is lower for FIIs.

 REITs can take out dividend in the form of interest income from the SPV. Under the regulations laid out, domestic investors pay higher tax on the REIT dividend as opposed to foreign investors that pay a withholding tax of 5% (additional paid depending on their tax jurisdiction). For both domestic investors and FIIs, REIT income is a pass through and is taxed at their hands (less withholding tax paid by the REIT). Thus for FIIs this is a good outcome. For domestic sponsors, technically, this will mean that entire rental income is taxed. Again for sponsors with large residential business can offset this. However, it might not be really attractive for pure commercial developers. We do note that the regulation is no worse than the existing tax structure. See pictorial representation below.