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February 6, 2021

What are Real Estate Investment Trust (REIT) – FAQs and Taxation

by CA Shivam Jaiswal in Compliance Law

What are Real Estate Investment Trust (REIT) – FAQs and Taxation

Real estate and infrastructure are some of the important sectors that drive a country’s economic growth. The Real Estate Investment Trust (REIT) is an excellent alternative for attracting investments in the infrastructure and real estate sectors. These investment instruments relieve the public funding intuitions and also allows investors to earn a share of the income through asset ownership. REIT is basically a company which develops and own ‘income producing’ real estate properties. They are corporations that manage the portfolios of high-value real estate properties and mortgages. Let us learn more about REIT’s in India in this article.

What do you mean by a REIT?

  • REIT is a business trust (not a trust formed u/s 11 and 12 of the Income Tax Act) which owns and operates income generating real estate assets through direct or indirect holding in SPVs (Special Purpose Vehicles).
  • REITs own many types of commercial assets ranging from office spaces to hospitals, shopping centres, hotels and warehouses.
  • There are two main types of REITs – Equity REITs and Mortgage REITs.

What do you mean by a SPV?

  • SPV is an entity which is established for a single, well-defined specific and narrow purpose.
  • An SPV can only be formed for any lawful purpose and cannot be formed for any activities to be undertaken which are prejudicial or opposed to public policy.
  • It is primarily a business organization of persons or entities that are eligible to participate in the association.
  • SPV’s are mainly formed to raise funds by collateralizing future receivables.

Who can constitute a REIT in India?

REITs need to adhere to the below criteria for their qualification as per SEBI guidelines 2019:

  • The company must have an asset base of at least 500 crores.
  • For an Asset to qualify as SPV (Special Purpose Vehicle), REIT shall hold controlling interest and at least 50% of the total nominal value of equity in that SPV.
  • 90% of net distributable cash flow shall be distributed to unit holders in the form of interest/dividend.
  • 80% of the investment must be made in income generating assets and only 20% of the total investment can be made in under construction assets.

Who is responsible for the operation of a REIT?

REITs operate with a Sponsor, Investment Manager and Trustee.

  • Sponsor is responsible for setting up of an REIT and transferring or undertaking to transfer assets, interest and rights in the SPV to the REIT prior to allotment of units to the applicants.
  • Investment Manager is responsible for making the investment decisions with respect to the underlying assets of the REIT including any further investment or divestment of assets. It is responsible for management of REIT assets and ensuring that the assets have legally enforceable titles and material contracts are enforceable under the law.
  • Trustee ensures that the money is managed in the interest of unit-holders. It is responsible for overseeing manager’s activities or operations and reviewing related party transactions

How much can be the minimum and maximum investment in a REIT?

Minimum investment in a REIT is of Rs 50,000 with no cap on the maximum investment amount

Is there any lock-in proposed on the units held by Sponsor?

As per the REIT Regulations, a sponsor is required to lock-in 25% of the total units (in value terms) in the REIT for a period of 3 years from the date of listing of the REIT.

Where can REIT’s invest in?

  • REITs in India can invest either directly in properties or indirectly through SPVs, i.e., a company or LLP, holding real estate assets.
  • At least 80% of total value of properties must be comprised of completed and income generating properties.
  • REITs cannot make speculative investments in vacant land or agricultural land.

How are the units traded on the stock exchange?

  • REITs are typically listed on the stock exchanges through an Initial Public Offer (IPO).
  • The units will be traded on the Equity Cash segment on the stock exchanges just like any other equity instrument is traded.
  • Once listed, they serve as permanent capital vehicles to raise debt and equity in the capital markets to acquire new assets to grow.

How much of its funds is a REIT supposed to distribute?

As per the SEBI regulations, Trust is required mandatorily to distribute 90% of the net distributable cash flows.

What do the distributed funds comprise of?

Distributions comprise the following:

  • Interest received on debt advanced by the Trust is distributed to the unitholders as interest
  • Any PAT at the SPV level will be paid out as dividend to the Trust and in return distributed as dividend to the unit holders
  • Amortization in the SPVs is up-streamed through repayment of loans

Is the REIT required to pay any tax?

  • REITs have been given a pass-through status u/s 10(23FC) w.r.t interest received or receivable from an SPV or dividend referred to in section 115(O)(7) of the Act.
  • Any income of a business trust by way of renting or leasing of any real estate asset directly owned by the trust does not form part of total income u/s 10(23FCA).
  • Subject to the provisions of section 111A and 112, the total income of a business trust shall be charged to tax at maximum marginal rate (MMR= 30% + applicable surcharge and cess).
  • As per section 115(O)(7), no tax shall be chargeable on dividends declared by a specified domestic company to a business trust out of its current income on or after specified date.
  • No tax shall be chargeable if the dividend is declared, distributed or paid by the specified domestic company out of its accumulated profits and current profits up to the specified date.
  • In case of REIT, section 115(O)(7) has to be read with section 115BBDA to establish taxability of dividends received form SPVs.
  • SPV in which REIT holds entire nominal value of equity share capital and dividend is distributed by such SPV out of current profits after specified date; then no tax is chargeable under section 115BBDA.
  • In all other cases, section 115BBDA is applicable on dividends received exceeding 10 lakh rupees.

How much tax will investors have to pay on interest received from REIT’s?

Interest income shall be taxable in the hands of Unit Holders:

  • At applicable rates for resident unit holders, the withholding tax on interest income is 10%.
  • At 5% for non-resident / offshore investors; benefits under DTAA, if any, shall be available

How much tax will investors have to pay on dividend received from REIT’s?

Dividend Income distributed by the REIT is exempt in the hands of the unit holders if the REIT follows the old tax regime

What is the tax treatment of sale of listed units of REIT?

Sale of listed units of REIT on the exchange to attract levy of STT at par with that of listed equity shares. Long term Capital Gains (LTCG) where units are held for over 36 months would be taxed at 10% and Short-term Capital Gains (STCG) would be taxable at 15%

Is there any assurance of returns from a REIT?

  • No, SEBI Regulations do not permit any assurance of fixed return in an REIT structure.
  • However, the REIT regulations require a distribution equivalent to 90% or more of the Net Distributable Cash Flows (NDCF) of the REIT.
  • The NDCF are to be calculated as per the definition in the Offer Document.
  • In summary, they include cash flows received by the REIT from the SPVs in the form of interest, dividends and repayment of term loans.

Do the unit holders of a REIT have any rights?

Broad rights of the unit holders are:

  • Right to receive returns through cash distributions made by the REIT
  • Rights to vote on matters pertaining to acquisition of new assets
  • Right to vote on matters such as appointment or change of Investment Manager

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