Real estate trusts may remain stillborn

Real Estate Investment Trusts (REIT) and Infrastructure Investment Trusts (InvIT) — together referred to as Business Trusts (BT) — were recognised by the UPA government as critical tools to raise necessary resources for infrastructure and the real estate sectors.

They were supposed to help developers ease loan overhang and release necessary capital for new construction and infrastructure activity.

BTs would also ease non-performing assets (NPAs) of banks and provide an alternate investment product in the financial market. Investors can participate in a yield product while benefiting from appreciation in asset values through fractional ownership.

The NDA, , realising the benefits, gave it a thrust through amendments made in its maiden Budget in June 2014.

These amendments were not adequate and BTs were not considered doable. Even the Finance Minister acknowledged these shortcomings and devoted an entire para in Budget 2015 to BTs: “A step was taken in the last Budget to encourage REITs and InvITs by providing partial pass-through to them... I therefore propose to rationalise the capital gains regime for the sponsors exiting at the time of listing of the units of REITs and InvITs, subject to payment of Securities Transaction Tax (STT). The rental income of REITs from their own assets will have pass through facility.”

While market regulator SEBI provided a workable structure, the mindset of the tax department has, unfortunately, not changed enough to help this innovative product that has been a success in many other parts of the world.

The sponsors, bankers and investors had mooted a few key demands. These included not levying taxes (capital gains or MAT on accounting profit) on swapping of shares of asset holding special purpose vehicles with units of BTs. A clarification is awaited from SEBI on whether existing multi-tier structures should be accepted.

The two major issues of levy of minimum alternate tax (MAT) on accounting profits and DDT on distribution of surplus by a BT are the reasons why BTs in India would likely be a still-born this time as well.

If a company swaps its shares or assets with units of a BT, it will be required to value the units of the BT at fair market value (FMV) and recognise the difference in FMV and cost of the shares or assets as a profit. This will result in a MAT of over 20 per cent being levied on the entire unrealised accounting profit, giving rise to a serious cash outflow without any inflow.

The tax department must realise that this is not a tax on profits earned but an unrealised accounting profit on the swap, and, hence, must not attract MAT.

Further, the tax department argues that there should not be DDT exemption to SPVs under BT since DDT is not exempt for SEZ and infrastructure projects also. This argument is misplaced.

A BT is a product to permit regular yield to an investor and permit benefits of appreciation of large assets through fractional ownership. Consequently, BTs worldwide are designed as trusts, holding properties.

India has some peculiar issues on account of which it is impossible to directly transfer assets to a BT, which therefore have to be retained in SPVs.

Necessity of an SPV arises in the infra sector due to regulatory reasons such as NHAI stipulations for road concessions and various PPAs for power projects. On the real estate side, land leases and propitiatory rates of stamp duty make it impossible or unviable for direct transfer of the asset to a BT.

Hence, the tax department needs to treat such SPVs held by the BTs to be a pass-through. This is what is commonly known in the US as check-the-box entities.

While undoubtedly, interest extraction from SPV would provide a tax efficient pass-through, most projects would not have adequate debt in the SPV and the surplus would attract DDT, making the BT yield unviable.

BTs are mandated to distribute at least 90 per cent of surplus. In the case of BTs, being a yield product, SEBI regulations provide a mandatory distribution of at least 90 per cent of the surplus. Hence, it is imperative that the tax department treats the BTs on a different footing and not compare it with an SEZ or infrastructure project.

There is a crying need in India for freeing up money blocked in infrastructure and completed projects so that developers can start reinvesting in new infra/projects by transferring developed projects to a BT. The released capital and further investment in construction / infra activity will, in fact, increase tax revenues, while a still-born BT will not yield any dividend, and, therefore, any DDT at all.

The tax department must change its mental block and modify the Budget proposals to make BTs a success in India.

The writer is Partner, Pricewaterhouse Coopers. The views are personal

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