Real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) are planning to make a representation to the government to reconsider a tax on distributions, in the form of repayment of capital, in the hands of unitholders.

The Budget last week brought in a proposal to tax a part of distributions by REITs and InvITs, classified as repayment of debt (or return of capital) in the hands of unitholders. REITs and InvITs feel that as an investment class they are still at a nascent stage and the tax proposal would impact them. REITs and InvITs have very little liquidity in the secondary market.

Also read: Budget 2023 - Returns on capital by REITs, InvITs taxable in the hands of unitholders

REITs and InvITs make distributions to their unitholders in the form of interest, dividend income, and rental income all of which have pass-through status and are taxed in the hands of unitholders. A fourth is through the return of capital and so far they were neither taxed in the hands of the trusts nor with unitholders.

The Budget has changed all that. In its explanatory memorandum, the Budget document said, “It may be noted that dual non-taxation of any distribution made by the business trust, which is exempt in the hands of the business trust as well as the unitholder, is not the intent of the special taxation regime applicable to business trusts.”

Listed entities

There are three listed REITs and of them Embassy Office Parks REIT and Brookfield India Real Estate Trust pay out as much as 40-50 per cent of their distributions in the form of repayment of capital. Making the distributions taxable in the hands of unitholders, at the marginal tax rate applicable, would have an impact of 60-150 basis points on the post-tax yield analysts said, making it unattractive for investors. Mindspace Business Parks REIT will not be affected by the proposal as it has large accumulated profits and makes most of its distributions in the form of dividends.

Among the listed InvITs, Powergrid InvIT pays out over 80 per cent in the form of interest and 10 per cent in the form of capital. IndiGrid also pays out 85 per cent in the form of interest income and the remaining as return of capital.

The Finance Ministry has categorised distributions in the form of return of capital as tax avoidance. The Budget memorandum said the special taxation regime was introduced for the trusts in order to address their challenges in financing and investment in infrastructure.    

Tax avoidance

Analysts said that in the hands of foreign portfolio investors, this will have an impact of 63 basis points on the post-tax yield for the unitholders of Embassy REIT and 74 bps for Brookfield REIT. For high net-worth individuals, the impact will be in the range of 127-148 bps, while there will be no impact for mutual funds. For Power Grid InvIT’s HNI unit holders, the impact is 40 bps and 20 bps for foreign portfolio investors. High net-worth unitholders of IndiGrid will get hit by 59 basis points and foreign portfolio investors by 30 bps.

AREITs and InvITs also want the government to understand the limitations that these curbs impose on paying out higher dividends.

REITs have to distribute cash profit and they are prevented by regulations from distributing a higher proportion of dividends due to depreciation. Therefore, project-specific special purpose vehicles repatriate funds in the form of interest on borrowed funds from the trust or as repayment of capital.