By Suraj Nangia, Partner and Chirag Nangia, Director, Nangia Advisors (Andersen Global)
Real estate is one of the vital sectors of the Indian economy. It’s the second largest employer in the country if you consider its four cornerstones – housing, retail, hospitality and commercial spaces.
The sector is expected to be a $650 billion sector, and its share in India’s gross domestic product (GDP) is projected to double from the current 7 per cent by 2040. Real estate investment trust (Reit), therefore, is an excellent opportunity for investors who want to get a slice of the growing realty pie.
Reits make high-end properties accessible
Reit is an investment vehicle which enables individual investors to earn income through the underlying commercial real estate, without directly owning it. The market experts speculate that Reit would act as a game changer since it can bring the much-required liquidity in the market with investment from retail and institutional investors.
It is difficult for a retail investor to get exposure to commercial real estate directly as the investment required is very high. For grade-A commercial property, it could be Rs 5 crore and above. Exiting such large investments can also be time-consuming. Many of these challenges of investing in commercial real estate get taken care of when an investor takes the Reit route. Investors can enter Reits with just Rs 2 lakh investment. Exiting these investments should also be less difficult as units of Reits are listed on the stock exchanges.
Structure of Reit
Reit is an investment vehicle which allows an investor to hold a share in the underlying real estate property. It is similar to the concept of a mutual fund, where a fund pools small sums from individuals and institution and invests in stocks. In Reit, the trust puts money in property. The investments can be made through a trust directly or via Special Purpose Vehicles (SPV). An SPV is a company or a limited liability partnership (LLP) in which a Reit holds or proposes to hold an equity stake or interest of at least 50 per cent. An SPV is not allowed to engage in any activity other than holding and developing a property and any incidental activity.
Taxation is complicated
Before considering investments in Reits, an investor needs to understand the taxability of returns. Under the Income-Tax Act, 1961, Reits are structured as a flow-through or hybrid pass-through entities. Such a structure exists to avoid the double taxation of income in the hands of investors.
The Securities and Exchange Board of India (Sebi) regulations provides that Reits should distribute 90 per cent or more of net distributable cash flows, which may consist of rental income, dividend, interest or capital gains, to its unitholders.
The income a Reit receives can be a dividend, rental and/or interest income. While rental income can be generated through properties in which a Reit invests, interest income may be through SPV, investment in the mortgage-based securities or money lent to the real estate owners. Dividend income is received if the investment in real estate is made through SPV.
When a Reit distributes its income to the unitholders; the treatment is the same as it is for the Reit. Dividend income for a Reit is also dividend income for investors and so is rental and interest income. But not all types of incomes received by the investors are chargeable to tax in their hands.
Interest income
Only the interest income that a Reit receives from the special purpose vehicle, and distributed to investors, will get taxed in the hands of the unitholder as interest income. But the interest income derived from any other source by a Reit shall not be taxed in the hands of unitholder. While making payment of interest income chargeable to tax to the unitholders, business trusts are under obligation to withhold tax at 10 per cent if the interest is paid to a resident or 5 per cent if interest is paid to non-resident.
Rental Income
The pass-through status has also been given to the rental income earned by REITs from the properties owned directly by it. Such rental income received by Reit shall be treated as rental income while computing the income of the unitholders and taxed in its hands as such. In the case of resident unitholder, the tax shall be deducted at 10 per cent.
Capital Gains
The units of REITs are subjected to securities transaction tax (STT) while trading on stock exchanges. Any short term capital gains arising on the transfer of units shall be chargeable to tax at 15 per cent, whereas long term capital gain shall be charged to tax at 10 per cent if the amount exceeds Rs 1 lakh.
To summarise, all the incomes of the investor received from Reits except the interest income received from special purpose vehicle by the Reit and rental income from the property owned directly by the Reit shall be exempt from taxation in the hands of the investors. A Reit mostly distributes most of its income in the form of a dividend, which is tax-free in the hand of the investor.
Reit platform will encourage all kinds of investors to invest in the Indian real estate market. It would create an opportunity worth $19.65 billion in the Indian market over the years. According to reports and estimates, Indian real estate is likely to provide investment opportunity worth up to $77 billion through REIT-eligible commercial office and retail, properties across the country’s top seven cities by 2020. REITs will also offer a safe and diversified portfolio at minimum risk and under professional management.
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