Real estate is one of the vital sectors of the Indian economy. REIT is an investment vehicle that enables individual investors to earn income via the underlying real estate property. They do this without directly owning the property. It is similar to the concept of a mutual fund. Where a fund pools small sums from individuals and institutions and invests in stocks. The investments take place through a trust directly or via Special Purpose Vehicles (SPV). In REIT, the trust puts money in property. REITs own many types of commercial assets ranging from office spaces to hospitals, shopping centers, hotels, and warehouses.
It is the most popular type of REIT. The majority of REITs are publicly traded equity REITs. Equity REITs own or operate income-producing commercial properties. The common source of income here is rents.
Commonly known as mREITs, it mostly involves itself with lending money to proprietors and extending mortgage facilities. REITs provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments. Mortgage REITs also generate income in the form of interest accrued on the money they lend to proprietors.
Investors can diversify their portfolio by parking their funds in both mortgage REITs and equity REITs. Hence, both rental income and interest income are the sources of income for this particular kind of REIT.
Public non-listed REITs (PNLRs)
Public non-listed REITs (PNLRs) are registered with the SEBI. However, they are not tradable on the National Stock Exchange. These options are less liquid. Also, they are more stable as they are not subject to any market fluctuations.
Private REITs are are exempt from SEC registration and whose shares do not trade on National Stock Exchanges. These trusts function as private placements, which caters to a selective list of investors.
REIT – Criteria’s to Comply With
REITs need to meet 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
Distribution of 90% of net distributable cash flow to unit-holders in the form of interest/dividend
80% of the investment should take place in income-generating assets. Furthermore, only 20% of the total investment can take place under-construction assets
In the case of REIT, section 115(O)(7) should be readable with section 115BBDA to establish the taxability of dividends received from SPVs
Taxability of REITs
REITs have a pass-through status u/s 10(23FC) w.r.t interest receivable from an SPV or dividend that refers 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)
The total income of a business trust consists of interest and dividend income from SPVs, rental income if it holds rent generating assets, investment income from funds/FDs where surplus money is available, capital gains under section 111A and 112
According to the sections 111A and 112 of the Income Tax Act, the total income of a business trust shall be chargeable to tax at a Maximum Marginal Rate
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 a specified date
If there is any declaration, distribution or any dividend payment by the specified domestic company out of its accumulated profits and current profits up to the specified date, in such cases no tax shall be chargeable
Income distributed by business trust to its unit holders shall be treated of the same nature. The treatment shall be in the same proportion as it is receivable by the trust
Unit-holders receiving any income distributed by trusts such as interest or dividend shall be treated as income of the unit-holder for that previous year subject to provisions of the Act
Whereas if trust repays principal to unit-holders, it shall be treated as capital receipts in the hands of unit-holders and not “income” since section 56(2)(x) read with section 115UA implies that the income received without consideration shall be taxable under section 56(2)(x) and section 115UA contains the words “income distributed by a business trust”
Since unit-holders are the beneficiaries of units held by them in the trust, the amount of principal received for units is not without consideration; henceforth section 56(2)(x) shall not apply
Transfer of units by unit-holders shall be chargeable to Capital Gains Tax at applicable rates
Any short-term capital gains arising on the transfer of units shall be chargeable to tax at 15 percent. Long-term capital gain is taxable at 10% if the amount exceeds INR 1 lakh
The dividend received was earlier tax-free in the hands of the investors. However, Finance Minister Nirmala Sitharaman in Budget 2020-21 scrapped the dividend distribution tax for companies and shifted the burden on investors. While nothing changes for SPVs and the trusts as they still won’t pay tax, unitholders of REITs are no longer exempt.
What is the impact of Covid on the REIT?
-Concern over the demand for office space as some companies are planning to continue with the work from home (WFH) model adopted to battle the covid-19 infection attributes to fall the value of REIT. – Also, the change in the income tax law, making dividend income taxable in the hands of some investors, will make REITs less attractive.