India – Implications Of The Finance Bill, 2020 On INVITs, REITs And Its Unitholders.

The Finance Minister, Nirmala Sitharaman, presented the Union Budget 2020-2021 on February 1, 2020 and consequently, introduced the Finance Bill, 2020 (“Bill”) in the Lok Sabha. The Bill comprises the financial proposals, including taxation related proposals, to amend the provisions of the Income-tax Act, 1961 (“Income-tax Act”) for the financial year 2021.

 

The Income-tax Act comprised provisions in relation to the taxability of, and exemptions available to, infrastructure investment trusts (“InvITs”) and real estate investment trusts (“REITs”, together with “InvITs”, referred to as “business trusts”) registered with the Securities and Exchange Board of India under the Securities Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”) or the Securities Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”), respectively.

 

The following are the proposed changes in the Bill, in relation to taxability and exemptions available to business trusts in India:

 

1. Change in the definition of ‘business trusts’:

 

 A `business trust’ is defined under Section 2(13A) of the Income-tax Act to mean a trust registered as an InvIT under the InvIT Regulations or a REIT under the REIT Regulations, units of which, are required to be listed on a recognised stock exchange in accordance with the InvIT Regulations or REIT Regulations, as the case may be.

 

The Bill proposes to amend the definition of `business trusts’ which earlier recognised only listed InvITs and REITs registered with SEBI to now include unlisted InvITs registered with SEBI as well. This amendment will take effect from April 1, 2020.

 

Capital gains realised on the transfer of units of unlisted private InvITs shall be taxable at the rate of 10% (plus applicable surcharge and cess) in hands of a non-resident unitholder and 20% (plus applicable surcharge and cess) for resident unit holder, provided the units have been held for more than 36 months. The short term capital gains (where units have been held for less than or equal to 36 months) will be taxed at the rate of 30% (plus applicable surcharge and cess) for residents and 40% (plus applicable surcharge and cess) for non-residents. Non-resident unitholders may claim the beneficial provision available under the applicable double tax avoidance agreement (“DTAA”), if any.  Long term capital gains arising from market sale of listed units, both in the hands of residents and non-residents, are taxed at the rate of 10% (plus applicable surcharge and cess) on gains exceeding ` 0.1 million. While short-term capital gains will be taxed at the rate of 15% (plus applicable surcharge and cess).

 

2. Dividend Distribution Tax replaced with Dividend Withholding Tax:

 

Under Section 115-O of the Income-tax Act, dividend distributed by a domestic company is subject to dividend distribution tax (“DDT”), in the hands of the company, at an effective rate of 20.56% (including surcharge and cess). Such dividends are generally exempt in the hands of the unitholders in India though they may be taxable in the home jurisdiction of a non-resident unitholder.

 

Further, as per Section 115-O of the Income-tax Act, dividend distributed by a special purpose vehicle (“SPV”) in which a business trust holds the entire share capital other than as required to be held by the Government or any regulatory authority, is exempt from DDT. The dividend received by business trusts from its SPVs is then distributed to the unitholders without any further tax levied on it.

 

The Bill proposes to abolish the DDT regime as applicable to companies and shift the incidence of taxation of dividend on the shareholder or unitholders. Accordingly, as per the proposed provisions of the Bill, (i) dividend income would be subject to tax in the hands of the shareholders, at the applicable rate; and (ii) the SPV would be required to withhold tax on the same. However, the business trust will be exempt from tax on dividend income from a SPV. Since the mechanism for an SPV not to withhold tax from dividend when distributing to business trust is not provided, the business trust may have to provide a nil withholding tax certificate to the SPV to ensure that no tax is withheld by the SPV while distributing dividend to the business trust.

 

The business trust would now be required to withhold tax on the distribution where the income being distributed is in the nature of dividend income received from the SPV as described below:

 

a. Taxation of dividends at the Business Trust Level: 

 

Section 10(23FC) of the Income-tax Act exempts certain income of business trust being,

 

(i) interest income received from a SPV, where the business trust holds controlling interest and such percentage holding prescribed under the InvIT Regulations or REIT Regulations; and

 

(ii) dividend income from a SPV in which the business trust holds the entire share capital other than as required to be held by the Government or any regulatory authority.

 

The Bill proposes no change in the taxation of interest income of a business trust. However, the Bill proposes to exempt the dividend income received by a business trust from a SPV, in which the business trust holds controlling interest or such percentage holding under the InvIT Regulations or REIT Regulations as may be prescribed. This amendment shall come into effect from April 1, 2020.

 

 

Subject to any capital gains tax that may be applicable, the total income of a business trust (other than interest and dividend) shall continue to be charged to tax at the maximum marginal rate of 42.7%.

 

b. Taxation of dividends at the Unitholder level: 

 

Section 10(23FD) of the Income-tax Act provided that any distributed income, received by a unitholder from the business trust, other than interest income or rental income (i.e. rental income earned directly by a REIT) is exempt from the total income of the unitholder. The Bill proposes that in addition to interest income and rental income, dividend income distributed by the business trust to the unitholders, shall also be subject to taxation in the hands of the unitholders with effect from April 1, 2020. Accordingly, interest and dividend income distributed to unitholders are proposed to be taxed at the tax rates applicable to each of the unitholders.

 

The Bill now proposes that dividend income received by residents and non-residents unitholder shall be subject to income tax deduction at the rate of 10%. However, in case of non-residents, any lower rate as may be provided in the DTAA between India and the country of residence of the non-resident unitholder, provided such non-resident is eligible for the benefits available in the DTAA provisions.

 

These amendments will take effect from April 1, 2020.

 

3. Taxation of interest and rental income on unit holders of a business trust:

 

In terms of Section 194(LBA)(1) of the Income-tax Act, any distributable income in the nature of interest income and rental income in the hands of a resident investor is subject to deduction of tax at the rate of 10%. Similarly in terms of Section 194(LBA)(2) of the Income-tax Act, any distributable income in the nature of interest income and rental income in the hands of a non-resident is subject to deduction of tax at the rate of 5%. No change is proposed in the Bill in respect of taxation of unitholders on interest and rental income received from the business trust.

 

4. Applicability of DDT in a multi-level business trust structure 

 

In terms of the InvIT Regulations and the REIT Regulations, an InvIT or a REIT is permitted to have a multi-level holding structure, being one where the business trust holds shares in the SPV through a holding company (“Multi-level Structure”). It would be relevant to note that Section 115-O of the Income-tax Act does not exempt a Multi-level structure from the applicability of DDT. Accordingly, dividend paid by an SPV to its holding company is subject to DDT at an effective rate of 20.56% (inclusive of surcharge and cess).

 

The Bill which abolishes Section 115-O of the Income-tax Act, proposes to reintroduce Section 80-M in the Income-tax Act. This section provides for a deduction for dividends received by one domestic company from another domestic company, limited to the amount of dividend received from the investee company if the shareholder company pays dividend before the specified due date. In light of the above, under the proposed provisions of the Bill, the holding company would be able to claim deduction for the dividends received from the SPV, resulting in reduction of its tax cost.

 

A comparison of taxation in the hands of an investor who invests in a business trust structure versus in the shares of a holding company structure, where in both cases the income stream comes from the underlying SPV, which would be helpful in deciphering the changed provisions: