Thursday, November 21, 2013

New REIT Regulations

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Recently, the Sec u r i t i e s and Exchange Board of India's Chairman, UK Sinha said that if Reits have to succeed, they will have to be taxefficient.

 

He further said he will ask tax- authorities to consider tax incentives for real estate investment trusts. Well talk to the  I- T department to make it happen.

 

The proposed introduction of the new guidelines for Real Estate Investment Trusts (REITs) has been considered as a move that will enable more investors to get an exposure to real estate as an asset class. But the expectations could be hampered by the fact that at the moment a key part of the entire guideline remains unclear. This is the taxation aspect of the whole Reit transaction because for a normal investor the final returns at the end of the day matter. Investors in Reit would like some favourable tax treatment so that this remains an attractive route for them to put money as compared to other options present in the market.

Indirect impact

 

There are two angles to the entire Reit taxation workings. The first is that the Reit structure has to be tax efficient otherwise it would not be profitable for the investor to actually put money into the instrument.

Even though this angle deals with taxation for the Reit and the income that it earns, it has an indirect impact for the investor because if the returns earned by the Reit get eaten away due to the higher taxes they would not reach them in a fully efficient manner.

 

The requirement is that the Reits should get a pass through status so that the tax impact is limited and hence this will be beneficial to the investor. Till this is clear it is likely that there will not be any launch of Reits in India. There are other angles related to the taxation of the individual that are also important and will be a factor in determining the interest of the investor in the entire issue.

 

Dividends

 

Dividends received by the investor from companies as well as mutual funds are tax free in their hands. Now Reits will enter the fray as a separate instrument so the question is whether the taxation of the dividend received from this instrument will be liable for the same treatment as witnessed for dividends. If this is not the case then the amount received would have to be taxed in the hands of the investor which would put a burden on them.

The burden for this can be higher due to the fact that if the amount is included in the income of the individual like any other figure then the taxation would be at the rate or slab under which the investor falls under. So you could find that there are investors who end up with a tax rate of 30 per cent plus and this could be a big disincentive. The nature of the proposed Reits is such that the initial investors are most likely to be high net worth investors who would naturally fall into the higher tax bracket.

 

Dividend distribution tax

 

There could be a dividend distribution tax that could be payable by the Reit on the declaration of dividends. Since 90 per cent of the income earned by the Reit has to be paid out it is important for the individual to ensure that the tax impact is negligible otherwise the net impact could turn out to be corrosive on the overall returns. The dividend distribution tax ultimately has to be paid by the individual in the fund so this would need to be considered in the overall calculation of the cost.

 

Capital gains benefit

 

There are favourable conditions related to the investments into equities and mutual funds when it comes to capital gains earned on these instruments.

 

For direct equities or equity oriented mutual funds the benefit is that if they are held for a period of more than 12 months then the long term capital gains tax that would have to be paid on this would be zero. In case of the Reit there is no clear guidelines on what would actually be considered as the nature of the that it will be listed will provide investors with an option to actually trade in them, if the security transaction tax has to be considered. This would be linked to the benefit of a lower capital gains tax otherwise there could be a position where the individual ends up being penalised for utilising one of the features of the instrument. Here there is a larger question involved which is that the Reit would also have to be classified as an approved security under the Securities Contract Regulation Act. Overall In the absence of clarity of tax matters on these issues, there is very little chance that an investor is going to be attracted towards a Reit in the form that has been proposed. The entire effort of earning returns in the investment could be negated by the tax position. This tax angle will be key before investors invest in them. Unless there is a beneficial way in which this is actually dealt with it could turn sentiment against Reits which could be difficult to correct at a later stage hence the important thing is to get the details right the first time around.

Happy Investing!!

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