What the financial services sector can expect: REITs, InvITs and AIFs

For the financial services sector, the past few years have been characterised by the emerging popularity of Alternate investment fund (AIF), real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). These methods of investment have been gaining investor confidence and are becoming a popular vehicle of investment across the board.

A REIT pools investor funds into a trust, which then investments the accumulated amount in real estate opportunities. Investors see returns on their investment in the form of dividends. REITs are gaining momentum as they offer a chance to invest in the real estate market without onloading a significant amount of risk and typing up large portions of an investor’s capital. InvITs are similar to REITs in that they are also an accumulation of investor funds. However, instead of investing in real estate, InvITs are focused on infrastructure projects such as highways, roads and irrigation projects. AIFs are privately pooled funds that are collected and invested in a clearly defined investment policy. AIFs do not include funds covered by the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999.

This year’s Union Budget is expected to have several announcements related to these investment vehicles. We have consolidated several expectations from the government in this year’s Union Budget, and these are presented below.

Suggestion from REITs and InvITs perspective

1. Section 2(42A) of the Act-Holding period for units of REITs and InvITs: There is a requirement to hold units of REITs and InvITs for more than 36 months for it to qualify as ‘long-term capital asset’. This acts as a disincentive for investors, who compare this period of 36 months with the 12-month holding period requirement for listed equity shares. To make investment in these vehicles popular and boost investment in this sector, second to section 2(42A) of the Act should be amended to include units of REIT / InvITs within its scope.
2. Section 47(xvii) – transfer of shares of special purpose vehicle (SPV) to REIT: The extant provision prescribes tax exemption for capital gains arising in the hands of the Sponsor upon transfer of shares of SPV’s (formed as companies) to REIT in exchange of units in REIT. Current exemption prescribed under Section 47 of the Act for shares of SPV contributed by Sponsor to REIT should be extended to contribution of shares of Holding Company and also contribution by transfer of interest in Limited Liability Partnership (LLP) (if SPV set up as LLP) to provide an impetus to real estate sector and also motivate Sponsors to move to REIT structure.
3. Section 79 – lapse of brought forward losses on account of change in shareholding: Right now, the brought forward losses of SPV shall lapse on account of change in shareholding beyond prescribed threshold pursuant to transfer / contribution of shares of SPV by Sponsor to business trust. It is proposed to carve out in Section 79 of the Act to exclude change in shareholding of SPV pursuant to transfer of shares of SPV to business trust so that the brought forward losses shall remain intact, in an attempt to reduce tax leakage and make business trust structure more attractive from tax efficiency perspective. 

Suggestion from AIFs (Onshore and IFSC GIFT City) perspective

1. Concessional tax rate for investors in debt AIFs: It is suggested that a new provision be inserted in Section 115A of the Income-tax Act, 1961 which provides a concessional tax rate of 5% for the interest income earned by a non-resident investor in an AIF making debt investments. This amendment will help bring parity in the tax treatment of non-residents investing via the AIF route with that of investors investing through FPI and external commercial borrowing route.
2. Taxation of AIF: in specie distribution exemption: Generally, AIFs are wound up on expiry of the duration, as mentioned in the offer document, which range from 5 to 8 years. It is suggested that exemption be provided under section 47 of the Act for transfer of units of AIF for the shares or securities received from an AIF on winding up. This will reduce hardship for the taxpayers, where a notional gain may be taxed even when there is no cash inflow.
3. Complete pass-through for all incomes of Category-I AIF and Category-II AIF under section 10(23FBA) and 10(23FBB) read with section115UB of the Act: Currently, only limited pass-through is accorded to Category-I and II AIFs. It is suggested that the taxation regime for Category-I AIF and Category-II AIF should be made similar to the taxation regime of Securitisation Trusts. Accordingly, complete pass-through status be accorded to such AIFs.
4. Specific tax rates for the Sponsors of Cat III AIF: As per the provisions of the Act, any income attributable to a non-resident investor in a Category III AIF set-up in IFSC GIFT City from transfer of securities (other than shares of Indian company) is exempt from tax. In case a Category III AIF set-up in GIFT City makes investment in equity shares of Indian companies which are listed on recognised stock exchanges in India, then the said Fund is also required to obtain a FPI license. However, there is no specific provisions in the Act which provides the tax rates on income earned by the Sponsor of such an AIF if he is a resident of India (ie whether to be taxed as an FPI income or normal tax rates applicable to a resident.
5. Clarity on NRI investment limit in Cat III AIF: Cat III AIF as per the extant FPI Regulations, the contribution by a single NRI, OCI and resident Indian in FPI shall be below 25% of the corpus of the FPI and the aggregate contribution of all NRIs, OCIs and resident Indians shall be below 50% of the total contribution in the corpus of the FPI. However, there are no such restrictions on NRI’s, OCIs or resident Indians investments into an AIF, set-up under IFSCA AIF Regulations. Thus, clarity is needed whether the said restrictions applicable to NRI, OCI and resident investors under the FPI Regulations would continue to apply to an AIF set-up in IFSC GIFT City?

These suggestions have been made after careful and extensive analysis of government documents, industry standards and behaviour of taxation trends. The impact of these suggestions may be accurately predicted basis the announcement made during the Union Budget.

This article was originally published in Business Today.