Of the many priorities, the infrastructure and real estate remain indispensable sectors to boost the overall development of the country; the government is aware of the factors impeding growth of these sectors, the major one being the funding.
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Finance Minister Nirmala Sitharaman is all set to present her maiden budget for 2019-20 on July 5 2019 amid huge expectations to propel growth, create employment opportunities and rationalise taxes while maintaining the fiscal prudence.
Of the many priorities, the infrastructure and real estate remain indispensable sectors to boost the overall development of the country. The government is aware of the factors impeding growth of these sectors, the major one being the funding. To provide a glimpse of this, the quantum of funding required for the infrastructure sector alone as per the Economic Survey of 2018 was estimated at $4.5 trillion by 2040. Alongside this, the government’s resolve to provide housing to all by 2022 necessitates augmentation of capital.
Keeping in mind the necessity of additional capital requirements of these sectors, the Securities Exchange Board of India (Sebi) brought in the novel concepts of infrastructure investment trusts (InvIT) and real estate investment trusts (REIT) in 2014. InvITs and REITs were intended to: (i) offer suitable platform for financing/refinancing infrastructure / real estate projects in India; (ii) broaden the investor base and allow the retail investors to take part in the growth story of India; (iii) reduce dependence on banks for funding; (iv) release of funds locked up in the existing infrastructural / real estate projects.
Thus far, data from the Sebi reveal that 11 funds have been registered as InvIT and two funds as REITS. The REIT made its debut in India just a couple of months back.
To attract investors, the government has already ensured that business trusts (i.e. InvITs / REITs) suffer only one level taxation i.e. fiscally transparent status has been granted to both InvITs and REITs. The government is making continuous and conscious attempts to make the sector more investor friendly both from regulatory and taxation perspective. Having said this, there are still certain tax issues which need to be addressed some of which are as under:
Under the current income-tax law when dividends are distributed by special purpose vehicles (SPV) to business trusts, no dividend distribution tax (DDT) is payable by such SPVs. However, where dividends are paid by SPVs to a holding company which in turn pays dividends to the business trust, SPVs are required to pay the DDT. Thus, merely having a holding company structure, DDT becomes payable by the SPV resulting in tax inefficiencies.
Currently, under the income-tax law, business trusts are defined as trusts registered under InvIT and REIT regulations whose units are required to be listed on a recognised stock exchange. All concessionary provisions under the income-tax law (viz. pass through status of business trusts or non-applicability of DDT) are linked to this definition of business trusts. As per Sebi’s recent amendment, unlisted InvITs have also are permitted. The said unlisted InvITs would not enjoy any income-tax concessions as units of such InvITs would not be listed. This would not enthuse the investors to invest in unlisted InvITs defeating the very objective of amendment of InvIT regulations.
Another issue with respect to business trusts is non-allowance of carry forward and set-off of losses when the shares of SPV are transferred to the business trust. As per section 79, where more than 51 percent shares of the closely held SPV are transferred to the business trust in exchange of units, the losses of the SPV become disentitled to be carried forward for set-off. The objective of section 79 was to discourage trading of tax losses of private companies. Since the transfer of assets to a business trust is based on the regulatory convenience provided by the government to mobilise savings and provide liquidity to infrastructure and real estate sector, the same is clearly outside the objective of section 79. However, with no exception provided under section 79 of the Act, the losses incurred by the SPV lapse on transfer of shares of SPV for units of business trust.
Transfer of shares of SPV to business trust in exchange of units of such business trust is not considered as taxable transfer. Correspondingly, when the units of the business trust are eventually sold, the cost of such units is the cost for which the shares of the SPV were acquired. Often, the erstwhile shareholders of the SPV are responsible for the past claims, whether receivable or payable, of the SPV. If eventually the SPV are the net beneficiaries in respect of such claims, the amounts received by the SPV need to be paid to the erstwhile shareholders. If it is decided to settle such amounts in cash, the same potentially takes away the benefit of transfer of shares of the SPV in exchange of units of the business trust not being a taxable transfer. On the other hand, if it is decided to settle such amounts by way allotment of additional units by the business trust to the erstwhile shareholders, the same have implications in terms of valuation of units at that time, dilution of stake of the other investors.
Any amendment addressing the aforesaid issues may perhaps make the growth and development of these sectors more robust and sustainable. With the stakeholders and investors joining hands with the government to take the India growth story ahead, it needs to be seen whether the finance minister pays heed to these taxation issues in budget 2019-20.
Sunil Badala is National Leader Financial Services. Tax at KPMG in India. Rinkesh Devnani is a chartered accountant.