india reit budget takeaways

7/25/2019 India REIT Budget Takeaways

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JM Financial Institutional Securities Limited

I-REITS: Building blocks in place

Indian Government announced amendments in Finance Bill/Income Tax Act

to facilitate the introduction of Real Estate Investment Trusts. The issuesaround double taxation, capital gains on transfer of SPVs to REITs, and

treatment of REITs as security products have been addressed. I-REITs are

one step closer to reality now, though further clarity is required on foreign

investment in REITs and treatment of income at SPV level. As mentioned in

our report I-REITs- Potential to recycle assets worth 3% of GDPsuccess of

REITs will be subject to quality of asset injection in REITs and going in cap

rates of these assets.

Tax pass-through approved: REITs have been granted tax pass-through

status by the Finance Ministry which means REITs are not liable for any tax on

income distributed. The tax will be collected at unitholdersend. Without tax

transparency, income of REIT units would have been subjected to double

taxationfirst, at the corporate level, and then, at the dividend distributionlevel (17%). The returns on REITs will now be contingent on the unit-holder

tax structure. In addition tax deduction at source for dividends distributed by

REIT will be at 10% and 5% for Residents and Non-Residents respectively.

However clarity is required on treatment of income at Special Purpose Vehicle

(holding commercial asset) and its pass through status.

Capital gains on transfer of SPV to REITs exempted:A direct transfer of the

property to be securitized to the trust vehicle will attract capital gains tax on

revaluation of property in current tax regime. Provisions in Finance Bill

provide for exchange of REITs units for shares of SPVs (holding rent yielding

assets) capital gains tax exemption. Waiver of capital gains was essential for

making REITs attractive for asset owners as it reduces the entry cost for

developers tapping the REITs channel. However clarity on tax relating to the

acquisition and disposal of assets by REITs is awaited.

REITs to be treated at par with equity securities:Another key amendment

essential for success of REITs as a tradable unit was its tax treatment as

compared to equities when transacted on exchanges. Level playing field has

been provided for taxation of sellers and purchasers on trading of REIT units

as in case of listed securities thus making them at par with equities (benefits

from favourable long term gains in-line with equity shares).

Way forward - Strong building blocks for REITs in place: Based on our

analysis of global REITs in our Report I-REITs- Potential to recycle assets

worth 3% of GDPdated 3 July14, key triggers for REITs success has been

tax transparency, exemption from capital gains tax and treatment of units atpar with equities. With MoF taking steps to address these issues we believe

REITs are likely to become a reality in the coming months. While clarity on

foreign participation and treatment of SPV income is still required, success of

REITs will be contingent on the quality of assets injected in REITs platform

and going in cap rates for these assets. In addition investors need to monitor

the checks in place for related party transactions and aligning the interest of

Asset Manager with unitholders.

E1.Vicky JM Financial Research is also available

Bloomberg - JMFR , Thomson Publisher & Reute

Please see important disclosure at the end of the rep

Abhishek Anand, [email protected]

Tel: (91 22) 663030

India REITs

10 July 2014

India | Real Estate | Flash Update
http://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdfhttp://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdfhttp://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdfhttp://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdfhttp://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdfhttp://jmflresearch.com/JMCRM/analystreports/analyst%20documents/India_REIT_%20Potential_03_07_2014.pdf


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India REIT 10 July 20

JM Financial Institutional Securities Limited Page

REIT Structure

Exhibit 2. REIT structure

SPV holding income generating

asset

Other Income

Income From

SPV

Other Income

Unit Holders

Income received orreceivable by REIT

No tax to be paidby REIT

Maximum marginal Tax rateto be paid by REIT

Distribution

Maximum

Marginal Taxrate paid byunit holders

No Tax paid byunit holders

No capital gains ontransfer of share inexchange of REITs

units

Source: JM Financial

Key amendments introduced in Finance Bill

Finance Bill has included special clauses for introduction of business trusts

(REITs and Infrastructure Investment Trust) in order to enable the evolution of

these avenues. We have analysed the key changes/incorporations in Finance

Bill and Income Tax act introduced by the Government below.

Section 47: Transactions not regarded as transfer (capital gains

exemption)

SPV transfer of shares for units of REITs is exempt from capital gains tax.Excerpts from the Finance Bill:

Exhibit 3. Section 47 amendments- Capital gains exemption

* Section 47 (xvii)- any transfer of a capital asset, being share of a special purpose vehicle

to a business trust in exchange of units allotted by that trust to the transferor.

* in the case of a capital asset, being a unit of a business trust, allotted pursuant to transfer

of share or shares as referred to in clause (xvii) of section 47, there shall be included the

period for which the share or shares were held by the assessee;

Source: MoF, JM Financial

Section 10: Incomes not included in total income (tax-pass through status

to REITs)

REIT has been granted tax pass through status with tax at the unitholders endthus doing away with the policy of double taxation and benefitting holders withlower marginal tax rates. However any income arising out of transfer of units forshares of SPV will be taxed at marginal Excerpts from the Finance Bill:


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Exhibit 4. Section 10 Amendments: Tax pass through status to REITs

* After clause (23FB), the following clauses shall be inserted, namely:

(23FC) any income of a business trust by way of interest received or receivable from a

special purpose vehicle.

(23FD) any distributed income, referred to in section 115UA, received by a unit holder from

the business trust, not being that proportion of the income which is of the same nature as

the income referred to in clause (23FC);

In clause (38) Provided further that the provisions of this clause shall not apply in respect

of any income arising from transfer of units of a business trust which were acquired in

consideration of a transfer referred to in clause (xvii) of section 47


Section 111A Tax on short-term capital gains not applicable on transfer

of assets

It is proposed that the provisions of Short term capital gains shall not apply inrespect of any income arising from transfer of units of a business trust which

were acquired by the assessee in consideration of a transfer.

Exhibit 5. Section 111A Tax on short-term capital gains not applicable

Provided further that the provisions of this sub-section shall not apply in respect of any

income arising from transfer of units of a business trust which were acquired by the

assessee in consideration of a transfer as referred to in clause (xvii) of section 47.


Special Provisions- Introduced for business trusts

Special provisions are introduced clarifying the tax at unitholders end. In additionany income other than that earned by dividends from SPVs will be taxed atmarginal tax rate at REITs end. Such income, when distributed at unit holders end will be tax exempted.

Exhibit 6. Special enabling provisions

115UA. (1) Notwithstanding anything contained in any other provisions of this Act, any

income distributed by a business trust to its unit holders shall be deemed to be of the same

nature and in the same proportion in the hands of the unit holder as it had been received

by, or accrued to, the business trust.

(2) Subject to the provisions of section 111A and section 112, the total income of a business

trust shall be charged to tax at the maximum marginal rate.

(3) If in any previous year, the distributed income or any part thereof, received by a unit

holder from the business trust is of the nature as referred to in clause (23FC) of section 10,

then, such distributed income or part thereof shall be deemed to be income of such unit

holder and shall be charged to tax as income of the previous year



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Tax deducted At source

REIT will deduct 5% and 10% TDS for non-resident and residents before

disbursing dividend.

Exhibit 7. Tax deducted before dividend payout

Inserted section 194LBA

(1) Where any distributed income referred to in section 115UA, being of the nature referredto in clause (23FC) of section 10, is payable by a business trust to its unit holder being a

resident, the person responsible for making the payment shall at the time of credit of such

payment to the account of the payee or at the time of payment thereof in cash or by the

issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax

thereon at the rate of ten per cent.

(2) Where any distributed income referred to in section 115UA, being of the nature referred

to in clause (23FC) of section 10, is payable by a business trust to its unit holder, being a

nonresident, not being a company or a foreign company, the person responsible for making

the payment shall at the time of credit of such payment to the account of the payee or at

the time of payment thereof in cash or by the issue of a cheque or draft or by any other

mode, whichever is earlier, deduct income-tax thereon at the rate of five per cent..


Treatment at par with equities on transaction in exchanges

REITs will be treated at par with equity shares thus making the trading of REITs

units attractive especially for long term holders.

Exhibit 8. STT on transactions in units of REIT similar to equities

Clause 109 of the Bill seeks to amend Chapter VII of the Finance (No. 2) Act, 2004 which

deals with levy of securities transaction tax on transaction of equity shares of a company on

the stock exchange.

It is proposed to amend the said Chapter in order to provide levy of securities transaction

tax on transactions in units of a business trust on the same line as are applicable to

transactions in equity shares in a company.



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Key triggers for success of REITs

Success of REITs despite all the benefits is contingent on a) policy support, and b)addressal of I-REIT specific issues.

a) Policy Support-

1) Tax treatment of REITs

Based on our study of international REITs market, Governments policies on

tax have been the key reason for propelling the REITs market. Key taxreforms necessary for making REITs attractive for the investors are 1)

Exemption from capital gains tax on transfer of assets to REIT (re-valuation of

assets)- Issue has been addressed an exchange of shares in SPV and trust

units; 2)Exemption from Local duties on transfer of assets (Stamp duty etc.);

3) Tax pass through for dividends paid by REITs (currently double taxation

with corporate tax and DDT); 4) Level playing field should be provided for

taxation of sellers and purchasers on trading of REIT units as in case of listed

securities and mutual funds.

Exhibit 9. Tax treatment

REIT Non-Transparent

REIT TaxTransparent-

marginal tax

REIT taxtransparent-

DDT

Operating income 100 100 100

Corporate tax @ 33.9% 34 0 0

After tax income 66 100 100

DDT@17% 11 0 17

Tax at unitholders end (33.9%) 0 34 0

Cash to shareholders 55 66 83

Increase in cash on tax transparency 20% 51%



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2) Foreign investment in Indian REIT

FDI Policy to enable Foreign Portfolio Investment (FPI) and other investors to

participate in REITs and exempt REITs from conditions applicable to FDI in

Real Estate.

SEBI REIT Regulations allow for foreign participation provided that in

case of foreign investors, such investment shall be subject to guidelines as

may be specified by RBI and the government from time to time.

Currently, the FDI Policy does not envisage REIT structures.

FDI in Real Estate is allowed up to 100% under the automatic route already

allowed in Townships, Housing, Built-up Infrastructure and Construction-

Development Projects which includes Housing, Commercial Premises, Hotels,

Resorts, Hospitals, Educational Institutions, Recreational Facilities, City and

Regional Level Infrastructure.

Key Conditions for real estate:

Minimum area to be developed under each project of 10 hectares for

development of serviced housing plots and 50,000 square meters in case

of construction-development projects In case of a combination, any 1

condition would suffice.

Minimum capitalization of US$10mn for wholly owned subsidiaries and

US$5mn for JV with Indian partners.

Original investment cannot be repatriated before a period of three years.

100% FDI is allowed in Industrial parks (press note 3) provided the parks meet

certain conditions.

It should comprise minimum 10 units and no single unit should occupy

more than 50% area.

Minimum 66% of allocable area should be allocated to industrial activity.

FPI Regulations permit individual holding of Foreign Portfolio Investment (FPI)

must be below 10% of the total issued capital of the company.

FDI Policy is proposed to enable FPI and other investors to participate in REITs

and exempt REITs from conditions applicable to FDI in Real Estate.


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b) I-REIT specific issues

Bridging expectations gap: Bridging gap between investor returns

expectations (G Sec+100-300bps, Exhibit 15) and developer cost of funding

expectations (LRDs executed at 8-9% post tax). We believe a middle ground

can be reached in a REIT model as developers will have access to a larger

capital (covenants free) while investors have access to the assets with yield

and capital appreciation.

Exhibit 10. REITs spread over G-Sec rates in key geographies (bps)

145

180

233

278292

Australia U.S.A Japan Singapore Hong Kong

Source: Bloomberg, JM Financial

Checks in place for related party transactions: REIT managers are often

closely affiliated with REIT sponsors which can create a conflict of interest in

which the REIT manager may engage in acquisitions that serve more as an

attractive exit for the sponsors than an attractive investment case for unit

holders. Indian REIT draft regulation addresses this concern by making itmandatory to get unit holders approvals (related party voting not considered

during the voting process). In our view quality of assets injected by the REIT

trust will be critical for success of REITs.

Conflict of Interest - Aligning goals of REIT Manager and unit holders: In

addition there lies a conflict of interest between REIT managers and unit

holders as REIT manager compensation is generally linked to assets under

management. The issue can be addressed by better management fee

schedule, in our view, that more closely aligns the interest of REIT managers

and unit holders. Some of the ways of aligning interests of unit holders and

REIT managers are partial payment of manager fees in REIT units and linking

performance fees to growth in rentals.


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