In recent times InvITs and REITs have gained popularity among investors. They offer retail investors the opportunity to invest in alternate asset classes, the downside being the slightly higher minimum ticket sizes compared to equities.
However, the tax treatment of income from entities is not straightforward.
In this article, Sandeep Koonaparaju helps us understand how taxation of income from Business trusts work. Sandeep is a practising Chartered Accountant based out of Bangalore.
Questions with no easy answer
First, what is a Business Trust? Income tax Act defines business trusts as:
An Infrastructure Investment Trust (InvIT) or a Real Estate Investment Trust (REIT) is registered under SEBI regulations.
This post discusses the taxation of income distributed by a Business Trust (trust) to its unitholders.
A business trust generally operates through Special Purpose Vehicles (SPVs). SPVs are formed as companies incorporated in India, in which the Business Trust owns a controlling interest.
Income of Business Trusts:
A business trust, in general, receives the following types of income:
- Dividend income from shares held in SPVs
- Interest received from SPVs
- Rental income from assets owned by the trust (applicable generally for REITs)
- Capital gains from the sale of assets owned by the trust
- Any other income(such as interest from term deposits from temporarily parking excess funds etc.)
Business trusts do not pay tax on the first three types of income listed above, i.e. dividend, interest, and rental income. Instead, these are taxed in the hands of the unitholder.
Any other income received is taxable at the trust level.
Taxability of income distributed by a business trust:
Income tax law states that any income distributed by a business trust to its unit holders shall be deemed the same nature and in the same proportion as such trusts had received it.
A unitholder pays tax on the following types of income distributed by a business trust:
- Interest income received from an SPV
- Rental income from assets owned by REITs.
- Dividend received from shares held in SPVs (taxed only if SPV has opted for concessional tax)
Accordingly, a business trust is obliged to apply TDS while distributing such income.
Any other income accruing to these trusts is taxed at the trust level, and the unitholder’s distribution of such income is exempt. So, for example, capital gains accruing to a business trust are taxed at the trust level. When the trust distributes such capital gains to the unitholder, there is no tax implication.
Here’s an illustration:
Let’s assume a business trust received an income of ₹ 2,00,000 during a year, consisting of Interest income of 60,000 from loan to SPV, Rental income from assets owned by the trust of 30,000, Dividend received from SPV 30,000, capital gains of 40,000 and 40,000 of other income (interest from term deposits etc.)
The amount is distributed to its unitholders. Let’s say an investor receives ₹ 60,000 as her share from the distribution.
Tax implications for her are explained below:
*These represent the interest and dividend received by the trust from SPV and distributed to the unitholder.
**Companies are generally taxed at 25/30%, depending on their turnover. Taxation Laws (Amendment Act) 2019 has inserted a new section (115BAA) applicable from Assessment year 2020-21, under which Indian companies can opt to be taxed at a lower rate of 22% subject to certain conditions.
Cost adjustment due to loan repayment
A question that is worth deliberating is, what is the tax implication to the unitholder on the distribution of proceeds from loan repayment?
Continuing with the above illustration. Let’s assume that the trust has received an additional 50,000 as proceeds from the loan repayment by the SPV, and the trust has distributed that money to its unitholders. Our illustrative investor receives ₹ 15,000 as her share of the distribution.
Will this have any impact on her taxes?
As noted above, a unitholder pays tax only on interest, dividend (subject to concessional tax condition), and rent received from the business trust.
So the simple answer to this question is no.
Will the trust pay tax on this money?
Definitely no, as loan repayment is a capital receipt by nature and not considered as income.
Some experts are of the view that the cost of acquisition of units in the trust should be reduced by such proceeds, meaning her cost of acquisition of units should be reduced by 15,000. Income tax law does not require any such adjustment as on date.
Some trusts suggest that the repayment should be considered a reduction of capital and reduced from investment cost in books but are silent on tax treatment.
There seems to be some ambiguity on this as of now. How does the unitholder tend to gain by not adjusting the cost? Is there an undue advantage?
A simple illustration to explain the concept:
Assuming our investor has purchased 1000 units of trust at ₹ 100 per unit. The total cost of acquisition is 1,00,000. The trust has lent the money to an SPV earning interest of 12,000 at the end of the year. Total assets of the trust would be ₹ 1,12,000 (1,00,000 loan to SPV and 12,000 of interest lying as cash with the trust).
Assuming there are no other transactions, the NAV of each unit at the end of the year will be 112.
Now the trust decided to distribute the proceeds to its unitholders, and she received ₹ 12,000. The NAV of each unit drops to 100. The next day she decides to sell her units.
Since the NAV is 100 and the acquisition cost is also 100, there is neither a capital gain nor loss from the sale of units; hence no tax is to be paid on this transaction. So, the 12,000 rupees is not getting taxed.
On the other hand, if she adjusts the cost of acquisition by 12,000, then he ends up paying capital gain tax on 12,000 (1,00,000 (sale proceeds)-88,000(adjusted cost)), which seems more logical.
Capital gain on sale of units of a business trust
Units of a business trust are treated at par with equity in relation to the tax rates. Short-term gains are taxed at 15% and long term (above 1,00,000) at 10% (both subject to payment of STT).
However, the period of holding the asset, for classification as long term/short term, is that of debt and not equity.
Units of a business trust should be held for more than 36 months to qualify as a long-term capital gain.
Statement of income distributed
Every business trust should circulate a statement of income distributed (in form 64B) to its unitholders, providing details of the income distributed by such trust during the financial year. Such statement should be circulated to all unitholders before 30th June of the following financial year.
In Summary: Taxation considerations for income from investing in InvITs and REITs
- Any money distributed by an InvIT or REIT like interest, dividend or rental income (for REITs) is taxable at the slab rate applicable to the unitholder
- The trust deducts tax (TDS) on such money at 10% (for residents)
- TDS on dividends is applicable only if the SPV has opted for concessional tax (explained above)
- Clarity is needed on tax impact on the distribution of proceeds from loan repayment. Hopefully Govt. will soon come out with a circular clarifying this.
As with most taxation-related topics, expect things to continue to evolve.
Other popular taxation related posts
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The Basics of Capital Gains Taxes
How to set-off and carry forward losses
If you’re a Capitalmind Premium member, you can continue the conversation and ask more specific questions on the #taxation channel in Slack. You can reach Sandeep by email sandeep.vvc98 [at] gmail.com
