With Eased MAT Norms, Will REITs Flourish In India?

In India, real estate is very popular as an asset class. Though people invest much in land in India, these assets are often not managed by experienced professionals. Unlike common stock, it is difficult to sell your real estate assets overnight. More importantly, to invest in real estate in India you need large sums of money. You portfolio is not well-diversified either. For instance, not many real estate investors in India are wealthy enough to diversify their portfolio by buying assets across the world, or even across the country.

If Real Estate Investment Trusts (REITs) flourish in India, people will be able to invest in apartments, shopping malls, hotels or almost any commercial real estate property with smaller sums of money. Investors will also be able to sell their assets easily whenever they want, without much discount to their value. In the Union Budget 2014-15, the Finance Minister, Arun Jaitley, had given a “pass-through” status for REITs. But, there isn’t much of an incentive to set up REITs in India because the tax structure is not favorable.

For instance, in the United States, where REITs are successful, investing in a REIT is the most tax-efficient way to invest in real estate in a securitized form. The reason is that REITs do not pay taxes on the net income if it is distributed to shareholders as dividends. But, the shareholders pay taxes on the dividend payment, except when the shares are held in a tax-deferred account. This is one the greatest merits of the REIT structure. But, in India, as REITs are likely to be formed through contribution of shares of special purpose vehicles (SPVs), which hold income-generating real estate assets, the income earned by these SPVs will be subject to a corporate tax of 30% and the dividend distributions by the SPVs will be subject to a dividend distribution tax (DDT) of 15%.

In the US, REITs that comprise of shares of SPVs can defer capital gains taxes and this gives such REITs a competitive advantage over other REITs. This was also a major barrier to the formation of REITs in India. But, the scenario is changing. As it is not a conventional commercial transaction when SPVs exchange shares for units of REITs, Jaitley had earlier exempted REITs from long-term capital gains tax. But a short-term capital gains tax of 15% still applies. The government also said rental income would be taxed only when it is in the hands of the unit holder, and not in the hands of REITs.

There was not enough reasons to form REITs in India because even if capital gains tax does not apply when an SPV transfers it shares for units of REITs, asset owners would have to pay a minimum alternate tax (MAT) of 20%. But recently, the finance minister exempted REITs from MAT. If India abolishes DDT too, REITs in India will have a tax structure similar to that of international markets where REITs have been very successful. The assets REITs purchase would be subject to stamp duty as well. Nevertheless, India might see its first REIT soon. DLF intends to float India’s first REIT. As the government has proposed tax reliefs, experts believe a handful of REITs might emerge this fiscal year itself. There is still much room for improvement because DDT will deter foreign investors and many Indian investors.

To know more, read PropTiger simplifies REITs for you.