Giving impetus to urban infrastructure

This article sheds light on the implications of the applicability of the Minimum Alternate Tax (MAT) regime to the REITs (and the exemption there from) in the context of boosting affordable urban infrastructure.

The availability and sufficiency of affordable housing has consistently been a pressing concern in India. The National Urban Housing and Habitat Policy released by the Government in December 2007 noted that there was a serious mismatch in the demand and supply of housing units, with the brunt of the shortage being borne by economically weaker sections of society. In recent times, the government has taken several steps with a view towards easing regulatory pressure on the sector, and encouraging private participation in order to boost growth. Significant amongst these steps is the easing of FDI norms applicable to construction and real estate, allocation of Rs 4000 crore for the provision of affordable housing for the urban poor through the National Housing Bank, incentivisation of housing loans, and the introduction of the concept of Real Estate Investment Trusts (REITs). A statement posted on the website of the office of the Prime Minister of India sets out that the intent of introducing the instrumentality of REITs is to reduce pressure on the banking system to which the real estate sector looks for funds, to free up existing funds of banks and to encourage construction activities. This article proposes to discuss the implications of the applicability of the Minimum Alternate Tax (MAT) regime to the REITs (and the exemption therefrom) in the context of boosting affordable urban infrastructure.

REITs: attracting private investment
An REIT is defined under the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations) as a trust registered under the said Regulations, which invests directly in real estate, through properties (other than vacant land and agricultural land) and/ or mortgages (other than mortgage backed securities) . The REIT is constituted as a trust under the Indian Trust Act, 1882 and is permitted to hold properties either directly or through a Special Purpose Vehicle (SPV). The REIT raises capital by way of issue of ´units´ which are required to be listed on a recognised stock exchange or through debts directly, both from resident as well as non-resident investors. The introduction of REITs is aimed at attracting private investment into the cash-strapped housing sector.

Significantly, under the REIT Regulations, there is a requirement for the shares of the SPV to be exchanged with units of the REITs. This aspect of the structuring of REITs (amongst others) has drawn industry attention, in relation to the taxation of REITs. A notable concern on their part relates to the potential imposition of Minimum Alternate Tax (MAT).

MAT: Applicability to REITs
MAT was first introduced under the IT Act in 1987 through the inclusion of a new chapter (Chapter XIIB) vide the Finance Act, 1987. The Memorandum to the corresponding Bill set out the rationale for bringing in these provisions, which was to tax so-called ´zero tax´ companies, i.e., companies which make high book profits but have no or insignificant taxable income under the IT Act as a result of the exemptions, deductions and/ or incentives provided to them in the form (inter alia) of sector-specific provisions. However, the provisions on MAT as they presently stand under the Income Tax Act, 1961 (IT Act) are set out under Section 115JB of the IT Act.

The extant MAT regime is applicable to every Indian company (including SPVs holding assets under the REIT Regulations) and its effect is to cause every such company to pay, at the least, the tax calculated in accordance with the IT Act, with respect to each assessment year. In context of the REIT framework, the MAT regime would ordinarily apply to the transactions of the SPV, including the exchange of the shares of the SPVs with the units of the REITs under the REIT Regulations. However, the popular industry view is that such exchanges of shares and units should be exempt from MAT since they are undertaken mainly in order to vest the REITs with their initial assets and do not result in any change in the ultimate owner of the asset or in the generation of any real income .

However, the Finance Minister announced on April 30, 2015 that it is proposed to exempt such SPVs from the levy of MAT on the gains and losses arising from the exchange of the shares of the SPV with the units of REITs. It is proposed that MAT shall only be applicable at the time of actual transfer of the REIT units. This news could kick start the formation of REITs by developers and such other entities, who had reportedly deferred their plans to do so, due to the fear that such impositions would render investments unviable.

However, certain concerns still remain. It is significant to note that as per the REIT Regulations, not less than 90 per cent of net distributable cash flows of the corresponding SPV is required to be distributed to the corresponding REIT in proportion of its holding in the SPV. Therefore, it may be argued that, should the MAT regime be applicable to such SPVs, such SPVs would necessarily bear income tax (in the form of MAT) in addition to dividend distribution tax (DDT) at the time of distributing income to the REIT. This could seriously impact the earnings of REITs and dampen investor enthusiasm, possibly resulting in a loss of interest in REITs as a mechanism of investment itself.

The impact of tax policies
In recent years, the Department of Income Tax has sought to impose MAT on Foreign Institutional Investors (FIIs) (previously known as Foreign Portfolio Investors or FPIs). This move has been viewed with great concern by FIIs, due to the potentially significant costs which the imposition of MAT represents. The Finance Minister has sought to allay their concerns by announcing (in his Union Budget speech for the year 2015-2016) that in order to rationalise the MAT provisions for FIIs, profits corresponding to their income from capital gains on transactions in securities, which are liable to tax at a lower rate, shall not be subjected to MAT. While this pronouncement has been welcomed, the phrasing of the exemption as a specific exemption for FIIs has raised concerns that other non-resident investors may be liable to pay MAT. It is hoped that tax law and policy, as it is developed, will clear the air on the applicability of MAT to non-resident investors, especially those located in treaty jurisdictions, such as the Netherlands and Singapore. It would be especially important to achieve clarity on this issue, since FIIs have invested significant amounts in Indian equities and debt (reportedly a net of US$ 43.5 billion so far in 2014-15), backed by market optimism and falling interest rates , and it would be crucial to present REIT units as an attractive proposition for investment as well.

Conclusion
REITs have been introduced by the government as a transparent and efficient alternate route for private investment in real estate sector. However, potential investors may be disheartened by the prospect of imposition of MAT on SPVs. Although the exemption from imposition of MAT at the stage of exchange of REIT units for shares of the SPVs undoubtedly comes as a relief, it may be prudent for the government to consider additional incentives for investment as well as clarify the policies on the taxation of non-resident investors in this context, in order to boost investment in the urban housing and commercial infrastructure sector.

DISCLAIMER: This article has been authored by Aakanksha Joshi, who is an Associate Partner and Divya Srikanth, who is an Associate at Economic Laws Practice (ELP), Advocates & Solicitors.

They can be reached at aakankshajoshi@elp-in.com or divyasrikanth@elp-in.com for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.