The tweaking in the rules to tax distributions by Real Estate Investment Trusts (Reits) and Infrastructure Investment Trusts (InvITs) in the form of repayment of capital will impact the post-tax yields for investors, especially for high-net-worth-individuals (HNIs). They may now find holding real estate directly more lucrative.
The rental on properties is allowed a standard deduction of 30%, which may not be available on Reits or InvITs. The capital gains on immovable property can be saved by directly investing into other residential property under Section 54 though it is restricted to Rs 10 crore, which is still a substantial amount.
Amit Maheshwari, tax partner, AKM Global, a tax and consulting firm, says for capital gains from Reits, limited avenues are available like investment under Section 54F but there too, the exemption is available to the proportion of investment and capital gains itself. “Due to these factors, physical real estate could prove lucrative and the Reits and InvITs may need to find assets having higher rental yield to provide greater return on equity to the investors, which could be challenging.
At present, distribution in the form of dividends and the repayment of capital are not taxed in the hands of unit holders. However, the interest payment is taxable. These trusts own income-generating commercial real estates and individuals can buy units of these trusts. After the proposed changes, any form of distribution christened as ‘repayment of debt’ and/or ‘amortisation of debt’ will now be taxable in the hands of investors. A note from Kotak Institutional Equities shows that the impact on the post-tax yield by the proposed changes in the tax structure would be up to 150 basis points.
Repayment of capital
While the dividend is paid from the post-tax income and interest is taxable in the hands of the unit holders, distribution in the form of repayment of capital went entirely untaxed. Experts say the Budget plugged this loophole by taxing the distribution of repayment of capital in the hands of the unit holders at the marginal tax rate.
Maheshwari of AKM Global says the Budget 2023 has proposed to make ‘repayment of loans’ from Reits/InvITs taxable as ‘other income’ in the hands of the investors. “This means the investors have to bear the taxes on such repayments. This change will reduce the post-tax distribution yield from the Reits or InvITs and will certainly impact HNIs who invest in these instruments,” he says.
Any form of distribution christened as ‘repayment of debt’ and/or ‘amortisation of debt’ will now be taxable in the hands of investor. Essentially, even if the principal amount lent by REIT was refunded to the unit holders, the same was neither recorded as income, nor was reduced from the carrying value of the units.
Vishwas Panjiar, partner, Nangia Andersen LLP, says the Finance Bill has sought to plug a loophole in the scheme of taxation of business trusts. “Come April 1, 2023, investors need to be cognisant of the amount received by them as repayment of debt from the business trust during the year and offer the same as income, unless the sum received on distribution is going on to reduce the cost of acquisition of the units,” he says.
Investing in real estate assets
Investing in REITs works like mutual fund investments as the trusts mobilise money from investors and invest the funds in real estate assets. In these, individuals invest in real estate without owning the asset and is an ideal way to diversify the portfolio apart from equities, debt and gold.
Like mutual funds, REITs are liquid assets and investors can sell their units in the secondary market unlike a capital-intensive physical real estate which is difficult to liquidate quickly. These are suitable for those who want to put money in a real estate asset primarily for investment purposes. The periodic payouts help investors to meet their cash flow requirements.
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