Real Estate Investment Trusts (REITs) have become a popular investment option for individuals seeking exposure to real estate without directly owning or managing properties. They offer a simplified and efficient way to invest in large-scale real estate projects with relatively small capital. However, income from REITs is taxable, and understanding the tax implications is crucial for optimising returns and making informed financial decisions.
What Are REITs?
REITs are entities that acquire, own, manage, or finance income-generating real estate. They function like mutual funds but focus exclusively on real estate rather than stocks or bonds. By pooling funds from multiple investors, REITs allow individuals to invest in commercial real estate projects without the operational responsibilities of property ownership. Investors earn income through rental revenue, interest, or capital gains from these properties.
In India, REITs primarily invest in assets like office spaces, shopping malls, and warehouses. Prominent Indian REITs include Embassy Office Parks REIT, Mindspace Business Parks REIT, Brookfield India REIT, and Nexus Select Trust REIT.
The SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”) provide a framework for registration and regulation of Real Estate Investment Trusts (“REIT’s”).
What is a Special Purpose Vehicle (SPV)?
SPV means any Indian company
(i) in which the REIT holds or proposes to hold not less than 50% of the equity share capital or interest;
(ii) which holds not less than 80% of its assets directly in properties and does not invest in other special purpose vehicles;
(iii) which is not engaged in any activity other than holding and developing property and any other activity incidental to such holding or development.
Eligibility Criteria for REIT Classification
To qualify as a REIT, entities must meet specific requirements to ensure their primary focus is on real estate income and serve the interests of diverse investors:
1. Trust Setup & Registration: REITs must be set up as trusts and registered with SEBI, involving a trustee, sponsor group, manager, and inducted sponsors.
2. Trustee Role: The trustee holds the REIT assets in trust for unit holders, must be SEBI-registered as a debenture trustee, and should not be associated with the sponsor(s) or manager.
3. Investment in Real Estate: REITs can invest in commercial real estate (both freehold and leasehold) directly or through SPVs and holding companies, excluding mortgage assets.
4. Fundraising Mechanism: REITs raise funds through an initial offer, with subsequent offerings via follow-on issues, rights issues, or QIPs.
5. Mandatory Listing: REITs must be listed on a recognised stock exchange and comply with continuous disclosure requirements.
6. Investment Restrictions: At least 80% of REIT assets must be invested in income-generating commercial properties, while up to 20% can be invested in development properties, debt securities, government bonds, etc.
7. Mandatory Distribution: REITs are required to distribute a minimum of 90% of net distributable cash flows to unitholders, at least semi-annually.
8. No Investment in Other REITs: REITs are prohibited from investing in the units of other REITs.
Taxation of REIT Income in India
India’s taxation framework for REITs aims to avoid double taxation by levying taxes either at the REIT level or the investor level. Tax treatment varies based on the type of income:
1. Dividend Income
If the SPV opts for the concessional tax rate regime under Section 115BAA, dividend income is taxable for unitholders at applicable slab rates. If the SPV does not opt for the concessional tax rate regime under Section 115BAA, the dividend income is exempt for unitholders.
10% TDS will be applicable for dividend paid to resident unitholders if the amount exceeds ₹5,000 p.a. (₹10,000 p.a. from FY 2025-26 onwards)
2. Interest Income
Interest income earned by unitholders from REITs is taxable as per the applicable slab rates.
10% TDS is deducted if interest income exceeds ₹5,000 p.a. (₹10,000 p.a. from FY 2025-26 onwards)
3. Capital Gains
Short-Term Capital Gains (STCG): Gains from selling REIT units held for less than one year are taxed at 20%.
Long-Term Capital Gains (LTCG): Gains from selling REIT units held for more than one year are taxed at 12.5% if they exceed ₹1.25 lakh annually. Indexation benefits are not available.
4. Rental Income
Rental income distributed by REITs is taxed at the applicable slab rates to the unitholder.
10% TDS is deducted on rental income.
Benefits of REITs
1. Liquidity: REITs units are listed on a recognised stock exchange, which makes it easy to buy and sell.
2. Simplified Investment: REITs provide a streamlined way to invest in real estate without the operational challenges of property ownership.
Challenges in REITs
1. No tax benefits: REITs are of not much help when it comes to tax benefits since the income is taxable in the hands of unitholders at the applicable tax rates.
2. Market Risk: REITs can be subject to fluctuations in the real estate market, leading to inconsistent returns. Economic recessions, changes in interest rates, or falls in property values can all impact the performance.
Final Thoughts
REITs offer an efficient and lucrative way to invest in real estate without direct ownership or management responsibilities. While the taxation of REIT income can be complex, strategic planning and professional advice can help investors minimise tax liabilities and maximise returns.
