Many investors are attracted to Real Estate Investment Trusts (REITs) because they seem to offer best of both the worlds – regular income payouts like bonds and the prospect of capital appreciation like equities. If you’re new to REITs and want to understand how to evaluate them, check out the two previous articles we’ve written:
But then, if you’re looking to compare investment options, it is post-tax returns you should be looking at. So before deciding to buy a REIT based on its 7% yield or 10% capital appreciation, you need to know how it is taxed.
Indian REITs enjoy (or more accurately suffer) something called a ‘hybrid pass-through’ status from the taxman. This means that, unlike a mutual fund which doesn’t pay any tax on its income, a REIT needs to pay tax on some types of income it earns while ‘passing through’ some types of income to its investors for them to pay tax. How the REIT itself calculates and pays taxes on its income is not really of interest to you as an investor. So, let’s focus mainly on how individual investors get taxed on their returns from a REIT.
REIT Taxation – Capital gains
Just like shares, REITs are listed on stock exchanges and traded at market prices. They also declare a periodic NAV. When you sell units of a REIT, you can make capital gains or losses from your investment based on whether your sale price is higher or lower than your buy price. Here’s how these gains or losses are taxed:
- The capital gains you make on your listed REIT units get treated as “long-term” capital gains if you held the units for more than 36 months.
- Long term gains exceeding Rs 1 lakh a year (this Rs 1 lakh exemption includes equity capital gains) get taxed at a flat rate of 10% plus surcharge and cess. (Section 112A of IT Act).
- Short term gains, where units are held for 36 months or less get taxed at a flat rate of 15% plus surcharge and cess. (Section 111A of IT Act).
- NRIs may claim lower rates of tax if their country has a Double Taxation Avoidance Agreement with India.
- These capital gains rates apply for REIT units where STT has been paid.
REIT Taxation – Distributions
Most investors buy REITs for their regular income distributions. When companies distribute income to you from NCDs, this is clearly interest income. When they pay out income on shares, this is dividend. In the case of REITs though, the distributions made to you are subject to differing tax treatment based on where they originally came from. As we explained in our previous article, REITs derive their own income from four sources.
- One, they may receive rental income on property they own.
- Two, they may earn dividends from their subsidiaries (called SPVs) which own property and earn rent.
- Three, they may have given loans to SPVs which either pay back interest or principal.
- Four, they may make capital gains when they sell their property assets or stakes in SPVs.
Though the REIT may aggregate all four kinds of income and distribute it as one payout to its unit holders, for tax purposes, the taxman digs into the underlying character of the payout. So, here’s how a REIT’s distributions are taxed in your hands.
#1 As rent or interest
When REIT distributes rental or interest income to unit holders, they are taxable at your applicable income tax slab rate.
#2 As dividends
In India, REITs often own property assets indirectly through Special Purpose Vehicles (SPVs). These SPVs contribute to the REIT’s income by paying out their own income (from rent and other sources) to the REIT as dividends. If any part of the distribution you receive from your REIT is in the form of dividend, then it may be taxed in two ways:
- If the SPVs from which the REIT receives dividends have not opted for the new concessional regime (under section 115BAA) on corporate tax, then your dividend from the REIT will be tax-free.
- If the SPVs from which the REIT receives dividends are paying a lower rate of corporate tax at 22% instead of the standard rate, then you will pay tax on dividend from the REIT at your income tax slab rate.
To decide whether the dividend part of your REIT’s distribution is taxable therefore, you will need to find out if the SPVs of the REIT have opted for the concessional tax regime. Most REITs, thankfully, provide this disclosure in their investor relations section. Both Embassy and Mindspace REIT have clarified that their SPVs have NOT opted for the concessional corporate tax regime. Therefore, the dividend part of their distributions is tax-free in your hands. The above tax changes were brought in, in the 2020 budget when the Dividend Distribution Tax regime for companies and business trusts was done away with, and replaced by a system that taxed dividends in the shareholders’ hands.
#3 As other income
Apart from distributing rental income, dividends and interest from SPVs, REITs may pay out other kinds of income to investors too. REITs extend loans to their SPVs to acquire and manage property assets. When SPVs repay these loans, REITs report it as part of their cash flows for the year. These cash flows may make up part of the distributions paid out by the REIT. Such repayments, when distributed by REIT, are exempt from tax in the hands of investors. If a REIT distributes other kinds of income apart from the above, such as investment income, those are exempt in the hands of investors too.
The Budget 2023 has amended the tax treatment of these types of payouts by REITS. The new tax treatment is as follows:
Where the distribution of a REIT is not in the nature of rent, interest or dividend (and not capital gain on redemption of units), it will be treated as ‘Income from Other Sources’ and taxed accordingly. This proposal therefore increases the tax outgo on distributions received.
What about NRIs?
The above taxation rules on REITs also apply to NRIs, except in cases where the NRI’s home country has different provisions in its DTAA (double taxation avoidance agreement) that it has with India.
As you can see from the above, REIT taxation is a complicated affair and can make your tax filings complex too. But the only saving grace is that while India’s tax regime for REITs has taken quite a few twists and turns in the last five years, listed REITs have tried to adapt their business models and distributions to these changes, to reduce the tax incidence on their investors. They also provide break-ups of their quarterly distributions so that your tax calculations become easier. Embassy Office Parks REIT for example, distributed Rs 15.88 per unit in the first nine months of FY21. Of this, Rs 9.01 was repayment of debt (tax-free) and Rs 6.07 was interest (taxable at slab rate), while only Rs 0.80 was dividend.