Real estate: Getting REIT right, says Kotak Institutional Equities

Jul 21 2014, 13:23 IST
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Finance Minister Arun Jaitley made a progressive announcement on REITs (Real Estate Investment Trust) in his budget speech. (Reuters) Finance Minister Arun Jaitley made a progressive announcement on REITs (Real Estate Investment Trust) in his budget speech. (Reuters)
SummaryBudget proposals on investment trust fall short of industry expectations.

most markets.

o Most sponsors with potential REIT offerings command a strong brand equity and thus better cost of borrowing versus others (11.5-12%, post-tax 7.5-8%). Ideally, a sponsor would look at monetising value, which is better than its existing funding options. If fund raising takes place at lower cap rates, it becomes unfavourable for the investor.

How do the tax announcements impact the current structure?

Capital gains are deferred, not exempt: The government has proposed to defer and not exempt capital gains arising to a sponsor from tax until the units of a REIT are sold. The tax on transfer of the sponsor’s shares in an SPV to a REIT in lieu of units of the trust is deferred. The Finance Bill proposes to insert an additional proviso, which denies preferential capital gains regime available in respect of units of a business trust, to the sponsor of the SPV in respect of these units when they are disposed of by it. Thus, capital gains will be taxable at the time of the sale of units of business trust received in exchange of shares even if the transaction of sale of units is carried out on a recognised stock exchange. This makes it non-viable for sponsors.

A pass-through on Dividend Distribution Tax? Not really: The government has proposed a pass-through on distribution tax when a REIT pays dividend to unitholders. But the SPV that owns the project is subject to corporate tax and the dividend paid by the SPV to the Trust is also subject to DDT. This makes it no different from the current structure in which a developer is holding projects in an SPV, which if pays dividends to the developer could be set-off if the developer in turn pays dividends to its investors. In fact the current structure is marginally better for the developer as investments in the SPVs are usually in the form of debt.

The government also proposed that in an investment of a REIT into an SPV, if in the form of debt, the interest income earned by the REIT will have a pass-through, that is, no tax on interest income of the REIT. But if such interest income is distributed to unit-holders as dividend (90% of the income of the REIT has to be distributed as dividend), it will have a 10% withholding tax for resident unit-holders and 5% for non-resident unit-holders. The resident unit holders will

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