Abstract

Real Estate Investment Trusts and Infrastructure Investment Trusts are considered synonymous with mutual funds. However, they vary in their inherent characteristics as they are focused on the real estate and infrastructure sector. They offer a unique mechanism to raise capital by investing in the Indian real estate and infrastructure sector. Since the onset of the COVID-19 pandemic, this sector has seen various highs and lows, such as invoking the force majeure clause and disputes related to the same, delay in completion of projects causing contractual disputes, and agony to the allottees, and other related conundrums.

Thus, considering the aforementioned, firstly, this blog post shall briefly introduce the concept of Real Estate Investment Trusts and Infrastructure Investment Trusts and discuss its general advantages. Secondly, this blog post shall scrutinize the Indian regulatory mechanism of these Trusts. Thirdly, this blog post shall explore the tax implications of these Trusts. And fourthly, this blog post shall anatomize whether these Trusts are the future drivers of growth in India.

Introduction to REITs and INVITs: Concept and General Advantages 

Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are essentially a pool of funds invested by retail and institutional investors. This pool is the investors’ portfolio which, in turn, invests the investors’ money in real estate projects (in case of REITs) and infrastructure projects (in case of InvITs) as notified in theHarmonized Master List published by the Ministry of Finance. These infrastructure projects include roads, shipyards, airports, urban public transport, telecommunication towers, water treatment plants, affordable housing, and other related projects. After investing money in these income-generating projects, the investors receive the income generated from these projects. Investors would want to invest in REITs and InvITs because they are a source of long-term stable cash generation. Further, they offer high liquidity as the shares of REITs and InvITs are publicly traded on major stock exchanges; this ensures transparency as they are subject to regular regulatory compliance and mandatory disclosure of financial reports by the Securities Exchange Board of India (SEBI). In finality, they offer a diverse investment portfolio as REITs and InvITs invest in a different range of properties. 

Despite these advantages, it is imperative to note that REITs and InvITs are yet to pick up pace in India. This is especially true because the real estate and the infrastructure sectorwere substantially affected by COVID-19, wherein various construction and other related activities’ pace was reduced. Thus, it is quintessential to analyze the regulatory mechanism, tax implications, and the future of REITs and InvITs in India.

Regulatory Analysis of REITs and InvITs 

REITs and InvITs help in raising debts and increasing the returns given to Unit Holders. Due to this, they are governed under the Regulations published by SEBI to ensure transparency, fairness, and justice. REITs are governed under the SEBI (Real Estate Investment Trusts) Regulations, 2014 (hereinafter “REITs Regulations”), and InvITs are governed under the SEBI (Infrastructure Investment Trusts) Regulations, 2014 (hereinafter “InvITs Regulations”). Both these Regulations are amended regularly to keep up with the real estate and infrastructure sector changes. For example, both these Regulations were last amended in July 2021 to accommodate the changes that occurred from the COVID-19 pandemic.

a. Definition and Purpose of REITs and InvITs 

REITs and InvITs are formally defined under the REITs Regulations and InvITs Regulations, respectively. Regulation 2(1)(zm) of REITs Regulations defines REITs as those Trusts that are registered under the REITs Regulations, and Regulation 2(1)(za) of InvITs Regulations defines InvITs as those Trusts that are registered under the InvITs Regulations. 

When we scrutinize the preamble of the REITs Regulations and the InvITs Regulations, we comprehend that the purpose behind formulating these Regulations is to set up an appropriate and adequate framework for the registration and regulation of REITs and InvITs. This need for a standardized framework is heightened in thecurrent times wherein the interest rates are at an all-time low, and the affordability in the real estate and infrastructure sector has substantially improved due to various factors like organizations resuming physical offices, improvement in rental rates, and other factors. 

Further, REITs are investor-friendly as Regulation 18(4) and (5) of REITs Regulations mandates REITs to invest 80% of their portfolio in completed and income-generating properties. On the other hand, the remaining 20% of their portfolio can be invested in projects still under-going construction. This essentially reduces the “execution risk” that an investor might face after a project is completed. The same principle of investor-friendliness is also applicable to InvITs as the InvITs’ portfolios are mandated with the same conditions mentioned above under Regulation 18(5)(a) and (b) of the InvIT Regulations. Thus, considering the increasing lucrativeness of the real estate and infrastructure sector, these Regulations are beneficial to the investors and the unitholders by providing statutory protection and flexibility to them. This protection is further enhanced as the REITs Regulations, and InvITs Regulations discuss explicit rights and responsibilities of Unit Holders, Sponsors, Trustees, and Managers/Investment Managers.

b. Integral Parts of REITs and InvITs: Unit Holders, Sponsors, Trustees, and Manager/Investment Manager 

When we describe Unit Holders, Regulation 2(1)(zy) of the REITs Regulations states that they are individuals who own units in a REIT. Similarly, Regulation 2(1)(zze) of the InvITs Regulations states that they are individuals who own units in an InvIT. However, when we compare these Unit Holders to Trustees, they differ in function. Regulation 2(1)(zv) of the REITs Regulations states that Trustees are those individuals who hold the REIT assets for the benefit of the Unit Holders. Similarly, Regulation 2(1)(zzb) of the InvITs Regulations states that Trustees are those individuals who hold InvIT assets for the benefit of the Unit Holders. This means that Trustees are those individuals who act on behalf of the Unit Holders. Further, these Trusteesundertake to ensure regulatory compliance and protect the rights of the Unit Holders on behalf of the Unit Holders. The existence of such Trustees is to ensure smooth facilitation of the investment process as this process requires complex managerial and legal skills offered in the form of particular services by these Trustees in return for Trustee Fees. Similarly, Unit Holders receive the income generated from the REITs/InvITs in the form of “income” or “distributions” as given under Regulation 22(1) of REITs Regulations and InvITs Regulations. 

Regulation 2(1)(zt) of the REITs Regulations state that Sponsors are those individual(s) who set up the REIT. Similarly, Regulation 2(1)(zz) of the InvITs Regulations states that Sponsors are those individual(s) who set up the InvIT. This means that Sponsors are generally those individuals whopour their properties into the initial REIT/InvIT portfolio. The presence of such a Sponsor is advantageous to REITs/InvITs because if a Sponsor backs a REIT/InvIT, it is more likely for financial institutions to lend money to the REIT/InvIT in cases of acquisition or refinancing of debt as the credibility of the Sponsor is attached with the REIT/InvIT. In the worst-case scenario, the Sponsor may advance credit to the REIT/InvIT. Further, they maygenerally own units in the REIT/InvIT and inject funds/equity into the REIT/InvIT to give a head start to the growth and development of the REITs/InvITs.

Regulation 2(1)(w) of the REITs Regulations states that the “Manager” is a company, Limited Liability Partnership, or a body corporate that is incorporated in India and is responsible for the management of the assets, investments, and operational activities of the REIT. Similarly, Regulation 2(1)(zf) of the InvITs Regulations state that an “Investment Manager” is a company, Limited Liability Partnership, or a body corporate that is incorporated in India and is responsible for the management of the assets, investments, and operational activities of the InvIT. These Managers/Investment Managers generally provide such managerial services for a Management Fee. They are of quintessence importance because although Trustees ensure regulatory compliance, they act in favor of the Unit Holders, due to which the administrative tasks may be neglected and not fully completed. Thus, these Managers/Investment Managers resolve this neglect by providing their managerial services to ensure effective and efficient functioning of the REITs/InvITs.

c. How are REITs and InvITs Formed and Registered 

Regulation 4(2)(a) of the REITs Regulations states that the REITs are generally formed as a Trust (under the Indian Trusts Act, 1882) wherein the Trust Deed is required to be registered in India under the statutory provisions of the Registration Act, 1908. Similarly, Regulation 4(2)(a) of the InvITs Regulations states the same. 

Further, there is a Certificate of Registration that must be obtained from SEBI. The requirements for the same are as follows: 

1. Regulation 4(2)(b) of REITs Regulations and InvITs Regulations – The Trust Deed’s main objective is that the REIT/InvIT shall undertake activity according to the SEBI Regulations.

2. Regulation 4(2)(c) of REITs Regulations and InvITs Regulations – Sponsor(s), Manager, and Trustee have been designated under the Regulations wherein all such individuals must be separate entities.

3. Regulation 4(2)(g) of REITs Regulations and Regulation 4(2)(h) of InvITs Regulations – The Unit Holders of REITs/InvITs must exercise equal voting rights and any other rights. Further, there must be no multiple classes of REITs/InvITs.

4. Regulation 4(2)(i) of REITs Regulations and Regulation 4(2)(j) of InvITs Regulations – The REIT/InvIT must disclose all its relevant details regarding the “proposed activities” of the REIT/InvIT.

Thus, it is imperative for the REIT/InvIT to comply with the conditions mentioned above and obtain a Certificate of Registration from SEBI to commence with its process of real estate/infrastructure investments.

d. Unit Holders’ Meeting and Exit Option for Dissenting Unit Holders 

Regulation 22(3) of the REITs Regulations and InvITs Regulations states that there shall be an annual Unit Holders’ meeting. The gap between two annual meetings should not exceed 15 months. The purpose behind this meeting is to apprise the Unit Holders of various matters such as: 

1. Disclosure of the recent performance and annual accounts of the REIT/InvIT.

2. Obtain approval for the utilization of an Auditor’s service and Auditor Fees.

3. Recent reports on the valuation of the REIT/InvIT.

4. Appointing a valuer for the REIT/InvIT.

Further, Regulation 22(6) of the REITs Regulations and Regulation 22(5) of the InvITs Regulations mention certain situations wherein the explicit majority approval of the Unit Holders are required, such as:

1. Suppose any change in the Manager/Investment Manager is required. This change may be in terms of removing the Manager/Investment Manager or a change in their control.

2. If any “material” change is required in the investment strategy or any change in the Management Fees of the REIT/InvIT.

3. If the Sponsor(s) or Manager/Investment Manager seeks to delist the units of the REIT/InvIT.

4. If any issue — which is not in the ordinary course of business of the REIT/InvIT — requires approval of the Unit Holders as deemed required by the Sponsor(s) or Manager/Investment Manager or Trustee or Board or the designated Stock Exchanges.

5. Some issues can require approval if the Unit Holders explicitly require for the same such as replacement of an Auditor or Valuer or Manager/Investment Manager and other issues as given under Regulation 22(6)(g) of the REITs Regulations and Regulation 22(5)(f) of the InvITs Regulations.

However, there can be situations wherein approval of all the Unit Holders is not obtained, due to which the dissenting Unit Holders must be provided with catharsis. SEBI amended the REITs Regulations and the InvITs Regulations in 2020 and provided exit options to the dissenting Unit Holders under Regulation 22(6A), 22(8)(b)(i) and (ii) of the REITs Regulations in cases related to the acquisition, change of sponsor, or change in control of sponsor respectively. Similarly, Regulation 22(5B) and 22(5C), and Regulation 22(7)(i) and (ii) of the InvITs Regulations provide similar exit options in cases related to the acquisition, change of sponsor, or change in control of sponsor respectively. Thus, Unit Holders are given tangible powers to make decisions on the REIT/InvIT in which they have invested their money despite the Trustees acting on behalf of the Unit Holders for regulatory compliance and other duties. This means that Unit Holders, including dissenting Unit Holders, play a quintessential role in “deciding” the administration and functioning of a REIT/InvIT alongside the Sponsor(s) and Manager/Investment Manager.

Tax Implications of REITs and InvITs

Due to an increase in the number of REITs and InvITs getting listed on the exchanges and the growing understanding of such instruments, investments in these instruments are picking up steam, primarily due to their post-tax yields. Moreover, the2021-2022 Indian Union Budget has made investments in such instruments alluring for the investors while broadening the available capital raising opportunities of REITs and InvITs.

While REITs and InvITs are mandated to distribute 90% of their distributable cash flows under Regulation 18(16) of the REITs Regulations and Regulation 18(6) of the InvITs Regulations, and these distributions are required to be made on a half-yearly basis,some of them make such distributions quarterly. And since REITs and InvITs are provided with pass-through status under income tax laws, the income distribution by REITs and InvITs to its Unit Holders are required to correspond to the nature and proportion of the income that they receive or accrue.

a. Tax on Dividends distributed from Special Purpose Vehicles to REITs and INVITs and from REITs and InvITs to Unit Holders

A Special Purpose Vehicle (SPVs) paying dividends to a REIT or InvIT is exempted from withholding taxes. In the case of distribution of dividends to Unit Holders by REITs and InvITs, the taxability in the hands of Unit Holders is dependent on whether the underlying SPV has availed beneficial tax rate. This means that, on the one hand, dividends received by Unit Holders from REITs and InvITs are tax-free if the SPV has not opted for the beneficial tax rate. On the other hand, dividends received by Unit Holders from REITs and InvITs are taxable in the hands of its Unit Holders if the SPV has already opted for the beneficial tax rate. Although this tax rate may vary based on the type of Unit Holders, i.e., Resident Unit Holder and Non-Resident Unit Holder, Section 194LBA of the Income Tax Act, 1961 states that REITs and InvITs arerequired to withhold tax at 10% regardless of whether the Unit Holder is a resident or non-resident.

b. Interests distributed from SPVs to REITs and INVITs and from REITs and InvITs to Unit Holders 

REITs and InvITs receiving interest from SPVs are exempt from tax. As a result, SPVs are not required to withhold tax on interest payments on loans that they have taken from REITs and InvITs. However, interest received on securities may be subject to withholding tax implications, and if the loan is utilized for business purposes of the SPV, such interest expense should be deductible by the SPV when its taxable income is computed as per the regular provisions of the Income Tax Act, 1961. 

Unit Holders receiving interest from REITs and InvITs is taxable in the hands of the Unit Holders at the rate of 5% in the hands of the Non-Resident Unit Holders and applicable rates in the hands of the resident Unit Holders. Consequently, taxes at the rate of 5% and 10% are required to be withheld for non-Resident and Resident Unit Holders, respectively.

c. Capital Gains and Capital Reduction by SPVs and Rental Income 

Capital gains tax differ on the time duration for which the shares of SPVs are held, i.e., the maximum marginal rate of up to 40% excluding surcharge and cess in the event of shares of SPVs being held for 24 months or less and 20% excluding surcharge and cess in the event of shares of SPVs being held for more than 24 months. Further, such income at the time of distribution is not taxable in the hands of the Unit Holders since it is taxed in the hands of REITs and InvITs. Consequently, there exists no provision or requirement of withholding taxes. In the case of a REIT generating income from leasing or letting out or renting of a real estate asset directly owned by that REIT, it is tax-free in the hands of such REIT. Thus, Tenants are exempt from withholding taxes from their rental payments to the REIT. However, distribution of the rental income to Unit Holders is taxable in the hands of such Unit Holders, and consequently, taxes are withheld at the rate of 10% in case of Resident Unit Holders and applicable rates in case of non-Resident Unit Holders.

Conclusion: Do REITs and InvITs Really Fuel Growth and Development in India?

To throw light on whether REITs and InvITs are fueling growth, it is worth pointing out the fact that as per current trends, REITs and InvITs are already showing encouraging performance in India, with the combined market capitalization of three listed REITs currently exceeding theUS $7 billion whereas that of the InvITs exceeding the US $10 billion. Thus, REITs and InvITs are expected to grow rapidly in the coming years, thereby fueling multi-sectoral growth, particularly in the Real Estate and Infrastructure-based sectors such as Highways, Roads, Ports, and Power sectors. 

a. Utility of REITs and InvITs to Investors 

REITs and InvITs offer unique benefits to the investor community by providing them with a scientific and a well-grounded way of investing in real estate and infrastructure. Through REITs and InvITs, investors hold fragments of real estate just like stocks and e-goldwithout having to go through the tedious process of buying actual real estate. Apart from ease of investing in real estate, tax benefits available while investing in such instruments are lucrative aspects that pave the way for the bright future of REITs and InvITs in India.

b. How to Tackle Funding Conundrums for Real Estate and Infrastructure Projects

Infrastructure and Real Estate are two vital sectors of a developing economy like that of India. Due to the paucity of public funds needed to fuel the sectors’ growth, additional financing channels such as REITs and InvITs play a pivotal role in mitigating funding challenges. REITs and InvITs are utilized to attract private investments while also reducing the strain on formal banking institutions. As part of the National Infrastructure Pipeline, the Indian governmentestimates a funding requirement of over US $1.4 trillion by 2025. This means that REITs and InvITs are expected to play a significant role in fulfilling the funding requirements, mitigating funding challenges for real estate and infrastructure projects by releasing their invested equity, and enabling developers to deploy capital into new projects. They also provide long-term infrastructure financing by alluring pension funds and insurance companies. Investors can exit through the self-amortizing nature of units over the life of REITs and InvITs, regardless of market conditions, portfolio size, or growth visibility challenges.

c. Enabling efficient distributions 

REITs and InvITs facilitate efficient cash upstreaming. Since Trusts are not subject to the Companies Act, 1956/2013, distribution can be done on a cash availability basis at REITs and InvITs level. Further, as far as dividends are concerned, they are subject to the Central Government’s beneficial tax regime. SPVs in REITs and InvITs, while distributing dividends, are tax-free to the Unit Holders straight through the chain if the old tax regime remains in place. InvITs are significantly affected by this since the SPVs from the infrastructure sector may undergo Tax holidays, Minimum Alternate Tax (MAT) credits, and unabsorbed depreciation, thereby making the sector well-suited to remain under the old tax regime.

d. Tapping into the Market of Global Capital: International Perspective 

Apart from private equity and mutual fund firms, REITs and InvITs have attracted international investments from an entirely new class of investors, such as pension funds, sovereign wealth funds, and insurance companies. Moreover, infrastructure projects with long project lifespans are ideal investments for sovereign wealth funds and pension funds with a long investment horizon. The InvIT route — such as Allianz, Blackstone, CPPIB, OMERS, Private Investment arm of World Band (IFC), and other institutions —was successful in alluring and receiving participation from various new pension funds, insurance companies, and sovereign wealth funds. In addition, small retail investors are also allowed to participate by public InvITs in significant infrastructure assets. Therefore, from the arguments mentioned above, it is lucid that REITs and InvITs offer a promising future for driving the growth and development of the real estate and infrastructure sectors.

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The views and opinions expressed by the authors are personal.

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