Finance Act 2023: How your income from Reits and InvITs will be taxed

Now, the ‘loan repayment’ distribution component from REITs and InvITs should not be treated as income from other sources, as stated in the Budget. As per the Finance Act 2023, such income gets capital gains tax treatment for a certain number of years (explained later).

This amendment has brought relief to investors as well as industry players as long term (36 months) capital gains are taxed at just 10%. This is against tax on ‘other income’ which is at the slab rates of the individual, which can go up to 42% (including surcharge and cess) in higher tax brackets.

What happened?

Reits and InvITs invest in income-generating commercial real estate properties and infrastructure assets through special purpose vehicles (SPVs) through equity or debt instruments. Any income distributed by these trusts to its unit holders should be of the same nature and in the same proportion as that distributed by the SPV to the business trust.

That is, if the SPV pays interest amount to the trust for the loan taken, the same amount is to be passed on by the trust to the unitholders as interest income. Since trusts are given a pass-through structure, such income is taxable to the unit holders.

These business trusts – REITs and InvITs – have been mandated by markets regulator SEBI to distribute at least 90% of available cash to unitholders. Thus, distributive income—which comes in the form of dividends, interest, rental income or loan repayments to unitholders—makes up a significant portion of the return from these trusts. The distribution yield, which is calculated by dividing the annual distribution paid by the trust by the share price, indicates the predictable return an investor can expect from such an investment each year.

In most cases, dividend income is exempt for unitholders. However, if the SPV has opted for the lower tax regime, the dividend along with the interest/rental income is taxed at the slab rates applicable to an investor.

Prior to this year’s budget, there was no provision in the Income Tax Act for the ‘loan repayment’ component of income distributed from trusts. Some investors treated this as tax free income.

To plug this loophole, the finance minister proposed on February 1 that such income should be taxed as part of ‘income from other sources’ of unitholders that attract tax at the slab rates of a person.

If this were to go into effect, the after-tax distribution yield from these trusts would decrease by 100 basis points. A basis point is one hundredth of a percentage point.

Industry experts expressed their concern that income by way of capital gains is not justified in being treated as ‘other income’ which attracts taxation at the slab rate.

The government heeded the plea of ​​the industry and amended the budget proposal. The revised tax rules state that the amount received as ‘loan repayment’ should be reduced from the cost of acquisition at the time of sale of the unit by the investor.

For example, you bought one unit of a REIT 400 and sold it after 3 years 500 in the secondary market. Distribute rets, over the period of your holding 50 as ‘loan repayment’.

To calculate capital gain at the time of sale, you need to reduce 50 from your cost of acquisition 400, which will come 350 per unit. Thus, your capital gain will be 150 per unit ( 500 – 350) no more 100 ( 500 – 400).

Effectively, the loan repayment component will be taxed as capital gain at the time of sale of the units.

but that’s not all. Like every tax rule, this provision is not without buts.

The capital gains tax treatment for the ‘loan repayment’ component is not forever. This is only as long as the aggregate of such amounts distributed by the REIT/InvIT does not exceed its issue price.

For example, the issue price of REIT/InvIT unit is 300 per unit. Say, you bought a unit of a trust when the total disbursed by that reit/invitation exceeded the ‘loan repayment’ component (from the issue date, the day you bought) 300.

Any distribution received by you as ‘loan repayment’, irrespective of your holding period, will be treated as income from other sources, attracting tax at the slab rate in the year of receipt of such income .

but your predecessor, who passed on the units before the amount of ‘loan repayment’ by the trust 300 (issue price), shall be eligible to set off such income from the cost of acquisition and treat the same as capital gain at the time of sale of the unit.

Now, a doubt may arise in your mind as to how you as an investor will know whether the REIT/InvIT has distributed ‘loan repayment’ in excess of its issue price or not. This is where the picture of corporate disclosures comes into play. Industry players are still unsure about how, whether and when such details should be disclosed by the trusts and await clarity from the government.

Industry experts believe that investors need not worry much about this. This is because they are of the view that it will take a minimum of 15-20 years for existing trusts before the total amount paid as loan repayment exceeds its issue price.

For example, take Embassy Reet, which has delivered an average 10 per annum as ‘Debt Repayment’ from the listing date (Issue Price 300). At the given rate, it will take 30 years for the company to exceed the issue price (300/10).

Note, this is only an example and the actual number of years may be less or more depending on the delivery made by the embassy.

Industry people are of the view that this is way ahead of other business trusts and before the total capital paid-up crosses the issue price.

Till then, investors in REITs/Invts have a reason to cheer that the income received as ‘loan repayment’ can be taxed at concessional capital gains tax and not at the slab rate. Unless you want to ‘invest and forget’, you have better predictability of after-tax returns from your investments in business trusts.

Having said that, investors would do well to pay attention to the details of loan repayment and consequent tax treatment when they buy or sell units of business trusts.