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June 8, 2015

The development of India’s REIT sector has become a long-running saga – and tax-related issues are largely to blame, JLL says.

India released its first draft guidelines for a REIT market in December 2007 but the initial framework did not receive approval because of a lack of clarity on taxes. And with the onset of the financial crisis in 2008, market conditions were very far from ideal.

As such, it wasn’t until 2013 that the Securities and Exchange Board of India (SEBI) released a consultation paper on a new set of guidelines for the REIT market. REITs also had the backing of India’s now Prime Minister Narendra Modi – his 2014 election win brought them a step closer to being a reality.

After further modifications to the tax structure for REITs, the final guidelines were finally released last September. However, the story is far from over with investors and industry experts still harboring concerns about tax rules in India’s REIT regulation. The Asia Pacific Real Estate Association (APREA) described them as “tax kinks”.

The 2015 February budget, the most highly anticipated event of Modi’s government by global investors, contained helpful fine-tuning, but didn’t remove all hurdles to an Indian REIT marketplace – which could be worth $15 billion in three years.

The taxing details

From the onset, India’s planned REITs had multiple levels of taxation, including capital gains tax and the minimum alternate tax (MAT), a tax paid on company profits. The 2015 budget modified the ruling to a single point of taxation in the hands of REIT unitholders. However, the industry still had issues primarily with the Dividend Distribution Tax (DDT) and the MAT.

“There are many advantages of having a REIT structure and key among them are increased transparency, professional real estate management and having a regular stream of dividend income that will act as a hedge against inflation,” says Shobhit Agarwal, JLL’s head of capital markets in India.

“However, the cons are, in the case of India, stamp duties for transfer or properties and the Dividend Distribution Tax.”

Agarwal added that the main taxation related gaps are “rationalizing dividend distribution leakages at the special purpose vehicles level, clarity on the applicability of MAT and simplifying tax liability computation for a REIT unit-holder.”

India’s REITs are structured via special purpose vehicles, which essentially are holders of the assets and a REIT is established via the contribution of shares of such special purpose vehicles, as opposed to a direct contribution of the real estate assets, into the REIT.

Dividends paid by a special purpose vehicle to a holding REIT attract DDT. Further income earned by the special purpose vehicles will be subject to corporate income tax, or the MAT.

“This approach artificially lowers yields as REITs distribute at least 90% of their income, unlike most Indian companies,” APREA said in a statement. While some industry experts have asked for changes to the SPV structure, “SPVs make sense – for instance, they are an elegant means of dealing with JVs and planning requirements,” according to APREA.

APREA argues that a solution is to exempt internal transfers between REIT and the special purpose vehicles from DDT.

What would an ideal framework look like?

An ideal framework would exempt REITs from tax, with income distributions being liable for tax on investors at applicable rates. This feature distinguishes markets where REITs have been more successful in countries such as Singapore and Japan.

Agarwal says policy makers have now agreed to make improvements with regards to the tax structure.

“We have amped up our dialogue with the Ministry of Finance, focusing on tax issues, in the lead-up to June’s final legislation,” says APREA.

REIT-compliant offices in top seven cities in India total about 203 million square feet, with about half of that may become listed REIT assets by 2018. Annual rentals will average $12 per annum per square foot with a cap rate at 8 percent, according to JLL’s research.

“The introduction of REIT will transform and impact overall capital flow and to a certain degree, this will impact urban planning. Ultimately this will take us to a different level of real estate development,” says Agarwal.

Shobhit Agarwal

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