ECM bankers in India are hoping that the upcoming budget for the next fiscal year will include new tax rules for real estate investment trusts (Reits) and infrastructure investment trusts (InvITs), as a lack of clarity has been a big deterrent to issuance, writes Rashmi Kumar.

But following discussions with officials at the Ministry of Finance over the past few months, market watchers are now optimistic that the government will respond to their requests for a simplified tax structure, writes Rashmi Kumar.

It has been a long journey to bring about a Reit market in India with talks on setting it up dating as far back as 2008.

The Securities and Exchange Board of India (Sebi) finally gave permission for the structure in August 2014, before publishing the final regulations in September.

While it was certainly a big step forward for the country’s capital markets, issuers and investors have been slow to capitalise on the new rules, largely due to onerous tax issues surrounding Reits and InvITs.

But bankers now hope that change is on the horizon. The government, under the leadership of prime minister Narendra Modi, plans to present its 2015/2016 (April to March) budget on February 28.

As part of the announcement, ECM bankers expect tweaks to be made to the tax rules, following what they say were lengthy discussions between the MoF, investors and investment bankers since the guidelines first emerged.

“Everyone is looking at Reits at the moment,” said a Hong Kong-based syndicate banker who focuses on the Indian ECM market. “People have been asking Sebi to make changes to tax-related rules since the approval for Reits first came through and we are now expecting them to have tackled dividend distribution tax and capital gains tax.”

Reits in India are subject to various levels of tax. At the moment, Reits and InvITs have a “pass-through” status as long as they divvy out at least 90% of the net distributable cashflows to investors on a semi-annual basis. By having a pass-through status, the income is only taxed in the hands of the investor rather than at the fund level as well, thereby avoiding double taxation.

But the burden on investors is extremely high. Domestic accounts have to pay 10% withholding tax while foreign unit holders have to shell out a smaller 5%, which many reckon is unfair to local investors.

Meanwhile sponsors, who are the owners of the assets, are subject to a 10%-20% capital gains tax if they sell their holdings, while also being forced to retain a minimum 25% stake in a Reit for at least three years. Dividends distributed by the special purpose vehicles (SPVs) to the Reit also face a 15% tax.

India-listed Reits are allowed to invest only in commercial assets, which can be done either directly or through SPVs. And to make things even more complicated, if a unit holder were to sell holdings in a Reit within 36 months, the investor would be subject to a 15% capital gains tax.

But it would be exempt if it held the units for longer.

Complicated layers

These convoluted layers of tax are the big reason issuers have refrained from taking advanced steps to set up a Reit. And as a result, many property associations as well as investment bankers have approached the MoF to discuss their concerns.

“We’ve been meeting with the MoF for the past few months,” according to a head of ECM at an Indian bank. “They now know that the tax structures are not in favour of investors and they seem to be understanding the investors’ perspective.”

Conversations held with government officials included discussions on yield and benefits that a Reit could provide over other products, he added.

“A Reit is effectively a debt product for many investors and not an equity product,” he said. “Or they look at it as a hybrid. But they want yield. If a Reit yields 6% or 7% plus tax, then it isn’t interesting for investors because they can simply put their money into say a corporate bond, which will give them 9% or more of returns. The government has understood that now.”

This means bankers are now pinning their hopes on the MoF and Sebi fine-tuning the regime to ease up on both investors and issuers. This could be by way of introducing policies that are either in line with international standards or even more appealing, as listing in rival exchanges like Singapore — one of the biggest Reit hubs in Asia — offers plenty of benefits.

India vs Singapore

Reits in Singapore are exempt from rental income tax, enjoy a 2%-3% stamp duty remission on purchase of assets, while also not being subject to a 7% goods and services tax.

“We recently did an analysis internally where we compared setting up Reits in Singapore versus in India,” added the India-based head of ECM. “And Singapore worked out to be just far more advantageous.”

While the Modi government will have to work fast to make the rules more Reits-friendly, what bankers want at this stage is more clarity.

“Whether the changes that are made will provide benefits or not is not too important right now,” said the banker. “Just some clarity about how everyone will be taxed will help. The rules need to streamlined and made clearer while avoiding different tax layers. And if that happens, it will be a big boost for India’s ECM market.”

Numerous names are already starting to sound out investors to get an indication of their interest in Reits. For instance, in an analyst presentation made by property DLF on February 9, it announced plans to set up two Reits in 2016.

One will focus on its office assets and the other on retail, with the company targeting to file a first draft of its prospectus within fiscal year 2016.

DLF gets going

To that extent, the board of DLF has put together a committee of independent directors to review the company’s rental business. And the committee, in turn, has appointed JP Morgan and Morgan Stanley to advise DLF on future growth plans, including listing the Reits.

DLF, which develops residential, commercial and retail properties, has already started holding talks with strategic and financial investors to gauge their interest for its Reits. But it said that any firm decisions and plans will be determined following clarification of tax issues during the budget announcement.

“Lots of names are looking at Reits,” said the Hong Kong-based banker. “There’s DLF, Indiabulls [Real Estate], [K] Raheja [Corp] and many more. So soon it will just come down to who will come first. But the benefits are many because companies can put their assets in a proper structure while being able to release some capital.”

By Rashmi Kumar 12 Feb 2015

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