All about how REITs would be taxed after finance bill amendment

Budget 2023, and later on the Finance Bill, had many announcements that hurt certain bonds and debt funds, making all gains taxable at slab rates, thus reducing their post-tax returns and attractiveness.

But amidst these moves, the Finance Bill made a climbdown — with some amendments to the proposals made in the Budget on taxability of payouts or distributions from real estate investment trusts (REITs) and infrastructure investment trusts (InvITs).

The Budget had proposed taxing of all distributions at the applicable tax slab of a REIT or InvIT investor. That would no longer be the case. Instead, the Finance Bill now proposes a layered structure for taxing payouts over the long term and also the capital gains made on sale of units.

Here’s more on how taxation would work on these instruments.

Distributions in REITs

All REITs distribute surplus amounts to unit holders periodically, usually every quarter. These payouts are made under different heads – interest, dividend, rental income, and repayment of debt. Before the Budget proposal, only the distributions made under the interest and rental income heads were taxable. The payout under the ‘repayment of debt or loan’ head was exempt from taxes.

The Budget proposed taxing the entire payout, irrespective of the head under which it was announced.  

This came as a huge blow to REITs, as it would drastically reduce their attractiveness. Embassy and Mindspace REITs distributed 80-92 per cent of their surplus under the tax-free heads, while for Brookfield the figure was a little over 52 per cent.

But the Finance Bill has gone a tad soft and proposed a tax structure that would tax dividends at your slab when they exceed the issue price. While selling units with capital gains, too, the purchase price would be lowered by the payout under the ‘repayment of debt’ head.

How payouts and capital gains would be taxed

Before getting into the taxation part, it is important to understand some associated terms. The issue price at which a REIT was issued is crucial. For example, for two REITs it was ₹275 (upper end) and it was ₹300 for the third one – it is quite literally the price at which units were issued. As mentioned earlier, the interest and rental income parts were anyway taxed. Now, the distribution related to loan repayment comes next.

Let’s say you bought a REIT at the time of issue for ₹300. Now assume the debt repayment component of distribution to the unitholder is ₹25 every year (and that there are no other payout heads), then after 12 years the total dividend paid would be ₹300. All payouts until this point would remain tax free. When in the 13th year, another ₹25 is paid, this amount would be taxed at your slab, as the dividend payouts over the years would add up to ₹325. In the fourteenth year, if another ₹30 is paid, this too would be taxed at your slab.

Even if you bought the REIT unit in the secondary market for a higher price than the issue price, only the latter would be applicable for dividends exceeding issue price. Also, when you buy from the secondary market, you need to know the payouts prior to your purchase as those would also be added and not just distributions made from the time you bought the units of the REIT.

Either the company issuing the REIT has to keep updating the total payouts made to unitholders at periodic intervals or investors need to keep track of all payments, so that calculations become easier.

Given the current payouts, it may take at least 12-15 years for the payouts to exceed issue prices for REITs.

Capital gains tax calculation has also been tweaked. Taking the above example, assume you buy REITs at ₹300 per unit in 2023 and sell at ₹400 in 2028, i.e., after five years. Let’s say the REIT paid ₹20 per unit as loan repayment in each of those five years, totalling ₹100 over this period.

The cost of acquisition would be ₹200 (₹300-100). Therefore, the capital gains would be ₹200 ( ₹400-₹200). This understanding is crucial as the cost of purchase at the time of issue would not be the cost of acquisition for calculating capital gains tax.

Long term capital gains (after a holding period of 36 months) are taxed at 10 per cent beyond ₹1 lakh.