India's Reit rules update sparks calls for more tax reform

India’s clarification of real estate investment trust (Reit) rules may have opened up a new channel for developers to shed assets, said industry players.

But there have been calls for further harmonisation of India’s tax code, particularly from the Asia Pacific Real Estate Association (Aprea), the Reit industry lobby group.

In the budget last Saturday, Indian finance minister Arun Jaitley presented a clearer version of Reit rules. Under the new regulations, transferring real estate assets into a Reit will not trigger a capital gains tax charge and the Reit will not be charged income tax on rental income earned from those assets.

The income will be ‘passed-through’ to investors, who will pay income tax at rates which will depend on where they are based.

But uncertainty remains over tax obligations when a special purpose vehicle is used to hold the Reit assets.

The budget proposals will be finalised when the finance bill is passed into law, which is expected to be in mid-2015. By then almost a year will have passed since India’s securities and exchange board introduced Reit rules in September 2014.

While greater clarity has been welcomed, the Reits industry’s challenge will be to offer a high enough yield to attract investors, though yesterday’s unscheduled interest rate cut by India’s central bank will go some way towards lowering the yield hurdle for issuers. Yesterday’s 25 basis point cut saw India’s benchmark interest rate reduced to 7.5%.

Peter Verwer, CEO of Aprea, said foreigners interested in highly leveraged vehicles will benefit more than domestic investors from the budget changes, since domestic investors can already earn 8-8.75% return on term bank deposits in India, equivalent to yields on commercial real estate assets in the country.

But while India is moving towards a more liberal framework for Reits, Aprea voiced concern that more needs to be done to harmonise the tax rules.

Verwer said: “The good news is that Reit income will flow through to beneficiaries – this is a big improvement on the partial flow-through previously announced. Plus, Reit IPOs and corporate IPOs will now enjoy the same capital gains tax treatment.”

The problem, said Verwer, is that a dividend tax will apply to Reit structures that employ special purpose vehicles to hold assets and distribute income to a parent fund, “which is likely to be most of them”.

In addition, the conversion to a Reit may well trigger a minimum alternate tax charge, he said. The charge is a way of ensuring that domestic firms which have used a large number of tax-efficient incentives still pay a minimum rate of tax.

Meanwhile Singapore, which has one of the most mature Reit listings markets in the region, has consolidated its position. “There are still a lot of assets in the pipeline to be listed [in Singapore] – notably assets from China,” said Teo Wee Hwee, Singapore-based real estate tax leader, fund structuring and international tax partner at PwC.

“People looking to list Reits in Singapore now are Chinese developers with assets on their balance sheet, who are facing difficulty refinancing assets.”

China has yet to develop a framework for public Reit IPOs, contrary to the headlines proclaiming the mainland’s “first Reit listing” in April last year, when Citic Securities undertook a private placement backed by real estate assets. That offering was more like an asset-backed security than a Reit, said ratings agency Fitch at the time.

The competitive landscape makes it all the more important for Reits to be tax neutral, said Aprea. A Korean company backing another high-profile Reit IPO last year also ended up taking a private – rather than public – markets approach. Some of the assets which were included in Korean department store operator Lotte’s planned Singapore listing, which was scrapped last May, were sold instead under a sale-and-leaseback structure, said Don Lim, senior director of capital markets at CBRE Korea.

Rather than tap international investors with a Singapore IPO, the department store operator found it could retain control of its assets by borrowing from domestic investors, who were willing to lend at a lower rate given Lotte’s high credit rating, Lim explained.

By taking a securitisation route, Lotte was able to borrow on the assets at a yield of 4-5% compared to the “closer to 7%” rate that investors require from a Singapore-listed Reit (S-Reit), said PwC’s Tan.