Dividend distributed by SPV to business trust exempt from levy of DDT [Section 115-O] 

Related amendment in sections: 10(23FC), 10(23FD), 115UA& 194LBA :

(i) The Finance (No.2) Act, 2014 had inserted Chapter XII-FA providing for a special taxation regime in respect of business trusts, comprising of Real Estate Investment Trust (REITs) and Infrastructure Investment Trust (Invits) regulated by SEBI.

(ii) Under the SEBI regulation, these business trusts can hold the income generating asset either directly or through a Special Purpose Vehicle (SPV). SPV is defined to mean any company in which REIT holds or proposes to hold controlling interest which is not less than 50% of the shareholding. The other conditions are that the SPV should hold at least 80% of the assets in properties and it should not invest in other SPVs.

(iii) Under this regime, there is no multiple taxation, i.e., only the income in respect of which the business trust enjoys a pass through status, is subject to tax in the hands of the unit holder, namely, interest income from SPV and rental income arising to REIT from real estate property directly held by it. An income which is subject to tax in the hands of the business trust is not charged to tax once again in the hands of the unit-holder, for example, capital gains on sale of developmental properties.

(iv) In respect of assets held through an SPV, being an Indian company, the company pays normal corporate tax and thereafter, when the income is distributed to the REIT being a shareholder, it pays dividend distribution tax. Therefore, the income distributed is exempt both in the hands of REIT [by virtue of section 10(34)] and also its investors [by virtue of section 10(23FD)].

(v) There is a similar regime in case of Invits, with the only exception being that there is no pass through for Invits holding income generating assets directly as normally, such large infrastructure projects are not held directly in the trust but are held through an SPV.

(vi) The levy of dividend distribution tax on the SPV at the time when its distributes dividend to the business trust makes the business trust structure tax inefficient and has an adverse impact on the rate of return for the unit-holder. This problem is critical since as per SEBI regulations, both the SPV and business trust have to distribute 90% of their operating income to the investors, whereas in case of normal real estate company, there is no requirement of such annual distribution of dividends. Consequent to the additional levy of DDT and associated tax inefficiency, the REITs and Invits are yet to take off.

(vii) For addressing this concern, the taxation regime for business trusts (REITs and Invits) and their investors has been further rationalised by providing for a special dispensation and exemption from levy of dividend distribution tax.

(viii) The key amendments in the special taxation regime for business trusts are :

(a) Dividend distributed by SPV to the business trust would be exempt from levy of DDT.

(b) Such dividend received by the business trust and its investor shall not be taxable in the hands of business trust or the unit holders;

(c) Exemption from levy of DDT would be applicable only in cases where the business trust either holds 100% of the share capital of the SPV or holds all of the share capital other than that which is required to be held by any other entity as part of any direction of any Government or specific requirement of any law to this effect or which is held by Government or Government bodies;

(d) Exemption from levy of DDT would be applicable only in respect of dividends paid out of current income after the date when the business trust acquires the shareholding referred in (c) above in the SPV. The dividends paid out of accumulated and current profits upto this date shall be liable for levy of DDT as and when any dividend out of these profits is distributed by the company either to the business trust or any other shareholder.

(e) Summary of amendments :

	Section	Provision
(1)	115-O(7) (w.e.f. 1.6.2016)	Exemption from levy of DDT on distributions by a SPV to a business trust
		Non-levy of DDT on distributed profits in respect of any amount declared, distributed or paid by way of dividends (whether interim or otherwise) out of its current income –
		(a)	By a domestic company in which a business trust has become a holder of the whole of the nominal value of equity share capital of the company (excluding the equity share capital required to be held mandatorily by any other person in accordance with any law for the time being in force or any directions of Government or any regulatory authority or equity share capital held by anyGovernment or Government body).
		(b)	On or after the date of acquisition of such holding referred  to in (a) above by the business trust
		However, this exemption would not be applicable in respect of any amount declared, distributed or paid at any time by the domestic company out of its accumulated profits or current profits upto the date of acquisition by the business trust of the specified holding [as per (a) above] in the SPV.
(2)	10(23FC) (w.e.f.A.Y.2017-18)	Exemption of dividend referred to in section 115-O(7) in the hands of the business trust. This is provided for in new sub-clause (b) of section 10(23FC).
(3)	10(23FD) (w.e.f.A.Y.2017-18)	Exemption of dividend referred to in section 115-O(7) in the hands of the unit-holders.   This section exempts any distributed income, referred to in section 115UA, received by a unit holder from the business trust, other than that proportion of the income which is of the same nature as the income referred to in –   (i) Sub-clause (a) of Clause (23FC) i.e., income of a business trust by way of interest received or receivable from a SPV;   (ii) Clause (23FCA) i.e., rental income from real estate asset directly owned by the REIT.   Consequently, dividend income, which is covered in sub-clause (b) of clause (23FC), is exempt in the hands of the unit holders.
(4)	115UA(3) (w.e.f. A.Y.2017-18)	This section provides for taxability of distributed income or any part thereof, which is in the nature of interest income received by the business trust from the SPV [referred to in sub-clause (a) of section 10(23FC)] or rental income from real estate assets owned directly by the REIT [referred to in section 10(23FCA)], in the hands of the unit holders.   Consequently, dividend income referred to in subclause (b) of section 10(23FC), which is exempt in the hands of the business trust would not also be taxable in the hands of the unit holders on distribution.
(5)	(5) 194LBA (w.e.f. 1.6.2016)	This section requires deduction of tax at source by the business trust on distribution to the unit holders, of income which is in the nature of interest income received by the business trust from the SPV [referred to in sub-clause (a) of section 10(23FC)] or rental income from real estate assets owned directly by the REIT [referred to in section 10(23FCA)].   Consequently, no tax is required to be deducted at source on distribution of income which is in the nature of dividend referred to in sub-clause (b) of section 10(23FC), by the business trust to the unit-holders, since the same is exempt in the hands of the unit holders.

 

Example

A business trust, registered under SEBI (Real Estate Investment Trusts) Regulations, 2014, gives particulars of its income for the P.Y.2016-17:

(1) Interest income from Beta Ltd. – ` 4 crore;

(2) Dividend income from Beta Ltd. – ` 2 crore (received on 1st October, 2016);

(3) Short-term capital gains on sale of listed shares of Beta Ltd. – ` 1.5 crore;

(4) Short-term capital gains on sale of developmental properties – ` 1 crore

(5) Interest received from investments in unlisted debentures of real estate companies – ` 10 lakh;

(6) Rental income from directly owned real estate assets – ` 2.50 crore

Beta Ltd. is an Indian company in which the business trust holds controlling interest. The business trust holds 100% of the shareholding of Beta Ltd.

Discuss the tax consequences of the above income earned by the business trust in the hands of the business trust and the unit holders, assuming that the business trust has distributed ` 10 crore to the unit holders in the P.Y.2016-17.

Answer

Tax consequences in the hands of the business trust and its unit holders

(1) Interest income of ` 4 crore from Beta Ltd.: There would be no tax liability in the hands of business trust due to pass-through status enjoyed by it under sub-clause (a) of section 10(23FC) in respect of interest income from Beta Ltd., being the special purpose vehicle. Therefore, Beta Ltd. is not required to deduct tax at source on interest payment to the business trust.

However, the business trust has to deduct tax at source under section 194LBA –

• @ 10%, on interest component of income distributed to resident unit holders; and

• @ 5%, on interest component of income distributed to non-corporate nonresident unit holders and foreign companies.

Interest component of income distributed to unit holders is taxable in the hands of the unit holders – @ 5%, in case of unit holders, being non-corporate nonresidents or foreign companies; and at normal rates of tax, in case of resident unit holders.

The interest component of income received from the business trust in the hands of each unit-holder would be determined in the proportion of 4/11.1, by virtue of section 115UA(1).

(2) Dividend income of ` 2 crore from Beta Ltd.: The dividend distributed by the SPV to the business trust is exempt by virtue of section 115-O(7), since the SPV is a specified domestic company in which the business trust has become the holder of whole of the nominal value of equity share capital of the company. Further, there would be no tax liability in the hands of the business trust, due to specific exemption provided under sub-clause (b) of section 10(23FC).

Any distributed income referred to in section 115UA, to the extent it does not comprise of interest [referred to in sub-clause (a) of section 10(23FC)] and rental income from real estate assets owned directly by the business trust [referred to in section 10(23FCA)] received by unit holders, is exempt in their hands under section 10(23FD). Therefore, by virtue of section 10(23FD), there would be no tax liability on the dividend component [referred to in sub-clause (b) of section 10(23FC)] of income distributed to unit holders in their hands.

(3) Short-term capital gains of ` 1.50 crore on sale of listed shares of Beta Ltd.: As per section 115UA(2), the business trust is liable to pay tax@15% under section 111A in respect of short-term capital gains on sale of listed shares of special purpose vehicle. There would, however, be no tax liability on the capital gain component of income distributed to unit holders, by virtue of the exemption contained in section 10(23FD).

(4) Short-term capital gains of ` 1 crore on sale of developmental properties: It is taxable at maximum marginal rate of 35.535% in the hands of the business trust as per section 115UA(2). There would be no tax liability in the hands of the unit holders on the capital gain component of income distributed to them, by virtue of the exemption contained in section 10(23FD).

(5) Interest of ` 10 lakh received in respect of investment in unlisteddebentures of real estate companies: Such interest is taxable @35.535%, being the maximum marginal rate, in the hands of the business trust, as per section 115UA(2). However, there would be no tax liability in the hands of theunit holders on the interest component of income distributed to them, by virtue of section 10(23FD).

(6) Rental income of ` 2.50 crore from directly owned real estate assets: Any income of a business trust, being a REIT, by way of renting or leasing or letting out any real estate asset owned directly by such business trust is exempt in the hands of the trust as per section 10(23FCA).

Where the income by way of rent is credited or paid to a business trust, being a REIT, in respect of any real estate asset held directly by such REIT, no tax is deductible at source under section 194-I.

The distributed income or any part thereof, received by a unit holder from the REIT, which is in the nature of income by way of renting or leasing or letting out any real estate asset owned directly by such REIT is deemed income of the unit holder as per section 115UA(3 ). The business trust has to deduct tax at source@10% under section 194LBA in case of distribution to a resident unit holder and at rates in force in case of distribution to a non-resident unit holder.

The rental income component received from the business trust in the hands of each unit-holder would be determined in the proportion of 2.5/11.1, by virtue of section 115UA(1).

Notes:
(1) New Chapter XII-FA contains the special provisions relating to business trusts. Section 115UA(1) provides that any income distributed by a business trust to its unit holders shall be deemed to be of the same nature and in the same proportion in the hands of the unit holder, as it had been received by, or accrued to the business trust.

(2) Sub-clause (a) of section 10(23FC) exempts any income of a business trust by way of interest received or receivable from a Special Purpose Vehicle (SPV). Thus, the business trust enjoys a pass-through status in respect of interest received or receivable from a SPV.

(3) Sub-clause (b) of section 10(23FC) exempts any income of a business trust by way of dividend received from SPV, being a specified domestic company in which a business trust has become the holder of the whole of the nominal value of equity share capital of the company. Such dividend income is also exempt in the hands of the unit-holder.

(4) SPV means an Indian company in which the business trust holds controlling interest and any specific percentage of shareholding, as may be required by the regulations under which such trust is granted registration [not less than 50% as per the current SEBI (Real Estate Investment Trusts) Regulations, 2014]. Such company should hold not less than 80% of its assets directly in properties
and should not invest in other SPVs and should not be engaged in any activity other than holding and developing property and any other activity incidental to such holding or development.

Since Beta Ltd. is an Indian company in which the business trust holds controlling interest and 100% of shareholding, it is a special purpose vehicle. It is presumed that Beta Ltd. fulfills the other conditions specified in the regulations to qualify as an SPV.

(5) The distributed income of the business trust, to the extent it comprises of interest referred to in sub-clause (a) of section 10(23FC) and rental income referred to in section 10(23FCA), is deemed to be the income of the unit holder in the previous year of distribution and subject to tax in the hands of the unit holder in that year. Accordingly, the business trust is required to deduct tax at source on the interest component and rental component of income distributed to its unit holders.

(6) Any distributed income referred to in section 115UA, to the extent it does not comprise of interest referred to in sub-clause (a) of section 10(23FC) and rental income referred to in section 10(23FCA), received by unit holders is exempt in their hands under section 10(23FD).

(7) Section 115UA(2) provides that subject to the provisions of sections 111A and 112, the total income of a business trust shall be chargeable to tax at the maximum marginal rate .