How Budget 2023 Can Reduce Tail-End Tax Issues To Boost InvIT Momentum

Infrastructure is the backbone of the economy. In the last few years, the government has sharpened its focus on infrastructure, as it is the key to making India a $5-trillion economy by 2025. As the geopolitical uncertainties and energy crisis continue to increase the stress, slowing the world economy and pushing it to the brink of a recession, one can expect the momentum on infrastructure investment to continue in FY2023.

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Globally, most investors have increased their allocations to infrastructure, which tends to provide a steady return and protection in an inflationary trend. This apart, infrastructure assets have been a preferred investment for sovereign wealth funds and pension funds. An efficient investment structure and revenue-generating operating assets are what appeal to these investors.

In 2014, infrastructure investment trusts (InvITs) were allowed as an investment vehicle to raise funds to acquire and hold infrastructure assets. Since then, the investment policies and regulations have been aligned to create a conducive environment for promoting investment in InvITs. Today, we have 19 InvITs registered with SEBI and more than a dozen have raised funds to the tune of Rs 76,121 crore (through public issue, private placement, preferential issue, institutional placement, rights issue till December 31, 2022) in the last few years. This traction is expected to continue as efforts on monetisation and infrastructure pipeline pick pace.

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A well-defined, certain and clear tax regime is critical for any investor, including for an InvIT. The Indian tax laws have a specific tax regime for InvITs as well as their investors. This includes an exemption to the sponsor on swap of shares for units in InvIT, pass-through for interest and dividend income, concessional withholding tax rates on distribution to investors as well as incentives to specified investors investing in InvITs. However, there are still a few tail-end issues that need to be ironed out to provide certainty to the InvITs as well as its investors.

For instance, sponsors to an InvIT have the advantage of deferring the capital gains arising on the swap of shares of the special purpose vehicle (SPV) in exchange of units of the InvIT. These gains are then taxed in the year in which the units are sold. This exemption appears to be available only to a sponsor of the InvIT and hence, if any other person swaps his shares in the SPV for units without being a sponsor to the InvIT, is subject to tax. Extending the benefit available to a sponsor to other shareholders of the SPV, would facilitate InvITs to acquire new SPVs in an efficient manner.

Another aspect is withholding tax. InvIT is required to withhold taxes from the income distributed to its investors. Here, there are a few difficulties, which need to be resolved. One is in respect of withholding tax rate to be applied on interest distributed to investors who are foreign portfolio investors (FPIs). InvIT is required to withhold tax at 5 per cent on the interest income distributed to its investors, whereas the withholding tax rate as well as the final rate of tax on the interest income of FPIs is 20 per cent or the relevant tax treaty rate, whichever is beneficial.

For foreign companies (other than FPIs), interest income distributed by InvITs is specifically taxed at 5 per cent. This puts FPI investors in a disadvantageous position. This seems to be an anomaly and needs clarification to provide certainty to the InvIT and the FPI investors. Another related aspect is the distribution of income to notified sovereign wealth funds/ pension funds. Income received by notified funds from an InvIT is exempt subject to fulfilling the prescribed conditions.

Nonetheless, an InvIT is required to withhold taxes on the distributions. This increases the compliance for both the InvIT and the notified funds. The interest and dividend income received from SPV is exempt in the hands of InvIT and therefore, SPV is not required to withhold taxes on these payments.

However, this specific exclusion is limited to interest paid on loan given by an InvIT and does not extend to interest paid on debt securities (ie debentures). This results in a cash trap at InvIT level making it inefficient for the InvIT to hold debt securities in the SPV.

Lastly, capital gains earned by InvITs from specified listed securities (equity shares and equity-oriented mutual funds), are taxed at a maximum marginal rate instead of the concessional tax rate of 10 per cent. This inconsistency seems to be inadvertent and could be because the concessional tax rate for specified listed securities was introduced by a subsequent amendment. A clarification on this is essential.

On the whole, the taxation regime for InvITs is fairly aligned to harness capital, and streamlining it further in the Budget 2023 to provide certainty and clarity will give a fillip to investor confidence.

(The author is partner (tax) at Grant Thornton Bharat)

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