Meaning of Business Trust and Taxation Of Real Estate Investment

Every day, we see new methods for doing business. There was a time when sale purchase can be done with the physical presence of seller and buyer and recently the concept of the online market becomes so evolved that now it covers the major market share. Likewise, the concept of a business trust is becoming famous. If you are in the finance or taxation field then it is very important for you to understand this concept because this going to be the future of India. 

Business Trust

In layman language, a business trust works like a mutual fund. Business trust can be of Real estate investment trust (REIT) and Infrastructure investment trust (InVIT).

 Real estate investment trust (REIT) and Infrastructure investment trust (InVIT) allows small investors to access large income-producing real estate assets and infrastructure facilities like how mutual funds access the stocks.

In this article, we will understand the need for business trust, how business trust works and taxation of Real estate investment trust (REIT)

Need for Business trust

The big question is why there is a need for business trust in India. Well, the answer is quite simple. Not all person is financially literate for making the best investment in real estate market or if they have a knowledge of the best investment then they might have a lack of capital for making the investment in such big projects.

Mostly the real estate projects consist of high-value investments and not all person is capable of making the investment in such projects. For example, there is a construction of a mall that requires a capital of Rs.100 crore hence an average investor cannot make the investment in such big projects. For this, the concept of business trust has come into force. Business trust issue units and buys the property. These unitholders are the investors who want to invest in such property. Hence, with this, they can make an investment in these properties.

Now I will tell you the whole process of how the business trust (Real state investment trust (REIT) and Infrastructure investment trust (InVIT) ) works:

If you read the legal language of the business trust then you may find it a little complicated. Hence, I will explain through a story. In this story, there are 3 characters:

  • 1st is Business trust
  • 2nd is Nikhil (property dealer)
  • 3rd is ABC Limited (A real estate company)
  • 4th is Mohit (An Investor)

Now let’s begin the story

Nikhil is a property dealer. He incorporated a company Bhatia Associates private Limited (BAPL) for the purpose of construction of the mall.

The cost of the construction is Rs.100 Lakhs. The capital of the company is Rs.10 Lakh which is owned by Nikhil. The company has taken a bank loan of Rs.90 Lakh with interest rate @ 15%.

Note: Under real estate, the developers mostly create a company for each project. Hence such a company is called a special purpose vehicle that has been created for such a particular project.

Note: You might be surprised that how the rate of interest from the bank is so high, well in the case of the real estate market, the risk is quite high hence the bank charge a high rate of interest.

The position of the balance sheet of BAPL is as follows:

Balance Sheet of BAPL as on 31.03.2019
Liability Amount Assets Amount
Share capital 10 Lakh Mall 100 Lakh
 
Bank Loan 90 Lakh  
100 Lakh   100 Lakh

As per the above balance sheet, Rs.10 Lakh is companies own capital however Rs.90 Lakhs is the bank loan on which the company has to pay the interest @ 15% which the company did not want to pay. 

This is the problem for BAPL.

There is one another character in the story i.e. Mr. Mohit, who is an investor who wants to make the investment in this mall but he cannot make the investment due to the requirement of the heavy amount of capital. This is the problem for Mr. Mohit.

Now, the main character of the story will come i.e. business trust. The business trust shall do the following things:

  • The business trust shall by the controlling interest of BAPL by issuing units to the shareholders of BAPL in exchange shares of BAPL.

Here, the shareholder is Nikhil and he sells his shares and buys the units of business trust.

  • By taking the controlling interest of BAPL, business trust becomes the ultimate owner of such a mall.
  • Now, Mr. Mohit may buy the units of business trust through which it becomes the investor of such a mall. Hence, the problem of Mr. Mohit gets solved.
  • The business trust shall give a loan to BAPL of Rs.90 Lakhs which it received from the issue of units. BAPL shall repay its loan to the Bank hence the problem of BAPL is solved and now they will pay the interest to business trust.

In simple words, Now the owner of BAPL is business trust and the owner of a business trust is Mohit and Nikhil hence the control remains the same except few changes.

Hence, by business trust, the problem of Mr. BAPL and Mr. Mohit gets resolved. Now let us discuss the taxability if Business trusts:

As we discussed above that the business trust can be of Real estate investment trust (REIT) and Infrastructure investment trust (InVIT).

REIT makes direct investments in real estate properties that are producing rent. They also invest in companies (SPV) which are holding real estate properties that are producing rent.

We have discussed that the business trust gives a loan to the SPV i.e. BAPL but do you know that from where it earned the income.

Following are the ways in which a business trust earns its income:

  • Earns Rental income on rented properties
  • Earns interest on Loan given to special purpose vehicle (I.e. BAPL in above example)
  • Since the owner of the SPV is business trust hence it earns the dividend income from SPV
  • Earns Long term capital gains and Short term Capital Gain on sale of properties
  • Earns Long term capital gains and Short term Capital Gain on sale of shares on the stock exchange and interest on FRR etc.

Register One Person Company

Other Points

  • Units of a business trust are to be compulsorily listed on a stock exchange in India.
  • For units of business trust, the holding period should be more than 36 months to qualify the long term gains.
  • STT is leviable when the units of a business trust are sold on the stock exchange.
  • STT is also levied on unlisted units of business by any holder of such units.

In the above, I have told you that business trust buys the controlling interest of SPV by issuing the units to shareholders of such SPV in exchange for the sale of shares to business trust.

Here, the shareholder of SPV is selling its share to Business trust then whether the capital gain shall arise on such shareholder. The answer is no. The reason is section 47(xvii) of the income tax act, 1961. As per this section, there is a certain capital gain that does not consider the transfer and hence no capital gain shall be levied on such shareholders of SPV. Also, it is a common sense, because in this particular case, the shareholder has not received anything except the units of business trust. Hence if the shareholder has not received the cash then how can he liable for the payment of capital gain.

Also, where the section 47 levies, the other section i.e. 49 (Cost of purchase) and Section 2(42)(A) (Period of holding) of the income tax act, 1961 shall also be levied.

As per section 2(42)(A), when the business trust wants to sell the shares of SPV, then the period of holding shall begin from the date on which shareholder has actually bought such share from SPV. Also. As per section 49, the cost of shares in the hands of business trust shall be the cost at which the shareholder buys the shares from SPV.

As per section 115-O of the income tax act, 1961, where the domestic company distributes the dividend to its shareholder then such a company has a liability to deduct the DDT (Dividend Distribution Tax). The applicability of section 115-O; the dividend distributed by SPV to business trust;

  • Out of current income arising on or after the date of acquisition of 100% equity shares of SPV by the business, trust is exempt from DDT.
  • Out of the accumulated profits and current profits up to the date of acquisition of 100% equity shares of SPV by the business, trust is liable for DDT.

Such a dividend is exempt in the hands of business trust. The dividend component distributed to unitholders is also exempted from exempt in their hands.

Dividend component in Income distributed to unitholder is also exempts under section 10(23FD)

However, if the amount of dividend is exceeding Rs.10 Lakhs, then dividends in excess of Rs.10 Lakhs shall be taxable in the hands of business trust @ 10% under section 11BBDDA if Income-tax Act, 1961. The proportionate share of such dividends in the hands of unitholders shall be exempt under section 10(23FD) and section 115BBDDA shall not apply to the unitholders.

When the unitholders sell their units in stock exchange then they shall be eligible for taking the benefits of section 111A in case of short term capital gain and 112A in case of long term capital gain.

Now let’s talk about the dividend received to business trust. Business trust can receive the dividend from SPV (BAPL in our above example) or any other company in which the business trust has made the investment. Such dividends shall be exempted in the hands of business trust under section 10(34).

However, if the amount of dividend exceeds Rs.10Lakhs then such business trust being the shareholders shall have to pay the tax @ 10% under section 115BBDA.

In the above paragraph, I have explained that the business trust gave the loan to SPV and charge interest on it. As per the income tax provisions, no TDS shall be deducted on the interest amount paid by the SPV to business trust.

I hope this article will help you to understand the concept of business trust and its taxation. Still, if you have any doubt in relation to taxation of business trust, then you can ask us through what’s app or Email. We will be happy to give our assistance.

2 thoughts on “Meaning of Business Trust and Taxation Of Real Estate Investment”

Leave a Comment