Union Budget 2021 Expectations: Business Trusts are Cash-Pooling Vehicles (CPVs) that aggregate the funds from investors to fund the large infrastructure or real estate projects. A business trust can be either registered as Real-Estate Investment Trust (‘REIT’) to invest in the real estate properties, malls, offices etc. or Infrastructure Investment Trust (InVIT) to invest in infrastructural projects such as bridges, roads etc.
A specific taxation mechanism for business trust was introduced by the Finance Act, 2014. A business trust (REIT or InVIT) is governed by Section 115UA, Section 10(23FC), Section 10(23FCA) and Section 10(23FD) of the Income-tax Act. A business trust is structured as a hybrid pass-through entity, wherein it is allowed to pass certain income to its unit-holders. Consequently, the incomes which are passed to the unit-holders are exempt at the level of business trust and taxable in the hands of unit-holders.
Nature of income received by the unit-holders would be the same as it was in the hands of the business trust. For instance, if the total income received from the business trust includes interest income, it would be taxable as interest in the hands of the unit-holders under the head of other sources.
The incomes which a business trust is allowed to pass through to its unit-holders are as follows:
- Dividend received from special purpose vehicle (SPV);
- Interest received from SPV; and
- Rental income from real estate properties directly owned by REITs.
The pass-through status is provided to the business trust only in respect of the aforesaid incomes and all other incomes are chargeable to tax in the hands of the business trust. Such other income is taxable under Section 115UA at a maximum marginal rate (i.e. 42.744%) except the capital gains covered under Section 111A and Section 112.
Section 111A provides for taxability in case of short term capital gains arising from the transfer of listed shares, equity-oriented mutual funds or units of business trust, and Section 112 prescribes the rate in case of long term capital gains arising from the transfer of any long-term capital asset.
The tax rates applicable in case of business trust can be summarized in the following table:
The Finance Act, 2018, inserted a new Section 112A in the Income-tax Act to tax the income arising from the transfer of a long term capital asset, being a listed equity share or a unit of an equity oriented fund or a unit of a business trust at the rate of 10% on the amount of capital gain in excess of Rs. 100,000. Before the introduction of Section 112A, long term capital gains arising from the transfer of such specified securities were exempt under section 10(38).
Section 115UA provides for the tax rates on income arising to a business trust. It specifies that any income other than income taxable under sections 111A or 112 will be taxed at a maximum marginal rate. It does not provide any reference to income taxable under section 112A.
After the introduction of section 112A, the consequential amendment should have been made under Section 115UA as well. Since earlier long term capital gains arising from such specified securities were exempt and hence there was no mention of such incomes under Section 115UA. However, after the introduction of section 112A, on a plain reading of section 115UA, it can be interpreted that income assessable under section 112A would be taxed at MMR which does not seem logical. Since Sections 111A, 112 and 112A work on the same line, if the exception to tax income assessable under sections 111A or 112 is provided to tax them at special tax rates then, such exception should also be extended to Section 112A.
Thus, it is recommended that the capital gains covered under Section 112A should be charged to tax at the rate of 10% and not at MMR in the hands of business trust to bring parity in the provisions.
(By CA Dipen Mittal, Senior Consultant, Taxmann, with CA Shivi Mittal, Assistant Manager, Taxmann)