Infrastructure is the backbone of the economy. In the last few years, the government has increased its focus on infrastructure, as it is the key to making India 5 trillion dollar economy by 2025. The pace of infrastructure investment can be expected to continue in FY2023 as geopolitical uncertainties and energy crisis escalate tensions, slowing the world economy and pushing it to the brink of recession.
Globally, most investors have increased their allocation to infrastructure, which provides a stable return and protection against inflationary trends. In addition, infrastructure assets have been a preferred investment choice for sovereign wealth funds and pension funds. An efficient investment structure and revenue generating operating assets attract these investors.
In 2014, Infrastructure Investment Trusts (InvITs) were permitted as an investment vehicle to raise funds to acquire and hold infrastructure assets. Since then, 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 over a dozen have raised Rs 76,121 crore (through public issue, private placement, preferential issue, institutional placement, rights issue by December 31, 2022) in the last few days Have gathered years. This traction is expected to continue as demonetisation and infrastructure pipeline efforts pick up pace.
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A well defined, definite and clear tax regime is important for any investor including an InvIT. Indian tax laws have a specific tax regime for InvITs as well as their investors. This includes sponsor exemption on exchange of shares for units in InvITs, pass-through for interest and dividend income, concessional withholding tax rates on distributions to investors as well as incentives to specified investors investing in InvITs. However, there are still some tail-end issues that need to be resolved to provide certainty to InvITs as well as its investors.
For example, sponsors of an InvIT get the benefit of deferment of capital gains arising on exchange of shares of a special purpose vehicle (SPV) for units of the InvIT. These gains are taxed in the year in which the units are sold. This exemption appears to be available only to the sponsor of the InvIT and hence, if any other person swaps his shares in the SPV without becoming a sponsor of the InvIT, he is liable to tax. Extending the benefits available to the sponsor to other shareholders of the SPV will help INVIT to acquire new SPVs in an efficient manner.
The other aspect is the withholding tax. InvITs are required to withhold taxes from the income distributed to its investors. There are some difficulties here, which need to be overcome. With respect to the tax rate applicable on the interest distributed to a Foreign Portfolio Investor (FPI). InvITs are required to withhold tax at 5 per cent on the interest income distributed to their investors, while the final rate of tax on interest income of FPIs plus withholding rate is 20 per cent or the respective 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 at a disadvantage. This appears to be an anomaly and needs clarification to provide certainty to InvIT and FPI investors. Another related aspect is distribution of income to notified Sovereign Wealth Funds/Pension Funds. Income from an InvIT by notified funds is exempt subject to fulfillment of prescribed conditions.
Nevertheless, an InvIT is required to withhold taxes on the distribution. It enhances compliance for both InvIT and notified funds. The interest and dividend income received from the SPV is exempt in the hands of the InvIT and hence, the SPV is not required to withhold taxes on these payments.
However, this specific exclusion is limited to interest paid on loans granted by an InvIT and does not extend to interest paid on debt securities (i.e. debentures). This results in a cash trap at the InvIT level, making it unviable for the InvIT to hold debt securities in the SPV.
Finally, capital gains arising from InvIT specified listed securities (equity shares and equity oriented mutual funds) are taxed at the maximum marginal rate instead of the concessional tax rate of 10 per cent. This inconsistency appears to be inadvertent and may be because the concessional tax rate for specified listed securities was introduced by a subsequent amendment. Clarification is necessary on this.
Overall, the taxation regime for InvITs is quite conducive for capital infusion, and further streamlining it in Budget 2023 to provide certainty and clarity will boost investor confidence.
(The author is Grant Thornton, partner (tax) in India)
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