UNIT-HOLDERS OF BUSINESS TRUST SHALL BE EXEMPT FROM PAYING TAX ON DIVIDEND IF SPV OPTS FOR SECTION 115BAA

1.1.           Taxability of dividend income

Business Trusts (Real Estate Investment Trusts (REITs) or Infrastructure Investment Trusts (InVITs)) have been provided the status of pass-through entities under the Income-tax Act whereby they are allowed to pass certain incomes to their unit  holders without paying tax thereon and, consequently, such income is taxable in the hands of the unit-holders.

The structure of a business trust is similar to that of a mutual fund wherein sponsor sets up the REITs or InVITs to collect money from the general public for investing on their behalf in income-generating real estate properties or infrastructure activities. The investment is made either by REITs or InVITs directly or through Special Purpose Vehicle (SPV), being an Indian company, in which the business trust holds the controlling interest and 50% or more equity share capital.

The taxability of business trust is governed by sections 115UA, 10(23FC) and 10(23FD) of the Income-tax Act whereby business trusts can pass certain incomes to its unit holders without paying the tax at their end due to specific exemption provided under section 10(23FC) and, consequently, such income is taxable in the hands of the unit holders. Incomes which a business trust can pass to its unit holders are as follows:

a)     Interest received from Special Purpose Vehicle (SPV);

b)     Dividend received from SPV; and

c)      Rental income of REITs from real estate property.

Thus, if a business trust distributes the aforesaid  incomes to its unit holders then   such income shall be taxable in the hands of the unit holders under section 115UA as  if they have earned such  income  by directly investing in  SPV or real estate properties. All other incomes which a business trust distributes to its unit holders  shall be exempt in the hands of the unit holders under section 10(23FD) of the Income-tax Act.

The Finance Bill, 2020 (as passed by the Lok Sabha) makes an amendment to section 10(23FD) to provide that no exemption shall available to a unit holder of business trust in respect of a dividend received from SPV if such SPV has not exercised the option of section 115BAA of the Income-tax Act.

Section 115BAA was introduced with effect from Assessment Year 2020-21 through the Taxation Laws (Amendment) Act, 2019 to provide for a concessional tax rate of 22% in case of domestic companies which do not claim specific deductions,

exemptions and allowances. Section 115BAA has been inserted to simplify the tax structure and to reduce the litigations arising due to numerous tax exemptions and deductions. The new corporate tax regime reduces the tax rates to 22%, but in return, the companies have to forego certain exemptions and deductions.

The possible reason to amend section 10(23FD), that restricts the exemption for dividend income if an SPV does not opt for tax regime of Section 115BAA, could be  the intention of the Government to pursue SPV to opt for section 115BAA. Where an SPV opts for new tax regime, no tax shall be levied at the time of distribution of dividend to business trust by an SPV or at the time of further distribution of such dividend by a business trust to the unit holder. Thus, dividend distributed by SPV who opts for section 115BAA shall be completely tax-free. Whereas, if an SPV opts to pay tax as per normal provisions of the Act, the unit holders will eventually be liable to pay tax on dividend distributed by SPV.

The taxability of dividend distributed by SPV after the Finance Bill, 2020 (as passed by the by Lok Sabha) can be explained with the help of the following table:

Particulars	SPV opts for section 115BAA	SPV does not opt for section 115BAA	Comments
Is SPV liable to pay DDT on dividend distributed to business trust?	No	No	DDT has been abolished by the Finance Bill, 2020. Thus, SPV shall not be required to pay DDT on distribution of dividend to business trust*.
Is business trust liable to pay tax on dividend received or receivable from SPV?	No	No	Dividend received from SPV by the business trust shall be exempt from tax under section 10(23FC).
Is unit-holder liable to pay tax on dividend received from a business trust?	No	Yes	The Finance Bill, 2020 (as passed by the Lok Sabha) provides an exemption under section 10(23FD) to unit- holders only if SPV opts for section 115BAA. The dividend shall be taxable in the hands of the unit holder if SPV does not opt for section 115BAA.

* An SPV was not liable to pay DDT even before the abolition of DDT by the Finance Bill, 2020 but only when a business trust holds the whole of the nominal value of equity share capital of the SPV.

1.2.           Consequential amendment to section 194LBA

Section 194LBA provides for deduction of tax at source by a business trust from income distributed to unit-holders. As dividend received by a unit-holder from a business trust will be exempt from tax if an SPV opts for section 115BAA, the

consequential amendment is also needed to section 194LBA to provide that no tax shall be deducted in such cases. The Finance Bill, 2020 (as passed by Lok Sabha) makes an amendment to Section 194LBA which conflicts with the amendment to Section 10(23FD).

A new sub-section (2A) is inserted under section 194LBA which reads as under:

“Nothing contained in sub-sections (1) and (2) shall apply in respect of income of the nature referred to in sub-clause (b) of clause (23FC) of section 10, if the special purpose vehicle referred to in the said clause has not exercised the option under section 115BAA.”

Sub-section (1) and sub-section (2) of section 194LBA provides for deduction of tax from income distributed to unit-holders by a business trust. Sub-clause (b) of clause (23FC) of section 10 talks about dividend received or receivable from SPV.

Section (2A) has been inserted to provide that no tax shall be deducted by a business trust from dividend distributed to the unit-holders provided such dividend is distributed out of sum received as dividend from an SPV and the SPV has not exercised the option under section 115BAA. In other words, if SPV has opted for section 115BAA then section 194LBA requires business trust to deduct tax from dividend distributed to unit-holders. Whereas, an amendment to section 10(23FD) provides an exemption in such a case. It appears that this is an unintentional mistake and the words ‘has not exercised’ in sub-section (2A) should be ‘has exercised’.