Business trusts are cash-pooling vehicles (CPVs) that aggregate funds from investors to fund large infrastructure or real estate projects.
A business trust can be either registered as a real estate investment trust (REIT) that invests in malls, offices, etc, or an infrastructure investment trust (InVIT) that invests in bridges, roads, etc.
The Finance Act, 2014, had introduced a specific taxation mechanism for business trust. Such trusts (REIT or InVIT) are 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. In such structures, the government allows the passing of certain income to unitholders (investors). Incomes passed to the unitholders are exempt at the level of business trust and taxable in the hands of the unitholders.
The nature of income that unitholders receive would be the same as it was in the hands of the business trust. For example, if the income received from a business trust includes interest income, it would be taxable as interest in the unitholders' hands.
The incomes which a business trust can pass to its unitholders include:
Dividends received from a special purpose vehicle (SPV).
Interest received from an SPV.
Rental income from real estate properties directly owned by REITs.
The pass-through status provided to the business trust is only in respect of the three incomes. All other incomes are taxable in the hands of the business trust under Section 115UA at the maximum marginal rate or MMR (42.744%). Capital gains covered under Section 111A and Section 112 are an exception to this.
Section 111A provides for taxability in the case of short-term capital gains arising from the transfer of listed shares, equity-oriented mutual funds, or units of business trust. Section 112 prescribes the rate in case of long-term capital gains arising from the transfer of any long-term capital asset.
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 such as 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 ₹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 the marginal rates which do 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.
We could see the Union Budget making suitable changes – the capital gains covered under Section 112A would be taxed at 10% instead of marginal rates in the hands of business trust to bring parity in the provisions.
Dipen Mittal is a senior consultant and Shivi Mittal is an assistant manager at Taxmann. Views expressed are their own.