[This guest post is contributed by Yashesh Ashar and Swati Adukia. They are tax professionals and specialize in mergers and acquisition tax. Please note that the views are personal]I. Introduction The Securities and Exchange Board of India (“SEBI”) notified the SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”) on September 26, 2014 , governing the real estate investment trusts (“REITs”) in India. REITs would: (i) Invest primarily in completed, revenue generating real estate assets;(ii) Be professionally managed; and(iii) Distribute a major part of their earnings to their investors. REITs are closed ended funds set up as trusts and registered with SEBI, just like mutual funds, with investment primarily in completed and revenue-generating real estate / infrastructure assets. The units of REITs are required to be mandatorily listed and freely traded on a recognized stock exchange in India. The income earned from properties will be distributed to the investors in the trusts. In long term, REITs are expected to complement the growth and cater to the financing needs of both sectors, drive the development of capital markets, provide retail investors with less risky, fixed income investment avenues and provide exit options for financial investors as well as developers. Effective April 1, 2015, a new tax regime for REITs (also referred to as “business trusts” or “BTs”) had come into effect to provide tax certainty in the hands of BTs as well as investors and to provide for a single of level taxation. Some of the salient features of this tax regime are discussed below.II. DividendsDividends distributed by a special purpose vehicle (‘SPV’) being a company, into which a BT invests, will be subject to a dividend distribution tax (“DDT”) at the rate of 15% on gross up basis; such dividends will be exempt from tax in the hands of the BT as well as the investors in the BT.III. InterestInterest received by a BT from an SPV, enjoys a complete tax pass through; such interest will be taxed in the hands of the investors in the BT. However, the BT is required to withhold tax (“WHT”) at the rate of 5% (for non-residents investors) and 10% (for resident investors) on distribution of such interest income to the investors.IV. Capital GainsThe BT will be taxed on any capital gains realized on disposal of its assets (including shares held in an SPV) at the applicable tax rates, depending on whether the gains are short term (“STCGs”) (i.e. assets are held for 36 months or less) or long term (“LTCGs”) (i.e. the assets are held for more than 36 months). Further, the capital gains component of the income distributed by the BT to its investors will be exempt from tax in the hands of the investors.V. Capital Gains Realized by BT Investors on Transfer of their BT UnitsInvestors in a BT will be liable to pay securities transaction tax (“STT”) on sale of their units in the BT. LTCGs realized by such investors on sale of their units in the BT will be exempt from tax in their hands, while STCGs realized by such investors on sale of their units in the BT will be taxable at the rate of 15%.VI. Tax Implications for a Sponsoron Exchange of its Shares in an SPV for Units in a BTThe exchange of shares of an SPV for units in a BT will be exempt from tax in the hands of a sponsor. LTCGs realized by such sponsors on sale of their units in the BT will be exempt from tax in their hands, if the aggregate period of holding of the SPV shares and REIT units together exceeds 36 month, subject to payment of STT. STCGs realized by such sponsors on sale of their units in the BT will be taxable at the rate of 15%, subject to payment of STT.The tax implications discussed above are summarized in the following table: Entity Streams of Income and its Distribution Dividend Interest Capital Gain Other income On transfer of assets by BT On Transfer of Units of BT SPV DDT @ 20.36% on gross up basis SPV exempt from withholding tax on interest paid to BTs N/A N/A N/A BT Exempt ExemptBTs liable to WHT at 5% (for residents) and 10% (for non-residents) Taxable at 20% and 30% for LTCG and STCG, respectivelyNo withholding obligation on BTs N/A Taxable @ 30%No withholding obligation on BTs Investors (including sponsors) Exempt Taxable at 30% (subject to credit of tax withheld by BT) Exempt In case of sponsors for exchanged units: Exempt, subject to payment of STT (as equity shares) and STCG at 15%In case of other units: LTCG – exempt and STCG at 15% N/A The above provisions were the first welcome move on the part of the Indian government as it lays down a basic framework for one-level taxation and thereby, provided much needed clarity on the tax implications for BTs and their investors. However, considering the international experience, tax efficiency is critical to the success of BTs. As the law stands today, there are several taxation and regulatory challenges which need critical evaluation and amendment to make the regime of BTs successful in India. Some of the key challenges that need to be addressed in the Budget 2016 at various levels of the BT structure are discussed below. VII. Tax ChallengesA. Transfer of Assets to BTs by SponsorsThough SEBI has permitted BTs to hold assets directly, the benefit as regards exchange of the shares of the SPV by the sponsors have not been extended to exchange of assets by sponsors in lieu of units of BTs. Accordingly, such an exchange of assets for units of BTs would be treated as a taxable transfer liable to tax. Further, direct transfer of assets to BTs would have stamp duty implications for the purchasing BT in the range of 5% to 11% on the market value of the assets as determined under stamp duty laws. This would make any direct transfer of assets commercially unviable for sponsors as well as BTs. Jurisdictions such as Singapore provides specific remission of stamp duties to REITs. Similar remission/exemption may also be provided to BTs to contain the transaction costs on direct purchase of assets by BTs.B. Partial Pass-Through only for Interest IncomeThe REIT Regulations (or “BT Regulations”) permit foreign investors to make investments in BTs. However, in the absence of pass through for the capital gains and incomes other than interest income earned by BTs, the foreign investors would not be eligible to claim the benefits of exemption or concessional rates provided under the tax treaties entered into by India with the relevant jurisdiction.As regards domestic investors, non-pass through for capital gains and other incomes (other than interest) would result in investors not eligible to set-off losses from other activities against income earned from units in BTs.C. Expense Deductibility for BTs as well as InvestorsAs per the Indian tax laws, expenditure attributable to earning exempt income is not allowed as deduction. This would lead to BTs not able to claim expenditure incurred in the form of management fees, interest on monies borrowed against interest income. Also, the investors would not be able to claim deduction for any interest paid on borrowings against capital gains and other income (other than interest) received from BTs. Moreover, generally, under Indian tax laws, management fees would not be allowed as a deduction to BTs from capital gains income. Thus, a complete pass-through for the BTs may allow the investors to claim the deduction, to the extent permissible, for the expenditure incurred in making investments in BTs against capital gains and other income (other than interest income) as well.D. Use of a Limited Liability Partnership (“LLPs”) as SPVLLPs, a globally popular business entity structure, are gaining popularity even in India since their introduction in 2008. LLPs enjoy a tax advantage over companies, as LLPs are not subject to DDT on any income distributed to its partners. Such income is exempt in the hands of BTs as partners to the LLPs. Unfortunately, unlike interest income from companies as SPVs, interest income from LLPs as SPVs have not been given pass through status and therefore, would be taxable at BT level at 30%. Thus, in order to allow a widespread use of the more flexible LLP vehicle, the pass through status for BTs should be extended to income from LLPs as well. VIII. Regulatory ChallengesRecently, the Reserve Bank of India had allowed foreign investments in BTs subject to certain conditions. Further, BTs are also added as eligible borrowers for the purpose of raising external commercial borrowings.However, compared with the regulations covering REITs in other jurisdictions, BT Regulations are more stringent with regard to form of entity, initial offer size, minimum number of investors, minimum distribution norms, disclosure and governance requirements, sponsor commitment and lock-in requirements etc., to achieve the dual objective of permitting only serious players to BT and protection of investors. However, BT Regulations miss out on providing the flexibility to listed entities to transition to BT model, investments in overseas assets and flexibility for BTs to launch open ended schemes which are available to REITs in other comparable jurisdictions.IX. ConclusionThe Indian regulators have decided to adopt a cautious approach towards the BT Regulations and therefore, the BT Regulations and the associated tax regimes are at best in ALPHA mode. The successful implementation, operation and development of the BT market in India will depend heavily on the key challenges identified above. The structural reform process in India is usually a lengthy process. However, considering the heavy reliance being placed by the regulators as well as investors on BTs to further develop the capital markets for the real estate and infrastructure sectors in India, hopefully, the regulators will act swiftly to remove the inflexibilities in regulations and inefficiencies in tax laws in the upcoming Budget 2016.- Yashesh Ashar & Swati Adukia  All the tax rates mentioned in this post will be required to be increased by applicable surcharge and education cess under Indian tax laws.  Sponsor is a person/persons who set up the REIT and satisfies conditions relating to minimum net worth and minimum experience and sound track record. The sponsors are also required to meet certain minimum commitment and lock-in requirements.