Why Dividend Distribution Tax Is A Barrier To REITs?

Real estate developer DLF is in the process of forming India's first real estate investment trust (REIT). In the current fiscal, the company is expected to file the preliminary prospectus with the Securities and Exchange Board of India. In the previous budgets, the NDA government had proposed norms that make the formation of REITs easier. In the Union Budget 2014-15, Finance Minister Arun Jaitley had proposed 'pass-through' status for REITs. But in the next Budget, he exempted REITs and special purpose vehicles (SPVs) from the minimum alternate tax (MAT).

But, many real estate developers, economists and industry experts think that the lack of clarity governing norms on taxation of dividends will be a major challenge before the creation of REITs. Reason: In the United States, for instance, REITs are expected to divide 90 per cent of its net income as dividends. But, once this is done, the net income of REITs will not be subject to tax. This is to avoid double taxation of the dividends distributed to investors, both in the hands of investors and that of the REIT.

As REITs tend to distribute much  its net income in the form of dividends to investors, it is difficult for them to expand their operations, even in countries where it is not taxed in the hands of the REIT. But, investors still invest in REITs because much of the net income is distributed in the form of dividends. So, double taxation will make this even more difficult.

Moreover, it is such a tax structure that makes REIT the most tax-efficient way to own real estate assets in many countries. If there is double taxation of dividends, this incentive will disappear. In fact, this is also the major reason why many corporations decide to become REITs—to avoid double taxation.
It is not merely that the REIT pays no corporate tax. In the US, even the money that is distributed as dividends to investors is not immediately taxable. If investors invest the money in a tax-deferred account, they will be exempted from taxation, depending on the norms that apply to their investments.