UPSC Prelims 2023 Q21: InvIT Taxation and SARFAESI — Explained
Consider the following statements:
Statement-I:
Interest income from the deposits in Infrastructure Investment Trusts (InvITs) distributed to their investors is exempted from tax, but the dividend is taxable.
Statement-II:
InvITs are recognized as borrowers under the 'Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002'.
Which one of the following is correct in respect of the above statements?
- Both Statement-I and Statement-II are correct and Statement-II is the correct explanation for Statement-I
- Both Statement-I and Statement-II are correct and Statement-II is not the correct explanation for Statement-I
- Statement-I is correct but Statement-II is incorrect
- Statement-I is incorrect but Statement-II is correct
Answer: (d) Statement-I is incorrect but Statement-II is correct
Statement-wise explanation
- Statement-I: incorrect — The statement has the tax treatment backwards. An InvIT is a 'pass-through' vehicle: under Section 115UA of the Income-tax Act, income it distributes keeps the same character in the unitholder's hands. The interest part is exempt for the trust under Section 10(23FC) but taxed in the hands of unitholders. The dividend part is normally exempt for unitholders under Section 10(23FD). It becomes taxable only if the underlying SPV has opted for the concessional corporate tax regime of Section 115BAA.
- Statement-II: correct — The Finance Act 2021 amended Section 2(1)(f) of the SARFAESI Act, with effect from 1 April 2021. The definition of 'borrower' now includes a 'pooled investment vehicle' as defined in Section 2(da) of the Securities Contracts (Regulation) Act, 1956. That term covers business trusts (InvITs and REITs) registered with SEBI, so lenders can enforce security interests against them. This is a rule about debt recovery, not taxation, so it cannot explain Statement-I in any case.
How to eliminate
Start with Statement-II. The SARFAESI change was part of the well-publicised Budget 2021 push to let InvITs and REITs raise debt, including from foreign portfolio investors. If you remember that InvITs became 'borrowers', you are down to two options: both statements correct, or only Statement-II correct. For Statement-I, use the pass-through logic. A business trust is exempt on the interest it receives from its SPVs precisely so that the interest can be taxed once, in the unitholder's hands. Dividends are exempt for the unitholder because the SPV has already paid corporate tax on those profits. A statement claiming that interest is exempt and dividend is taxable runs against this logic, which is enough to reject it. Also notice that the two statements belong to different fields: Statement-I is about income tax and Statement-II is about secured-debt recovery. Even if you think both are true, 'explains' is very unlikely. Fact to remember: for InvIT unitholders, interest is taxable and dividend is generally exempt (unless the SPV opted for Section 115BAA).
Know more
Infrastructure Investment Trusts (InvITs) were introduced by SEBI through the InvIT Regulations, 2014. An InvIT is set up as a trust under the Indian Trusts Act and registered with SEBI. It owns operating infrastructure, such as toll roads and transmission lines, usually through special purpose vehicles (SPVs). It passes most of the cash flow from these assets to its unitholders. Governments use InvITs to monetise assets. NHAI and POWERGRID, for example, have used them to recycle capital into new projects.
Taxation: the pass-through design (Section 115UA)
| Income from the SPV | In the trust's hands | In the unitholder's hands |
|---|---|---|
| Interest | Exempt, s.10(23FC) | Taxable |
| Dividend | Exempt, s.10(23FC) | Exempt, s.10(23FD), unless the SPV opted for s.115BAA |
| Rent (REITs) | Exempt, s.10(23FCA) | Taxable |
| Debt repayment / other distributions | — | Since Finance Act 2023: first reduces the cost of the units; any excess is taxed as 'income from other sources' |
The aim is to tax each rupee once. Dividends come out of profits that have already paid corporate tax. Interest is a deductible expense for the SPV, so it is taxed at the investor's end.
Debt-side reforms (Finance Act 2021)
- 'Pooled investment vehicle' was defined in Section 2(da) of the SCRA, 1956. It covers mutual funds, AIFs, collective investment schemes and business trusts registered with SEBI.
- These vehicles were added to the definition of 'borrower' under SARFAESI and under the Recovery of Debts and Bankruptcy Act, 1993. Banks can now enforce security and approach DRTs against InvITs and REITs.
- Foreign portfolio investors were allowed to buy debt securities issued by InvITs and REITs.
InvIT vs REIT: both are SEBI-regulated business trusts. InvITs hold infrastructure assets and REITs hold income-producing real estate.
In the news
Budget 2021-22 recognised InvITs and REITs as borrowers under SARFAESI and opened their debt to FPIs. Then Budget 2023-24 (February 2023), presented months before the exam, proposed taxing debt-repayment distributions by business trusts. That revived debate on how InvIT income is taxed.
NCERT Concepts to Revise
- Infrastructure Investment Trust: Both statements are about InvITs, so you need to know what this trust owns and how its income reaches unitholders.
- Asset Reconstruction Company: ARCs are registered under the SARFAESI Act, which Statement-II names. This entry places that law in context.
- Alternative Investment Fund: AIFs, like InvITs, fall under the legal category of 'pooled investment vehicle' that is relevant to Statement-II.
- Mutual fund: Mutual funds are the best-known pooled investment vehicle. Comparing them helps you see where InvITs sit legally.