InvITs: Small ‘potholes’ to be smoothened to avoid a ‘log-jam’

Infrastructure sector is a vital cog in the developmental wheel of an economy. According to the 12^th Five Year Plan, India requires an investment in Infrastructure sector of around 65 lakh crores over the duration of 2012-2017.

In order to meet the financial needs of cash starved infrastructure sector, SEBI introduced new investment vehicle named Infrastructure Investment Trusts (‘InvITs’) and regulations on InvITs were rolled effective from 26 September 2014.  InvITs are aimed at providing suitable platform for financing / refinancing infrastructure projects in India and also allow the retail investors to participate in the growth story of infrastructure. With the introduction of InvITs, SEBI sought to reduce dependence of the Infrastructure sector on banks for funding and facilitate release of locked up capital in the existing infrastructure projects. Further, to make the InvIT successful, the Government introduced favourable taxation framework for InvITs consecutively in Finance Budgets for FY 2014-15, FY 2015-16 and FY 2016-17.  

In continuation of its efforts to make the regulations effective and to cater to the specific needs of infrastructure players, the SEBI issued another Consultation Paper in August 2015 detailing proposed amendments to InvIT regulations and sought public comments thereon. Most important amendment proposed in the Consultation Paper was allowing two level SPV structure, which was recently approved by the SEBI in its meeting held on 23 September 2016.

As per the current regulations, InvITs can hold infrastructure assets either directly or through a single layer SPV. Per the amended regime, now InvITs are allowed to invest in infrastructure projects through Holding company (‘Holdco’) structure whereby infrastructure projects/assets are held by the SPV, subject to fulfilment of certain conditions. The logic behind this amendment is that infrastructure assets in India are generally held through different SPVs, which in turn are held by a Holding Company HoldCo.

While the SEBI has approved the two layer SPV structure (although the notification detailing the fine prints are yet to come), corresponding changes in the Income-tax Act also needs to be made to extend the similar favourable taxation regime to the two layer SPV structure. 

For instance, the exemption from the dividend distribution tax is available on dividend declared by SPV to InvIT in a single level SPV structure.  Whereas, under the two layer SPV structure, dividend will travel from SPV to HoldCo and from Holdco to InvIT. The dividend paid by SPV to HoldCo will not enjoy the exemption under the current taxation scheme and will be subjected to dividend distribution tax @ 20.358 %. This will result into an additional tax cost and will have a significant adverse impact on the investors return as compared to single level SPV structure.

Further, under the single level SPV (company) structure, interest income earned from SPV is exempted in the hands of InvIT under the current taxation regime.  However, there is no provision providing similar exemption to interest income earned by the HoldCo from SPV under the two layer structure. This additional tax cost could make the structure tax inefficient unless there is a back to back interest pay out by the HoldCo.

While the two layer SPV structure is essential having regard to the current industry practice due to various commercial reasons, it would be equally important that the consequential tax leakages are addressed appropriately to bring tax parity with single level SPV structure.

Other than above tax issue, it needs to be examined whether CIC or NBFC regulations will be applicable to HoldCo under the two level SPV structure as the HoldCo will be merely holding the investments in the underlying SPVs. The SEBI should provide exemption from CIC or NBFC regulations to the HoldCo under the two layer SPV structure as InvITs are already regulated by SEBI.

Further, if InvIT is regarded as foreign owned and controlled (InvIT will be regarded as foreign owned and controlled if the Sponsor or the Manager or the Investment Manager of InvIT is not Indian ‘owned and controlled’ as per RBI Regulations) under the FDI Policy, then the investment in HoldCo will require Government/ FIPB approval.

The SEBI has been very pro-active to the demands of various stakeholders to make InvITs successful and the subject relaxation permitting two level structure is a welcome step in this direction.  We recommend that the Government should provide clarity on tax and regulatory matters relating to two level SPV structure through appropriate amendments in the regulations and Income tax Act in order to provide much needed impetus for successful take off of InvITs. These small “potholes” on the path of InvIT should be smoothened quickly before it reaches a “log jam” situation.