Saturday August 16, 03:02 AM
Column Still grounded
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By Punit Shah
Real estate mutual funds (REMFs), an idea mooted by Sebi as early as in 2006, was given shape in April 2008, when the Sebi mutual funds regulations were amended to include a sub-set on REMFs. It has been a few months since the amendment; however, against expectations, a REMF boom is yet to hit the capital market. This article provides an overview of the tax and regulatory issues which may be discouraging genuine players from venturing into REMFs. REMFs permit mutual funds (and their investors) to take exposure to the real estate sector. Thus, they add an investment avenue, especially for retail investors who may find it difficult to invest into real estate as an asset class. There are other advantages such as increase in liquidity from developer perspective, more transparency, etc. Except for few leading asset management companies (AMCs) and a developer who have evinced interest, the new regulations have seemingly found no takers so far. There are several practical challenges inherent in the regulations. For example, under the current framework, a REMF sponsored by a real estate developer is essentially precluded from investing in properties of that developer, thus making it a non-starter for many people. There are also restrictions on investing outside the prescribed cities, caps on project exposures, holding companies with projects, developer group, etc. While these restrictions are sought to broadbase risks, they create a trade-off with investment opportunities available to a REMF. Even in the case of investment in physical real estate assets, REMFs can invest only in immoveable property on which construction is completed and the property is free from all encumbrances and litigation. Instead of blanket prohibitions, appropriate checks and balance should be introduced. REMF schemes have to be close- ended and have to be listed; there are no exceptions to this rule. REMFs can lease property for a period co-terminus with the scheme. This, again, limits investment opportunities for REMFs. Consider SEZ projects, where an SEZ developer is only permitted to lease the land/built-up space to an SEZ unit and the lease period should be for a minimum five years. This could pose a challenge where the REMF scheme expires in less than five years. Further, AMCs promoted by financial services players need to have adequate personnel and directors with real estate experience and similarly, AMCs promoted by real estate developers need to have adequate professional experience in finance and financial services for REMF to invest in other securities where a mutual fund can invest. Again, conditions imposed out of good intent will help only if these requirements are made more specific. Recent news reports suggest that Reserve Bank of India has voiced concern over foreign institutional investment (FII) into REMFs. This issue seem to have been addressed by the finance ministry in a communication to the central bank. It will be of great help if the government could formally issue a clarification on the permissibility of FII investment into REMFs. In its current form, tax regime for REMFs may not be attractive. Given the regulatory requirement of a REMF investing at least 35% of its funds in physical real estate, it may not qualify as an 'equity-oriented' mutual fund. Thus, distributions from the REMF may entail higher distribution tax and concessional rate of tax on short-term and long-term capital gains may not be available to unit holders. This is perceived to be a major dampener. REMFs will receive a significant fillip if they are treated at par with equity-oriented mutual funds. The above challenges need to be addressed for making the REMF story a success in India. The author is leader, financial services tax practice, PricewaterhouseCoopers
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