💎How are investments in AIFs and REITs taxed in the hands of investors?


In this newsletter, let's explore how investments in AIFs and REITs are taxed –

1. AIFs (Alternative Investment Funds)

What are AIFs?

AIFs are privately pooled investment vehicles, typically formed as a trust or a company. AIFs offer an alternative way to invest in assets like real estate, private companies, commodities, or even artworks. The risks are generally higher, but the potential rewards can also be high.

AIFs are classified into 3 categories, and their tax treatment varies based on the fund's classification and legal structure.

AIF classification

AIFs are categorised into 3 main types:

  • Category I AIFs: These include funds that invest in startups, social ventures, infrastructure, or other sectors deemed socially or economically beneficial by the government.
  • Category II AIFs: This category includes private equity funds, debt funds, and funds that do not fall in Category I and III.
  • Category III AIFs: These funds use complex trading strategies and may leverage facilities such as derivatives for generating returns. Hedge funds typically fall under this category.

SEBI permits AIFs to be set up in various legal structures such as a trust, a company, a Limited Liability Partnership (LLP), or a body corporate. Usually, trust structure is the most common structure.

Here's how investments in AIFs are taxed –

Category I and II AIFs are granted pass-through status.

Pass-through means that the income generated by the fund will be taxed in the hands of the investor and not at the fund level.

Income (other than business income) earned by Category I and II AIFs are exempt from tax in the hands of the AIF. The AIF is exempt from all tax obligations (excluding withholding tax on distribution) on the investment income.

For Category III AIFs, the pass-through tax regime has not been extended, and the investment income is taxed in the hands of the AIF.

Below is a summary of the tax payables by investors on investments made in Alternative Investment Funds (AIFs):

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2. Real Estate Investment Trusts (REITs)

REITs are investment vehicles that pool the money of several investors to purchase, own, manage, or finance income-producing real estate properties.

In India, there are primarily 3 types of REITs:

  1. Equity REITs: These REITs own and manage income-producing real estate. They generate income by collecting rent on and from the sale of the properties they hold for the long term.

  2. Mortgage REITs: These REITs lend money to real estate owners and operators directly through mortgages and loans or indirectly through acquiring mortgage-backed securities.

  3. Hybrid REITs: These REITs are a combination of equity and mortgage REITs. They both own and operate income-producing properties and engage in lending activities.

Recently, Nexus Properties also introduced India's first retail REIT. Retail REITs invest in commercial properties like shopping malls, complexes, etc.

3 Ways to Invest in REITs in India

  1. Direct Purchase: Buy REIT units directly from the stock exchange like you would buy company shares.
  2. Mutual Funds: Invest in mutual funds with REIT units in their portfolio, offering diversification and professional management.
  3. IPOs: Participate in the Initial Public Offering (IPO) of a REIT, getting in at the ground level of a new real estate investment opportunity.
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 Investing in AIFs and REITs can offer exciting opportunities for portfolio diversification and wealth creation. However, understanding the tax implications is essential to make informed decisions and optimise returns.

When you look at so much information, it is natural to get overwhelmed. So, it is always advisable to consult with your tax advisor to understand the nuances specific to your requirements and circumstances.