Understanding InvITs

As a constant effort to explore new market opportunities and provide the best investing guidance to our investors, we decided to explore- Infrastructure Investment Trusts (InvITs). While this instrument is not talked about a lot, in our view it is a smart avenue via which one can invest in the infrastructure space in India.  

Given there is limited literature around InvITs, we think it shall be appropriate to educate our investor community about the workings of InvITs, right from its structure to its tax treatment. It always excites us to know about new market concepts and we hope you’re looking forward to knowing everything about InvITs in detail, so let’s get going!

What are InvITs?

Let us get the basics first. If I ask you – ‘What are the major infrastructure projects in India?’ You will reply, ‘Roads, Highways, Power Transmission & Distribution, and so on.’ Fair enough. Similarly, all of us know that these big infrastructure projects are primarily funded by the government or large corporations. Before the advent of InvITs, common people (like you and me) would not be able to directly invest in such magnanimous projects. 

Now, I’ll take the help of an easy example to clearly make you understand what InvITs are.

ABC Ltd. is constructing a bridge that will require ₹5000 crores of expenditure. Against this, the company has been allowed to collect ₹50 as toll per vehicle. As obvious logic would guide, recovering that ₹5000 crores will be a time-consuming process and so will be making the entire project profitable. Now, there are two ways to fund this project cost – a) company funds, b) external debt. There is a third way too – InvITs. 

Essentially, the company can invite the general public to participate in this project by investing. ABC Ltd. can set up an InvIT via which the company can issue units to investors. For instance, the company can issue 10 crore units of ₹500 each at an initial Net Asset Value (NAV), which shall be tradeable in the stock exchanges. One thing to note is that, InvITs have the flexibility of being either privately listed or publicly listed. As a matter of fact, the majority of InvITs in India are privately issued. I hope you’re with me until now.

InvITs – A basic structure

The key stakeholders of this investment instrument are as follows:

• Trustee – The Trustee is like the Board of Directors of a company. The main role of the trustee is to oversee the functioning of the InvIT and make sure that the managers are acting in the best interest of the unit-holders. As per regulations, the trustee needs to invest at least 80% of the funds in infrastructure assets.  
• Sponsor  – Sponsor is essentially the entity that sets up the InvIT, usually a body corporate. As per SEBI diktat, the Sponsor is required to hold at least 15% of the InvIT with a minimum lock-in of 3 years.    
• Investment Manager – Basically, an asset manager who makes investment decisions and ensures sound operations of the InvIT. 
• Project Manager – The entity that is responsible for executing the concerned projects. 
• Investor – Last but not the least, the investors or the unitholders.

To provide further context, there are primarily 3 types of InvITs –

• Publicly listed – InvITs are listed on the exchanges.
• Privately listed – InvIT units that are issued via private placement, are considered as privately listed. To add to that, a listed private InvIT has to comply with various requirements, including having at least 5 investors other than the sponsor(s), its related parties and its associates.
• Privately unlisted – These InvITs do not come under the gamut of any regulations and are plainly held privately.

SEBI Rules – InvITs

The market regulator, SEBI have given guidelines concerning the working of an InvIT, to ensure investor safety. These guidelines come under the InvITs Regulations, 2014. I feel it’s important for one to be aware of these rules, as they ensure that you’re not being misguided by any company. So here’s a list of important regulations:

• Minimum Ownership – To have skin in the game, InvIT sponsors are directed to hold at least 15% of units issued with a lock-in period of 3 years.
• InvIT Investments – In order to ensure steady cash flow to unitholders, SEBI has mandated that the InvIT has to necessarily invest 80% of its available corpus in completed and revenue-generating projects. On the other hand, they cannot invest more than 10% in under-construction projects.
• Cash Flow Distribution – InvITs have to mandatorily distribute 90% of its Net Distributable Cash Flow (NDCF).
• Leverage Limits – There is a leverage cap of 70% on the Net Asset Value (NAV), which prevents them from over leveraging.

You can read the full SEBI guidelines here.

Investing in InvITs – how it works!

Just like stocks and ETFs, InvITs are also being traded on the markets for you to buy and sell. Not to mention, the underlying base for an InvIT is the collection of the infrastructure assets under the company. While the concept of InvITs have gained ground in developed markets, Indian investors are still catching up. As a result, market regulator (SEBI), has been constantly trying to improve the prospects of the space, by introducing investor friendly measures around these new investment instruments. Infra companies have also been encouraged to set up InvITs in the public markets, in order to increase the depth of the markets.

How do you make money by investing in InvITs?

I’m pretty sure that while reading this you must be wondering – ‘I get all that, but how does the InvIT make money?’ Let’s address that. 

Going back to the initial example I had used, we saw that ABC Ltd. was charging ₹50/vehicle as toll. This is, fundamentally, the cash that is available to the company for distribution to its unitholders. However, this entire ₹50 shall not be distributed, but a part of it will be, post deducting expenses and maintenance cost. The technical term for this is – Net Distributable Cash Flow (NDCF). 

As per the mandate, an InvIT has to distribute at least 90% of its NDCF to its unitholders. This takes us to the next question – how is it distributed?

• As dividends
• As interest
• As capital return, via buyback of units.

Tax treatment – InvITs

Here’s how returns from InvITs are treated for taxation –

• Dividend received by the InvIT from SPVs and distributed to unitholders: Taxability of dividend in hands of unitholders shall be dependent on if the underlying SPV (from which the REIT or InvIT has received such dividends) has opted for a beneficial tax rate.
  • In case the SPV has not opted for the beneficial tax rate, the dividend received by the unitholders from the REIT or InvIT is exempt from tax. Further, no withholding tax shall be deducted by the REIT or InvIT in such a case.
  • In case the SPV has opted for the beneficial tax rate, then in such a case, the dividend is taxable in hands of the unitholders. For resident unitholders, such dividend is taxable at rates applicable under the provisions of income tax and for the non-residents, the dividend is taxable @ 20% or rate as per the relevant tax treaty, whichever is more beneficial. Consequently, the REIT or InvIT is required to withhold taxes @ 10% under section 194LBA of the Act, whether the unitholder is a resident or a non-resident.
• Interest received by the InvIT from SPVs and distributed to unit Holders: Interest distributed by REIT or InvIT to the unitholders shall be taxable in hands of the unitholders at applicable rates in hands of resident unitholders and @ 5% in hands of non-resident unitholders. Accordingly, taxes are required to be withheld by REIT or InvIT @ 10% for a resident unitholder and @ 5% for a non-resident unitholder.
• Buyback: For capital appreciation, capital gains are taxed as per short-term or long-term. Less than 36 months, 15% short term capital gains are taxed, whereas for more than 36 months, 10% long term capital gains are taxed.

The classic comparison – InvITs vs REITs

Pros & Cons

Like any other investment instrument, InvITs come along with their own set of positives and negatives, so let’s take a look at them –

Pros:

1. Diversification – Since InvITs caters to a niche set of assets, it acts as a good avenue with respect to portfolio diversification.
2. Tradability – InvITs are tradable on the exchanges, which negates the issue of illiquidity.
3. Professional Management – Assets under InvITs are professionally managed that is a great source of relief for a common investor, as capital allocation is one of the key focuses of this instrument.

Cons:

1. Limited choice – There are currently only 3 listed InvITs in India which cramps the user for space. 

Comparison of publicly listed InvITs in India

Additions to the Infra Tracker smallcase

From the research we conducted, our view is that India Grid Trust and Power Grid Trust is well poised in the InvITs space currently. They have shown strong distribution in the fiscal year gone by, which is a big positive. On top of that, India Grid has constantly grown their NDCF over the last 5 years, flaunting consistency. While both operate in the power transmission space, we remain fairly constructive on the power sector, given the rapid changes that are taking place. On the flipside, IRB didn’t make the cut for us primarily due to the underlying asset that is roads and highways. You see, roads are extremely dependent on the country’s mobility. If the socio-economic environment is sombre, people will travel less and hence toll collection will drop, which in turn would adversely affect IRB. For instance, if a toll road connects city to a airport and 5 years later a metro line comes in, the entire long term toll collection projections from that project goes for a toss. That is why the toll collections are not so sticky as compared to tariffs generated from power transmission infrastructure. A classic case is the COVID-19 pandemic. With national lockdowns in place, people didn’t travel and IRB’s price took a serious beating.  

As a result, we have added India Grid Trust and Power Grid Trust to our Infra Tracker in the recently concluded rebalance in September 2022.