The TOLA, 2026 Effect: A Stable Tax Regime for Business Trusts
The Taxation and Other Laws (Amendment) Act, 2026 (‘TOLA, 2026’) has recently amended some provisions of the Income Tax Act, 2025 (‘IT Act, 2025’). The amendment to Schedule V, Serial No. 5.D, clause (b) of the IT Act, 2025, provides tax exemption on dividends received by unitholders of business trusts. Section 2(21), IT Act, 2025 defines business trust to mean a trust registered as an Infrastructure Investment Trust (‘InvIT’) or a Real Estate Investment Trust (‘REIT’) under the relevant Securities and Exchange Board of India (‘SEBI’) Regulations. The previous substantial change in relation to taxation of business trusts was in 2014, when Section 115UA was introduced in the Income Tax Act, 1961 (‘IT Act, 1961’). Section 115UA provided business trusts a see-through status. Thus, if a business trust received profits from the Special Purpose Vehicle (‘SPV’), in which it held capital, it was not liable to tax to the extent it distributed the profits to its unitholders. Only SPV and unitholders were considered as taxable entities. This legal position was preserved under Section 223 of the IT Act, 2025.
This article comments on the direct tax regime relating to business trusts and divides it into two phases: (i) Initial phase of 2014-2026: which introduced tax certainty by applying see through principle to business trusts; (ii) Second phase from 2026 onwards: initiated by the TOLA, 2026 to exclude dividends from income of unitholders to incentivize investments in business trusts. This article argues that creating a special taxation regime for business trusts was necessary because they cannot be neatly classified as private or public trusts since they have characteristics of both. Equally, business trusts are distinct from companies, partly because of their regulatory obligations. For example, Regulation 18(1), SEBI (Real Estate Investment Trusts) Regulations, 2014 (‘REIT Regulations’) requires that for a business trust such as REIT, investment in properties shall only be through a holding company or SPV. And Regulation 18(16)(b) of REIT Regulations requires REITs to distribute at least ninety per cent of its distributable cash flows to the unitholders. SEBI (Infrastructure Investment Trusts) Regulations, 2014 (‘InvIT Regulations’) contain similar obligations for InvITs. Domestic companies do not operate under similar regulatory constraints.
This article concludes that the current taxation regime of business trusts – after the TOLA, 2026 – is an elegant framework, and adequately balances various intersecting principles of tax certainty, prevention of double taxation, and preservation of revenue. One aspect that remains unaddressed by the TOLA, 2026 is Section 393(1), A.4, clause (ii) of the IT Act, 2025 which mandates a business trust to withhold tax on income distributed to unitholders. Both resident and non-resident unitholders who receive dividends from business trusts, will have to seek refund of the tax withheld by filing income tax returns. Apart from the withholding tax provision, any further attempts to alter the taxation regime of business trusts must be resisted unless the corresponding regulatory framework forces a change in their corporate structure and/or cash distribution obligations towards unitholders.
Need for See Through Principle
Prior to 2014, the IT Act, 1961 contained specific provisions for private trusts and public trusts. Section 161-164 governed the taxability of trustees and beneficiaries depending on the nature of the trust. For example, Section 161(1) stated that if beneficiaries of a private trust are explicitly defined, the trust will be taxed at individual tax slabs applicable to the beneficiaries. Section 161(1A) overrode Section 161(1) and stated that if the income of a trust included business income, then the whole of its income shall be liable to be taxed at maximum marginal rate. Section 161(1A) was enacted as an anti-tax avoidance provision to prevent the use of private trusts as conduits for business profits and take advantage of lower tax slabs of beneficiaries. Thus, if a private trust earned any business income its entire income was subjected to an onerous tax liability by subjecting the trust’s income to maximum marginal rate. The Kerala High Court diluted the punitive impact of Section 161(1A) and held that only business income of trust shall be subjected to maximum marginal rate and not income under any other head of income. Overall, the provisions relating to private trusts under the IT Act, 1961 were appropriate for private trusts that did not have a business income. On the other hand, provisions relating to public trusts – Sections 11 to 13 of the IT Act, 1961 – were designed for public trusts which had a charitable purpose and were eligible for income tax exemption. However, the Supreme Court restrained public trusts from indulging in commercial activity and held that their receipts from commercial activities could not exceed 20% of the gross receipts in a financial year. Else, the tax exemption of public trusts was liable to be withdrawn.
In 2014, regulatory and taxation provisions relating to a new category of trusts – business trusts – were enacted. SEBI enacted the InvIT Regulations and the REIT Regulations which envisaged InvITs and REITs as a separate category of trusts, i.e., business trusts. The aim was for business trusts to act as collective investment vehicles for their investors/unitholders. REITs were envisaged as vehicles for investment in real estate and InvITs for investment in infrastructure. Both possess an indisputable commercial identity and have features of private trusts as well as public trusts. For example, business trusts such as REITs are typically settled under the Indian Trusts Act, 1882 for the benefit of identifiable investors or unitholders akin to a private trust. But REITs assume the nature of a public trust when listed on the stock exchange since members of the public become their unitholders. The Finance Act, 2014, acknowledging the InvIT Regulations and REIT Regulations and the sui generis category of business trusts created a special taxation regime for business trusts to introduce tax certainty for investors.
Contemporaneously, via the Finance Act, 2014 a new provision – Section 115UA – was introduced in the IT Act, 1961. Section 115UA provided business trusts the status of a see-through entity. Section 115UA of the IT Act, 2025 served three distinct purposes: (i) by identifying SPV associated with InvIT/REIT as a taxable entity, it preserved the corporate tax base and ensured that SPVs do not escape tax payments on their profits. In future, if and as InvITs/REITs multiply, the corporate tax base will expand proportionately; (ii) by treating InvITs/REITs as a see-through entity, Section 115UA avoided double taxation of profits in the hands of SPV as well as InvIT/REIT. Instead, by treating the latter as a see-through entity, Section 115UA alleviated the tax burden on regular cash transfers to unitholders mandated by the relevant SEBI Regulations; (iii) underlined that business trusts were a specific sub-category under the broader category of trusts. The earmarking of business trusts as a distinct category was necessary because as per the Supreme Court, a private trust, per se, is not an association of persons under Section 2(31) of the IT Act, 1961 and now under Section 2(77) of the IT Act, 2025. And thereby a private trust is not a taxable entity. However, if the trustees and beneficiaries pool resources for a joint commercial venture to earn profits, the trust can be assessed as an association of persons. The amendments to the IT Act, 1961 in 2014 ensured that rules relating to private trusts or public trusts did not govern InvITs/REITs and ring-fenced business trusts as a distinct category of trusts with specific taxation rules, creating certainty for investors.
Realigning Dividend Tax Policy
Before the TOLA, 2026 dividends of InvITs/REITs were only extended conditional tax exemptions. Before 2020, Union of India levied Dividend Distribution Tax (‘DDT’) and under Section 115-O of the IT Act, 1961 it was payable by companies that distributed dividends to its shareholders. Two aims for levying DDT on companies were: (i) incentivizing them to reinvest their profits as clarified by the Union Finance Minister in his Budget Speech of 1997 while introducing DDT; (ii) ease of tax collection at company level as stated in Explanatory Memorandum accompanying the Finance Act, 2003. Since InvITs/REITs operated with the additional layer of a business trust holding share capital in SPV and were novel investment vehicles in need of investor attention, they received a differential treatment. Section 115-0(7) exempted SPV from DDT on distribution of profits if a business trust, such as InvIT/REIT, held entire share capital in the SPV. The dividends received by InvIT/REIT were further transferred to unitholders without any tax obligations. Since SPVs were exempt from DDT only if 100% of the shareholding in SPV was held by the REIT/InvIT, it was not an absolute tax exemption. The Finance Act, 2020 abolished DDT in favor of the classical system of dividend taxation wherein dividends were made taxable in the hands of shareholders of companies. Contemporaneously, dividend was made tax-free in hands of unitholders but with a new condition – only if the SPV opted for the old tax regime. If the SPV opted for the new tax regime, tax exemption on dividends was not available to unitholders. Thus, there was never an across-the-board tax exemption on dividends received by unitholders of InvITs/REITs until 2026.
The TOLA, 2026, for the first time, makes dividends tax-free in hands of unitholders without any accompanying conditions. Dividends are exempt from tax irrespective of whether the SPV opts for a new or old tax regime. Nor is their tax exemption contingent on complying with an accompanying statutory or other obligation. However, to compensate for the revenue loss on account of providing tax exemption to unitholders, the surcharge payable by SPVs has been increased from 10% to 25%. On first blush, one can argue that the tax exemption on dividends received by unitholders is superficial as it is counterbalanced by an additional levy on SPVs. However, a more considered view involves appreciating that increase in surcharge results in adding only a small percentage to the income tax paid by SPVs before 2026. Earlier if the SPV chose the new tax regime, its effective corporate tax rate was 25.16% and unitholders paid income tax on dividends as per the applicable tax slabs. After the TOLA, 2026, the effective tax rate for SPV rises to 28.6%, but unitholders do not have any tax liability on dividends received. Even if SPVs reduce gross distribution of profits to offset their increased tax liability, TOLA, 2026, ensures superior payout for some unitholders who, before 2026, were liable to pay 10-40% tax on dividends, depending on their respective tax slabs. By providing unitholders in InvITs/REITs a tax exemption on dividends, the aim is to incentivize investments in business trusts. And when the tax exemption on dividends interlocks with the SEBI’s mandate to distribute at least 90% of distributable cash flows, business trusts emerge as an attractive option for regular tax-free returns on investments.
One aspect that the TOLA, 2026 fails to address is the withholding tax obligations of business trusts. Despite unitholders – residents and non-residents – being not liable to pay on dividends distributed by business trusts, they will receive the dividends after deduction of tax. Because Section 393 of the IT Act, 2025 which imposes the obligation of withholding tax on business trust was not amended by the TOLA, 2026. The business trusts’ continued obligation to withhold tax creates an onerous obligation on non-resident unitholders to necessarily file their income tax returns in India to get a refund of the tax withheld. While resident unitholders will be under a similar obligation, it will be comparatively less onerous as they will, regardless, file their income tax returns to account for income earned from other sources. But one common denominator remains: withholding of tax on income that is exempt from tax.
Finally, it is worth noting that unitholders do not merely receive dividends, they also receive interest income. SPVs distribute cash to business trusts in different components and an important quantum is the interest on loans provided by business trusts to SPVs. For the SPV, the interest it pays on the loan advanced by business trust is an expense and deductible from its profits. Business trusts are not liable to pay tax on interest because of their see-through status. When a business trust distributes interest income to unitholders, it is deemed to be of the ‘same nature’ as per Section 115UA. Thus, in the hands of unitholders the interest income retains the character of an interest earned on loan and is treated as a taxable income in their hands. The TOLA, 2026 preserves this legal position since providing tax exemption on interest income will not serve the purpose of removing double taxation because no other entity apart from the unitholder pays tax on interest. In fact, if interest income is made tax exempt in the unitholders’ hands it will amount to sacrificing revenue. One could argue that if interest income is exempted from tax in hands of unitholders, it can be offset by increasing the surcharge on SPVs like the one introduced by the TOLA, 2026. However, it will amount to indirectly levying tax on SPV for interest which is not its income, but an expense. Interest is only an income for unitholders. Thus, providing tax exemption on dividends received by unitholders while subjecting interest income to tax creates an elegant tax regime for business trusts.
Conclusion
Introduction of Section 115UA in 2014 prevented double taxation of profits earned by SPVs because of the see-through status provided to business trusts. While providing business trusts a see-through status under the IT Act, 1961 was an indirect incentive for attracting investments in REITs. However, the conditional exemptions for dividends accompanied by change in taxation policy for dividends resulted in a partial exemption for unitholders of business trusts. The TOLA, 2026 takes a decisive step further by making dividends tax-free in hands of unitholders of business trusts without any accompanying conditions, and ensures revenue preservation by increasing the tax liability of SPVs through an enhanced surcharge. If one overlooks the continuing obligation of withholding tax, the current tax regime achieves objectives of preventing double taxation of profits, incentivizes investments in business trusts, and ensures tax certainty while preserving revenue collection.
*Rav Pratap Singh is an Associate Professor of Legal Practice at OP Jindal Global University. He is a generalist economic lawyer with a variety of specialised interests. He has active interests in taxation laws, gambling laws, and insolvency law. He blogs at https://theleagle.in