Infrastructure development has been one of the focal points of Narendra Modi’s government. The infrastructure sector in India has still failed to attract significant offshore capital for a variety of systemic reasons, including the lack of a fiscally optimal and well-managed investment structure.

To address this issue, after years of deliberation, the Securities and Exchange Board of India introduced infrastructure investment trusts enabling a tax-optimized investment regime governed by the SEBI. InvITs can be public or private. One of the challenges that even private listed InvITs faced was that key private communication between the manager and the sponsor or investors had to be made public. Although private in nature, listed private InvITs had to comply with regulations regarding leverage, investments, number of unitholders, etc., similar to listed InvITs.

In order to offer a more flexible regime to informed investors, SEBI has introduced the concept of “unlisted” InvITs.

At the heart of it, unlisted InvITs have achieved two important objectives:

(a) a fiscally optimal investment regime for global investors; and

(b) SEBI oversight (to inspire investor confidence) with light regulations.

Once the tax benefits were aligned between listed and unlisted InvITs, the latter became the preferred asset monetization vehicle for all developers and investors.

In no time, the industry has already witnessed two large unlisted InvITs.

As of August 2021, SEBI has prescribed that each unlisted InvIT must have

These changes strike at the heart of the unlisted InvIT scheme for the following reasons.

Counterintuitive amendments

Legislative “certainty” is the cornerstone of any new vehicle for mergers and acquisitions.

Unlisted InvITs were introduced just a few years ago after much deliberation, and as a result investors naturally expected the broader legal landscape to remain unchanged. Imposing a minimum of “public” float (people unrelated to the promoter / sponsor are usually referred to as public) in an unlisted vehicle not only seems counterintuitive, but destroys the vestiges of regulatory predictability that foreign investors have come to expect.

Such drastic regulatory about-faces can be devastating, especially when the government unveils multiple programs simultaneously to attract investment in the infrastructure sector.

Misaligned intent and amendment

The SEBI changes were intended to: discourage sponsors from setting up unlisted InvITs that are motivated by tax incentives, but do not result in (a) a new injection of capital, (b) monetization of assets, (c) infrastructure development, or (d) repayment of existing domestic debt.

The simplest solution in such a scenario would have been to require that any unlisted InvIT, which does not meet the objectives sought by the amendment, not be allowed to claim the tax benefits. However, prescribing public float requirements (not related to the sponsor) without adequate industry consultation disrupts the paradigm of regulatory predictability that forms the basis of foreign investor sentiment. The SEBI amendment, in fact, encourages an “innovative” structure whereby the simple letter of the law is respected but brings very few practical advantages.

“Unrelated” ambiguity

The SEBI Amendment defines “related parties” and “associates” of the sponsorship relationship as broadly as possible. The terms derive their meaning from the definition in the Companies Act 2013 and applicable accounting standards, which define the term in the context of “significant influence”. A simple appointment of an investor administrator within the sponsor could lead to the qualification of the investor as an associate of the sponsor. The broad scope of the terms has created uncertainty of interpretation, leaving the door wide open to regulatory misinterpretation. SEBI should, in accordance with its general practice, engage in industry-wide consultations before enacting such pervasive legislation that upsets the balance of agreements and has far-reaching implications.

For starters, given the capital-intensive nature of the infrastructure industry, only a select group of large global finance companies have the capacity to engage patient capital. In most cases, this capital came from sovereign wealth funds and pension funds which patiently invest under what is called “social license”. At least these investors, known for their stature and ethics in the world, should be treated differently.

Acquired rights omitted; Sub-optimal compliance times

Existing InvITs are required to find new unitholders within a six-month grace period.

First, SEBI’s reluctance to grant vested rights to existing legitimate structures (which have already fulfilled the objectives of the amendments) is a glaring exception to the well-accepted principle of “legitimate expectation” and should be reassessed.

Second, given the high valuations of existing InvITs and the current global outlook, SEBI should consider a longer grace period, as the introduction of new independent investors will need to be done carefully and could take a long time.

Overall, while SEBI’s goal with the amendment appears to address a tax abuse issue (i.e. developers moving assets to clean InvITs), it disrupts the fundamentals unlisted InvITs in several respects.

The unlisted InvIT scheme was first introduced as a scheme for sophisticated investors and private ownership of assets. Confusing the regime with a public float requirement is unlikely to send the right signals to the global investment community. SEBI and the Ministry of Finance should consider realigning the changes so that the goal of preventing tax abuse is achieved without disrupting the cogs of the existing unlisted InvIT framework.

Ruchir Sinha is partner and chef-Mumbai; Shreyas Bhushan is a senior partner; at Touchstone Partners. Ruchir co-chairs the “Infrastructure and InvIT Committee” of the Asia-Pacific Real Estate Assets Association and has advised several investors in the InvIT space.

The opinions expressed here are those of the authors and do not necessarily represent those of BloombergQuint or its editorial team.

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