TOLA 2026 fixes dividend exemption but leaves withholding tax mismatch for non-resident investors

Synopsis

The Taxation and Other Laws (Amendment) Act, 2026 addresses existing dividend tax discrepancies for unitholders by granting unconditional exemptions. Despite this, the established withholding tax regulations for BTs have not been modified, leading to possible inconsistencies. Non-resident investors may need to submit tax returns to retrieve withheld taxes, highlighting the need for a future alignment of withholding practices with the new exemption framework.

The Taxation and Other Laws (Amendment) Act, 2026 (“TOLA 2026”) which was passed on 17 August 2026, has been celebrated as a fix for a long-running tax anomaly regarding dividend income for unit holders from REITs and InvITs, also known as BTs.

A BT holds its rent or cash yielding assets either directly or indirectly through Special Purpose Vehicles (SPVs) or through an intermediate holding company which in turn owns the SPVs. Apart from offering pass-through treatment, these structures also benefitted from a regime under which dividend income was entirely exempt from taxation since 2016, making them commercially and fiscally efficient investment vehicles.

But from 2020, a conditional tax regime was introduced for dividends distributed by BTs which essentially depended upon the corporate tax regime chosen by the SPV. Consequently, dividend income was exempt in the hands of the unitholder only if the SPV chose a regular regime of taxation (30%). Such exemption was lost the moment the SPV migrated to the concessional taxation regime (22%).

The problem was further aggravated by the loss of accumulated MAT credit the moment SPV chose the concessional tax regime. These tax inefficiencies forced many BTs to continue to be under the old regime of taxation. Although Finance Act 2026 amendments permitted BTs to avail MAT credits while transitioning to the concessional tax regime, the option continued to find few takers. The perceived benefit was significantly diluted by the tax implications that could arise for unitholders where the underlying SPV opts for the new regime.

Recently, TOLA 2026 resolved this problem by making the dividend exemption unconditional for the unitholders regardless of the tax regime chosen by the SPV. However, to offset the revenue lost through the unitholder level exemption, TOLA 2026 raises the surcharge applicable on SPVs under the concessional tax regime from 10% to 25%, pushing their effective corporate tax rate to about 28.6% from 25.17%.

Absence of simultaneous exemption from withholding

TOLA 2026 has fixed the dividend exemption for unitholders once and for all. But what it does not amend is the withholding tax machinery that sits alongside that exemption.

As the earlier provisions required taxation of dividend in the hands of unitholders when the SPV opted for the concessional tax regime, there was a corresponding withholding tax obligation on the BTs to withhold tax at 10% in such situations.

Unitholders can now enjoy a substantial exemption from dividends, no matter which tax regime the SPV’s under, but the corresponding TDS rules haven’t changed at all. The result is a mismatch: the income is exempt in the hands of the unitholder, but the withholding provisions will continue to apply to the BTs if the SPV opts for the concessional tax regime. It’s hard to tell if this omission was an inadvertent legislative oversight or a deliberate policy choice.

Also read: REIT, InvIT investors can benefit if trust switches income tax regime: Know how maximum effective tax rate of 34.94% under old tax regime comes down to 28.60% under new tax regime

Impact on non-resident unitholders

For resident unitholders, this omission has limited practical consequence. Most resident investors file an annual return of income in India. In any case, tax withheld in excess of actual liability is adjusted or refunded in the ordinary course of assessment.

However, non-resident unitholders may be greatly impacted by this change. Many such non-resident investors would not otherwise have any independent obligation to file a return in India. However, with the introduction of TOLA 2026, the investors investing in BTs may need to file their tax returns solely to claim refund of taxes withheld on exempt dividend income.

Suppose a non-resident investor receives Rs.10 lakh of dividend income from a BT whose underlying SPV has opted for the concessional regime. Following TOLA 2026, the dividend is exempt in the investor’s hands. Yet, a withholding tax of Rs. 1 lakh may still be deducted from the Rs. 10 lakh distribution. The investor therefore receives Rs. 9 lakh despite having no ultimate Indian tax liability on the Rs.10 lakh dividend income.

Indian income tax laws provide that every claim for refund has to be made by furnishing a tax return. This means that the investor may need to enter the Indian return-filing system just to recover tax that was deducted from an income Parliament has made exempt. The compliance sequence could, therefore, be to obtain or activate an Indian PAN, file a return, and wait for the refund to be processed.

Why trustees are unlikely to stop withholding in the absence of any amendment

The withholding tax omission also places BTs in a difficult tax position. Under the Indian income tax law, any person who fails to deduct or short-deducts tax at source (withholding tax) may be treated as an assessee in default, exposing it to recovery of the shortfall together with interest and penalty.

A trustee that chooses not to withhold tax on dividend income from an SPV in the concessional regime deliberately in light of the unconditional exemption under TOLA 2026, bears the risk that this position may later be disputed, with interest accruing from the date the deduction ought to have been made till the date such deduction is actually made.

On the other hand, a trustee that continues to withhold tax strictly in accordance with the law bears no such risk. In the absence of a legislative or administrative clarification, trustees can be expected to adopt the more conservative position with the practical consequence that the compliance burden created by this gap is transferred entirely to the non-resident unitholder.

An existing remedy is available, but is inadequate

There is an interim relief mechanism under the income tax law. The law permits the person making the payment (BTs) or the person receiving the income (non-resident unitholders) to approach the Assessing Officer where it considers that the sums being remitted would not be chargeable to tax in the hands of the recipient.

This could potentially allow a non-resident investor to seek NIL withholding tax certificate before the distribution is made. But it is inherently case-specific. It requires an application and an order, rather than giving all similarly situated investors an automatic exemption at source. For a listed REIT or InvIT with a large non-resident investor base, requiring individual investors to obtain withholding relief is therefore an inefficient substitute for correcting the underlying provision. The alternative of BTs applying for NIL withholding tax certificate to the Assessing Officer may be a better option, however, it still has to go through the approval process.

Way forward

TOLA 2026 has therefore corrected the substantive tax anomaly but left behind a procedural one. Unless the withholding provisions are brought in line with the tax exemption, a non-resident investor could face the unintended outcome of being subject to withholding of tax and bearing the compliance cost of recovering tax that was never ultimately due to the Parliament. Aligning the withholding provisions with the exemption would be a natural and necessary final step in realising Parliament's intent and enhancing the attractiveness of Indian REITs and InvITs for global investors.

The authors are from Lakshmikumaran & Sridharan law firm.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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