TOLA 2026 Anomaly: Tax-Exempt SPV Dividends Still Trigger TDS for Business Trusts

1. Executive Summary & Legislative Background

Under the Indian tax regime, Business Trusts operate as pass-through vehicles for specific streams of income, including interest, rental income, and dividends received from underlying Special Purpose Vehicles (SPVs). Historically, the taxability of dividend distributions in the hands of unitholders was contingent upon the tax regime elected by the underlying SPVs.

With the passage of TOLA 2026, lawmakers removed this dependency to streamline tax treatment for retail and institutional investors. However, because corresponding amendments were not simultaneously incorporated into the withholding tax provisions under Section 393 of the Income-tax Act, 2025, a statutory mismatch now exists: dividends are 100% tax-exempt for unitholders, yet Business Trusts remain statutory obligated to deduct TDS upon distribution.

2. The Pre-TOLA vs. Post-TOLA Dividend Framework

To appreciate the current conflict, tax practitioners must analyze how the legal position shifted following the 2026 retrospective amendments.

The Pre-TOLA 2026 Regime

Prior to TOLA 2026, the taxability of SPV dividend distributions passed through a Business Trust to its unitholders hinged entirely on the SPV's tax election:

• Non-Concessional Tax Regime: If the underlying SPV did not opt for the concessional corporate tax rate, the dividend distributed by the Business Trust was exempt from tax in the hands of unitholders.
• Concessional Tax Regime: If the underlying SPV opted for the lower concessional corporate tax regime, the dividend lost its pass-through exemption and became fully taxable in the hands of unitholders.

The TOLA 2026 Amendment

Effective retrospectively from April 1, 2026, TOLA 2026 removed the conditional taxability test. Dividend income received by unitholders from a Business Trust is now universally exempt from income tax, regardless of whether the underlying SPV has opted for the concessional tax regime.

To compensate the exchequer for granting total exemption to unitholders, TOLA 2026 introduced a trade-off at the SPV level: underlying SPVs opting for the concessional tax regime are now subject to an increased surcharge of 25% (up from the previous rate of 10%).

3. The Statutory Friction: Section 393 vs. Exemption Provisions

While the chargeability section was amended to exempt all SPV dividends in the hands of unitholders, the corresponding withholding tax provisions under the Income-tax Act, 2025 were left unadjusted.

Specifically, Item No. 5 of Table 4 under Section 393 governs exceptions where a Business Trust is not required to deduct TDS on dividend payouts. This provision continues to state that TDS exemption applies only if the underlying SPVs have not opted for the concessional tax regime.

Because withholding provisions operate independently of chargeability provisions unless explicitly linked or harmonized by statutory language, Business Trusts are legally compelled to deduct TDS at the time of payout, even though the income represents non-taxable receipts for the recipient.

4. Practical Impact on CFOs, Tax Practitioners, and Investors

This legislative oversight creates operational complexities and cash flow friction across the investment ecosystem:

A. Cash Flow Lock-up & Mandatory Return Filing

Unitholders receiving exempt dividend distributions from Business Trusts linked to concessional-regime SPVs will experience unwanted TDS deductions. Consequently, investors who otherwise have no taxable income must file annual Income Tax Returns (ITR) solely to claim refunds of withheld tax.

B. Compliance Burden for Business Trusts

REIT and InvIT fund managers face a dilemma: failing to deduct TDS exposes the trust to interest under default provisions and potential disallowance penalties, whereas deducting TDS causes dissatisfaction among unitholders due to uncoordinated tax deductions.

C. Fundamental Rule of Direct Taxation

This situation highlights a core principle in Indian income tax jurisprudence: an exemption under charging provisions does not automatically eliminate TDS obligations unless procedural withholding rules are explicitly aligned.

5. Key Takeaways Checklist for Tax Teams

• ☑ Exemption Status: Dividends distributed by Business Trusts are tax-exempt for unitholders post-TOLA 2026.
• ☑ SPV Surcharge: SPVs under concessional regimes now pay a 25% surcharge instead of 10%.
• ☑ TDS Obligation Persists: Business Trusts must continue deducting TDS under Section 393 if the underlying SPV operates under the concessional regime.
• ☑ Refund Mechanism: Affected unitholders must claim TDS refunds by filing their annual income tax returns.
• ☑ Anticipated Circular: Tax practitioners expect a corrective amendment or CBDT circular to harmonize Section 393 with TOLA 2026.

6. Strategic Recommendations & Conclusion

Tax teams, CFOs, and advisors handling REIT/InvIT distributions should advise Business Trusts to strictly adhere to withholding obligations under Section 393 to avoid penal consequences. While this mismatch is likely an unintentional drafting oversight that may be rectified via a CBDT clarification or technical amendment, compliance officers must prioritize literal interpretation of withholding tables over general exemption provisions in the interim.