Tokenization of Real Assets in India: Navigating the Legal and Regulatory Crossroads

Executive Summary

Tokenization of real assets digitizing ownership or economic rights in tangible property via blockchain has become a prominent global innovation theme. The Indian market, with its strong appetite for real estate, gold, and infrastructure investments, is fertile ground for tokenization. Yet, the legal framework is complex. In the absence of a bespoke “tokenization statute,” regulators will assess projects through existing regimes, particularly the Securities and Exchange Board of India (SEBI).

SEBI’s Collective Investment Scheme (CIS) framework under Section 11AA of the SEBI Act is especially relevant. Many token structures fractional real estate, gold or art-backed schemes, and pooled operating assets, mirror the CIS elements of pooling, managerial control, return expectation, and lack of investor day-to-day control. Absent registration as a Collective Investment Management Company (CIMC), such structures are prima facie unlawful.

SEBI has already demonstrated a regulatory pathway through Small and Medium Real Estate Investment Trusts (SM-REITs), notified in March 2024, to bring fractional real estate platforms into the business-trust framework. Infrastructure Investment Trusts (InvITs) and Alternative Investment Funds (AIFs) serve as other lawful channels.

This article examines India’s tokenization landscape, focusing on CIS risk, lawful alternatives, judicial interpretation, and comparative international approaches, before outlining practical compliance strategies.

Introduction

Digital innovation has consistently tested the boundaries of financial regulation. Tokenization is the latest frontier, promising to democratize investment in high-value assets by breaking them into digital, tradable units. For India, tokenization intersects with two realities:

1. Cultural affinity for real assets-Indian households invest heavily in real estate and gold.
2. Regulatory conservatism-India’s financial regulators prioritize investor protection, particularly retail investors, over unbridled innovation.

Against this backdrop, tokenization raises key questions: Can tokens legally represent ownership in immovable property? Do they fall under securities law? If structured as pooled yield products, do they become CIS? And are there safer regulatory wrappers such as REITs, InvITs, or AIFs?

Tokenization of Real Assets: Concept and Mechanics

What is tokenization: Tokenization is the process of representing ownership or economic rights in a physical asset through blockchain-based tokens. Each token embodies a fraction of ownership or entitlement.

How does it work: Typically, the asset is ring-fenced into a Special Purpose Vehicle (SPV) or trust. Tokens represent rights in that SPV (shares, units, or contractual claims). Smart contracts automate distribution of income or enforce transfer restrictions.

Benefits:

• Fractional ownership: Enables small investors to access high-value assets.
• Liquidity: Peer-to-peer transfers improve exit opportunities.
• Transparency: Blockchain immutability enhances trust.
• Efficiency: Smart contracts reduce intermediaries.

Challenges:

• Property law: Transfers of immovable property must be registered and stamped; blockchain entries cannot replace statutory registration.
• Regulatory uncertainty: Tokens may be treated as securities or CIS.
• Enforceability: Dispute resolution remains anchored in traditional courts/arbitration.
• Cross-border issues: Offshore tokenization risks FEMA violations.

The Indian Regulatory Framework

SEBI and securities regulation: The Securities Contracts (Regulation) Act, 1956 (SCRA) defines “securities” broadly. Tokens that resemble shares, units, or marketable rights may be treated as securities. SEBI has jurisdiction over issuance, marketing, and trading of such instruments.

Reserve Bank of India (RBI): The RBI has opposed private cryptocurrencies, but with the Finance Act, 2022, Virtual Digital Assets (VDAs) have been taxed, implicitly acknowledging their existence. RBI’s pilot of the Digital Rupee (CBDC) could eventually integrate with tokenized securities for settlement.

Real estate law: The Real Estate (Regulation and Development) Act, 2016 (RERA) regulates real estate developers and agents. Property transfers must comply with the Registration Act, 1908 and state stamp duty laws. Tokenization does not exempt compliance with these requirements.

FEMA: The Foreign Exchange Management Act, 1999 governs cross-border investments. Tokenization accessible to non-residents must align with FDI and FEMA rules. Offshore listing or trading of India-linked tokens raises compliance risks.

Taxation: The Finance Act, 2022 imposes 30% tax on transfer of VDAs and 1% TDS on transactions. Whether a token is a VDA, a security, or a business-trust unit affects tax treatment.

Collective Investment Schemes (CIS): The Elephant in the Room

Statutory definition

Section 11AA of the SEBI Act, 1992 defines CIS as any scheme where:

1. Contributions are pooled.
2. The scheme is intended to receive income, produce, or returns.
3. The contributions/assets are managed on behalf of investors.
4. Investors lack day-to-day control.

If all four prongs are satisfied, the scheme qualifies as a CIS and must register with SEBI under the SEBI (CIS) Regulations, 1999.

CIS Regulations, 1999

• Mandatory registration of a Collective Investment Management Company (CIMC).
• Trustee structure.
• Independent valuation.
• Periodic disclosures.
• Prohibition on assured returns.

Judicial interpretation

• PGF Ltd. v. Union of India (2013): The Supreme Court held that plantation schemes with pooled investor contributions and promised returns were CIS, despite being couched as “land sales.”
• Art funds (2008): SEBI held that art funds are CIS; the “Osian’s Art Fund” enforcement is a leading example.
• Principle: Substance prevails over form. Labeling an arrangement as “co-ownership” or “token” does not shield it from CIS classification.

Application to tokenization

• Fractional real estate tokens:
• Pooling: Investor funds combine to purchase property.
• Returns: Rental yields or appreciation.
• Management: Platform handles leasing and maintenance.
• Control: Investors passive. → Likely CIS, unless wrapped into SM-REIT.

Commodity or art tokens: Custodian-managed, with returns on appreciation. → CIS risk, consistent with art fund precedent.

Infrastructure tokens:

• Yield from tolls, tariffs, or PPAs.
• Central operator manages. → CIS, unless within InvIT.

Utility tokens: If strictly conferring usage rights (e.g., co-working time slots) without pooling or returns, CIS may not apply. But the line is thin.

Consequences of CIS classification: Operating a CIS without SEBI registration is illegal. Consequences include:

• Directions to wind up/refund.
• Monetary penalties.
• Criminal liability for willful violations.

CIS “red flags” for token promoters:

• Assured returns or buybacks.
• Broad retail marketing of yield.
• Centralized cashflow management.
• Investor passivity.

Lawful Alternatives: SM-REITs, InvITs, and AIFs

Small and Medium REITs (SM-REITs)

Background: Fractional ownership platforms (FOPs) proliferated in India, offering retail investors fractions of commercial real estate. SEBI flagged CIS risk and, in March 2024, amended the REIT Regulations to create SM-REITs.

Features

• Eligibility: Income-generating, completed real estate projects.
• Size: Smaller thresholds than traditional REITs (e.g., ₹50–500 crore per scheme, as discussed in industry commentary).
• Structure: Trust with independent trustee and investment manager.
• Units: Listed on exchanges.

Valuation: Independent periodic valuation.

Investor protection: Disclosure, audits, restrictions on related-party transactions.

Implications for tokenization: SM-REITs are the intended pathway for tokenized fractional real estate. Tokens may be layered as technological representation of listed units, but the legal rights flow from the REIT framework.

Infrastructure Investment Trusts (InvITs)

Background: InvITs were introduced in 2014 to pool investments into infrastructure projects such as roads, power transmission, and renewables.

Features

• Trustee-investment manager structure.
• Units listed on exchanges.
• Cashflow distribution from operating infrastructure.
• Independent valuation and disclosure requirements.

Implications for tokenization: Tokenizing InvIT units is possible as a technological overlay. Attempting to market infrastructure “yield tokens” outside InvIT invites CIS classification.

Alternative Investment Funds (AIFs)

Background: SEBI’s AIF Regulations, 2012 provide a framework for pooled investment funds outside the mutual fund regime.

Categories:

• Category I: Venture, SME, social funds.
• Category II: Private equity, debt, real estate.
• Category III: Hedge funds, long-short strategies.

Features

• Private placement to sophisticated investors.
• Minimum investment thresholds.
• Disclosure obligations via placement memoranda.

Implications for tokenization: Tokenization may work within AIFs if tokens are mere technological representations of units, and transfer restrictions are enforced. Marketing to retail investors is prohibited.

Choosing the right wrapper:

• Income-generating real estate: SM-REITs.
• Operating infrastructure: InvITs.
• Alternative strategies (real estate development, art funds): AIFs.
• Unregistered schemes marketed as yield tokens: CIS risk.

Grey Areas and Risks

• Lack of explicit recognition of tokenized rights.
• Regulatory overlaps between SEBI, RBI, MCA, and state authorities.
• FEMA implications for foreign investors.
• Tax ambiguity (VDA vs security vs REIT unit).
• Marketing risk: “assured returns” invite enforcement.

Comparative International Perspective

• United States: SEC applies the Howey Test; many token offerings qualify as securities.
• Singapore: MAS regulates security tokens under the Securities and Futures Act.
• Switzerland/EU: Explicit frameworks for asset tokens; EU’s MiCA regulation provides harmonized rules.

Policy Outlook

• SEBI’s direction is clear: migrate fractional real estate into SM-REITs; keep infrastructure in InvITs; regulate alternative strategies through AIFs.
• CBDC potential: RBI’s digital rupee could enable blockchain-based settlement for regulated units.
• Future reforms: Clarification of VDA vs security classification; potential sandbox for tokenization pilots.

Conclusion

Tokenization of real assets offers a compelling promise: democratized access, enhanced liquidity, and operational efficiency. Yet in India, regulatory compliance is non-negotiable.

The CIS regime is a broad catch-all for unregulated pooled-return schemes. Token promoters relying on retail participation and centralized management will almost inevitably trigger CIS classification unless they operate within SM-REITs, InvITs, or AIFs.

The message is clear: blockchain may revolutionize rails, but the legal foundation must be built on recognized regulatory frameworks. Attempting to circumvent SEBI’s investor-protection perimeter will invite enforcement. Conversely, embedding tokenization within business trusts and funds can unleash innovation while safeguarding investors a balance consistent with India’s cautious but progressive approach to financial regulation.

Contributed by – Adnan Siddiqui