Anuj Puri, chairman and country head of JLL India discusses the impact of GST and demonetization on the Indian real estate sector.
Goods and Services Tax, or GST
While the GST tax structure has been announced, the real estate industry is waiting with bated breath to see which tax rate is applied to the real estate and construction industry. Given the Finance Minister’s clarification that the highest tax slab will be applicable to ‘sin’ items and other categories that are currently taxed at around 30%, it can be assumed that this rate will not apply to real estate and construction.
Similarly, the lowest tax rate of 5% will apply on common use items and is highly unlikely to be applied to housing. That leaves us with two probable scenarios: the tax rate either being set at 12% or 18%.
Naturally, a lower tax rate of 12% would be welcomed by the industry, as it will help reduce the cost of apartments and increase affordability for end-users. Developers may resultantly see an uptick in sales in a slow market.
A higher rate of 18%, however, could end up increasing the cost of homes, especially in projects which are under construction, unless the Government offers more clarity on the composition scheme (i.e. abatements for cost of land) as well as on service tax and value added tax (VAT) already paid by developers on under-construction properties.
Under the service tax regime, developers and home buyers can obtain benefits under the abatement scheme. In the case of buying an under-construction flat, an abatement of 75% was allowed, subject to the flat being less than 2,000 sq ft and sold for less than Rs 1 crore, taking the effective tax rate from 15% to 3.75%.
If these two conditions are not met, the abatement was reduced to 70% and the effective tax rate to be borne by the home buyer increased to 4.5%.
As most houses in Mumbai are priced above Rs 1 crore, an end-user buying an under-construction apartment would currently pay both service tax (4.5%) and VAT (1% in Maharashtra, varies from state to state). Besides, there are other taxes applicable such as excise duty, customs duty, central sales tax, octroi, etc., which are paid by the developer during procurement and passed on to the home buyer. Stamp duty, which is payable on property transfers, will not be subsumed into the GST.
Now, assuming that the same rules of abatement apply under the GST regime, properties under construction will attract a tax rate of 4.5% (after 75% abatement on a tax rate of 18%), which is the same as today. However, if the abatement rules do not apply, the applicable tax rate would shoot up drastically. Moreover, developers would have already paid service tax and VAT for procurement of goods and services for their properties currently under construction. Will they be allowed to claim credits for input tax paid?
Clarification would also be needed on whether credit for input tax would be allowed by the government if the composition scheme has been availed by developers. Only after these clarifications have been issued in coming days will the real estate industry understand the implications of the upcoming GST regime. On the positive side, there will be reduction in the tax management expenses incurred by developers thanks to the single unified tax. The compliance costs would also go down.
Union Budget 2016 had announced a zero service tax policy for developers constructing flats of less than 30 sqm in tier-I cities and less than 60 sqm in tier-II cities, with the intention of incentivising developers to create affordable housing. Whether similar benefits will continue to be given for the real estate sector under the GST regime remains to be seen.
Demonetization
There is currently a lot of debate happening on how the government’s demonetization move will impact the real estate sector.
The primary sales segment is largely influenced by home finance players, and deals tend to be facilitated in a transparent manner. This segment will therefore see at best a limited impact in the larger cities, though some tier 2 and tier 3 cities where cash components have been a factor even in primary sales will see a business crunch. The secondary or resale market will, however, certainly be impacted, given the fact that this segment does see the involvement of cash component.
There will be a minimum impact on office / industrial leasing and transactions business, given that cash components do not play a significant role in such transactions.
- Real estate investment markets
Projects could get stretched as informal sources of capital may not be available. This, in fact, spells more opportunities for institutional capital. FDI, private equity and debt players will suddenly find the market even more transparent and attractive. Moreover, banks could start funding land transactions, thereby decelerating land prices.
Retailers could see some impact on their business in the short-to-medium term due to reduced cash transactions. The luxury segment is likely to be hit because of the historically high incidence of black money acceptance in this segment. However, credit / debit cards and e-Wallets should come to the rescue. Overall, the domestic consumption story remains intact, with no threat to the overall strength and growth of the Indian retail industry.
Where land transactions have been happening in the realm of joint ventures, joint development or facilitating corporate divestments, will see very little impact of the demonetization move. This is because JVs, JDs and corporate divestments are all quite institutionalized, with little or no cash involvement. However, those carrying out direct land deals will doubtlessly suffer - especially when it comes to agricultural land transactions, which tend to involve significant cash involvement.
There will be minimal impact on large institutionalized players with a solid brand and governance framework. Sales largely driven by the salaried class or investors with limited cash involvement would not suffer. Smaller developers are understandably very concerned right now because many of them have depended on cash transactions. We are very likely to see a clean-up of non-serious players due to this ‘surgical strike’ on the parallel economy. The impact of RERA will further discipline the industry, which will be good for its health in the long term.
- Hotels and hospitality-related real estate
In the organized sector, this will see a very negligible impact by the demonetization.
