The levy of indirect taxes in India on the real estate sector has always been fraught with disputes and litigation.
The levy finds its origin in the constitution of India, which grants power to the state to levy a value added tax (VAT) on the transfer of property involved in the execution of a work contract (i.e. a contract involving the supply of labour and materials for an agreed price).
In 2010, the central government introduced a service tax on the sale of properties under-construction to capture the service element involved in such transactions. The industry subsequently commenced a colossal legal battle against this taxing spree, stating that the sale of immovable property cannot be subject to either VAT or a service tax. However, the debate ended with the issue settled in favour of the government.
It was held that the tax is levied on the activity of construction prior to the completion of the immovable property. Rules were framed to ensure that there was no double taxation (i.e. levy of both VAT and service tax on the same contract value).
However, litigation continued, as there were challenges in determining the proper value to be taxed under each law, the deductions available, and the eligibility of set-offs considering the law differed from state to state. Aligning these with the central laws was turning out to be a matter of conflict between the builders and the tax authorities.
Furthermore, there were disputes around the applicability of service tax on the transfer of land development rights. There were also restrictions under each law with regards to eligibility in claiming credits, which added to the chaos and increased tax cost.
Goods and services (GST) tax
The introduction of the goods and service tax (GST) promised better times for the real estate sector, with assimilation of state and central laws leading to a single tax regime in India. The new GST categorises construction and work contract activities as ‘services’, with a GST ranging between 8%-18%, along with appropriate deductions (1/3rd amount) towards the cost of land and set-offs.
This higher tax impact came with clarity on taxation and the opening-up of greater set-offs. However, the benefit was diluted due to reasons such as larger procurements from unregistered dealers etc. Further confusion arose where sales of units post completion were not liable to GST, and therefore, whether the same requires partial reversal. This led to a confusion on the quantum of tax benefits to be passed.
All the while, the industry was pulled into conflicts with the tax authorities on the transition of credits from the erstwhile regime into the new GST regime, whereby the tax authorities sought to restrict the set-offs that could be carried forward, only to the extent of the inputs lying in stock and not already forming a part of under-construction properties.
Another area of debate was the taxation of development rights transferred by landowners to builders, whereby the majority of landowners were individuals unwilling to take any tax obligations. Even in situations where set-offs were available, the builders remained in a credit accumulation situation, with no real possibility of utilisation. Hence, the effective tax rate post set-off was a matter of contention. The non-passing of benefit was seen as profiteering by builders, resulting in the issuance of anti-profiteering notices (a provision under GST law which mandates passing of benefit arising as a result increase in set-off).
Real estate tax changes
A plea by the industry to the Government for rationalisation and a tax reduction saw sizable changes. On April 1 2019, GST rates were reduced to 1% for affordable housing and 5% for all other residential properties, with no set-offs.
Construction of commercial properties will continue to be taxed at the rate of 12%, with the benefit of a set-off. Lower tax rates come attached with various conditions (i.e. 80% of procurements need to be made from registered contractors etc.).
Non-compliance will lead to reverse charge liability in the hands of the promoter.
Transition provisions have been introduced to allow the industry to continue with the old GST rates, provided the same is conveyed by taxpayers to the tax authorities within the stipulated time.
Development rights are exempt from GST payments, to the extent of the units on which tax has been charged. Onus has been placed on promoters to discharge GST under a reverse charge on such rights, to the extent of any units sold post the completion of the construction (which is not subject to GST).
The rules are complex and transfer the entire liability into the hands of the promoters / builders. The coming days will see whether the industry is able to decipher and apply the law, or whether it leads to further disputes with the tax authorities.
Having said this, the new rules do resolve a number of issues, disputes around set-off and passing-on of the benefit, and GST on development rights, at least for the construction of residential properties.
|Ritesh Kanodia||Meetika Baghel|
This article was written by Ritesh Kanodia and Meetika Baghel of Dhruva Advisors.