India reforms property tax

The levying of indirect taxes in India on the real estate sector has always been fraught with pitfalls and disputes.

The levy has its origins in the constitution of India, which grants the state the power to levy value added tax (VAT) on the transfer of property involved in the performance of a contract of employment (c i.e. a contract involving the supply of labor 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 then engaged in a colossal legal battle against this tax frenzy, declaring that the sale of real estate cannot be subject to either VAT or a service tax. However, the debate ended with the question settled in favor of the government.

It has been held that the tax is levied on construction activity prior to the completion of the property. Rules were developed to ensure that there was no double taxation (i.e. the collection of both VAT and service tax on the same contract value).

However, litigation continued, as there were difficulties in determining the appropriate value to tax under each law, the deductions available and the eligibility of offsets given the different law from state to state. . Their alignment with the central laws proved to be a subject of conflict between the builders and the tax authorities.

In addition, there were disputes around the applicability of the service charge on the transfer of land development rights. There were also restrictions under each statute regarding eligibility to apply for credits, which added to the chaos and increased the tax cost.

Goods and Services Tax (GST)

The introduction of the Goods and Services Tax (GST) has promised better times for the property sector, with the assimilation of state and central laws leading to a unique tax regime in India. The new GST categorizes construction and contract work activities as “services,” with GST between 8% and 18%, along with appropriate deductions (1/3rd amount) for the cost of land and compensation.

This higher tax impact was accompanied by a clarification of taxation and the opening of greater compensations. However, the benefit has been diluted for reasons such as larger purchases from unregistered resellers, etc. This has led to confusion over the quantum of tax benefits to be passed on.

Throughout this time, the industry has been embroiled in disputes with tax authorities over the transition of credits from the old regime to the new GST regime, with tax authorities seeking to limit the offsets that can be carried over, only in to the extent that inputs are in stock and not already part of buildings under construction.

Another area of ​​debate was the taxation of development rights transferred from landowners to builders, with the majority of landowners being individuals who did not want to take on any tax liability. Even in situations where offsets were available, builders remained in a situation of credit accumulation, with no real possibility of use. Therefore, the effective tax rate after offsetting was a point of contention. The non-transfer of benefits was viewed as profiteering by builders, leading to the issuance of anti-profit notices (a provision of the GST Act that mandates the transfer of benefits resulting from an increase in compensation).

Changes in real estate taxation

Advocacy by industry to government for rationalization and tax reduction has led to significant changes. On April 1, 2019, GST rates were reduced to 1% for affordable housing and 5% for all other residential properties, without offset.

The construction of commercial buildings will continue to be taxed at the rate of 12%, with the benefit of compensation. Lower tax rates come with various conditions (ie 80% of purchases must be made from registered contractors, etc.).

Failure to comply will result in reverse charge liability in the hands of the promoter.

Transitional arrangements have been introduced to allow industry to retain the old GST rates, provided these are reported by taxpayers to the tax authorities within the stipulated timeframes.

Development rights are exempt from GST payments, to the extent of the units on which the tax was levied. Developers are responsible for paying GST under a reverse charge on these fees, to the extent of all units sold after construction is completed (which is not subject to GST).

The rules are complex and transfer full responsibility into the hands of developers/builders. The next few days will see if the industry is able to decipher and apply the law, or if it leads to new disputes with the tax authorities.

That said, the new rules resolve a number of issues, disputes around offset and benefit passing-on, and GST on development charges, at least for the construction of residential properties.

Ritesh Kanodia Ritesh Kanodia Meetika Baghel - Small Meetika Baghel

This article was written by Ritesh Kanodia and Meetika Baghel from Dhruva Advisors.

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