Some of the key taxation developments of 2018 which impacted the real estate are discussed here.
The once booming real estate sector, which contributed to India’s economic growth in last couple of decades, has been experiencing a fiscal slowdown in recent years. Though such a slowdown is a result of interplay of multiple economic factors, there have been some important tax & regulatory issues during the past one year, which also impacted the real estate sector. Some of the key taxation developments which impacted the real estate are discussed hereunder.Direct taxes
Prior to FY 2018-19, on sale of immovable property, income from capital gains, business profits and other sources was taxed on higher of sale consideration as per contract and stamp duty value. From FY 2018-19 onwards, the contract value has been considered as sale consideration as long as the difference between stamp duty value and contract value is not more than 5% of the contract value.
While this was a welcome step to help minimize hardship in case of genuine transactions in the real estate sector, where variation may occur in respect of similar properties in the same area, the tolerance band of 5% may not be sufficient since actual deviation between circle rates and market rates in some areas is as high as 30%.
Another pertinent change during the year was on inventory tax. Since 1985, conversion of capital asset into stock-in-trade has been taxable as capital gains in the year when the converted item is sold. For this purpose, the Fair Market Value (FMV) on date of conversion was deemed to be the sale consideration, even though the actual sale may occur subsequently.
According to the Memorandum to Finance Bill 2018, the absence of rules on taxing conversion of stock-in-trade into capital asset was leading to asymmetrical treatment and tax deferment. Despite more than 30 years of having no specific rules on this aspect, the Income Tax Law was amended to treat FMV on conversion of inventory into capital asset as business income of the taxpayer in the year of conversion (not on eventual sale).
Instead of bringing symmetry, the amendment leads to some lop-sided outcomes. For instance, unlike conversion of capital asset to inventory where ‘income’ is taxable, the inventory tax provisions seem to tax the entire value of FMV by specifically deeming FMV on conversion to be income. A more consistent approach would have been to clarify (by way of a circular) that inventory-related costs would be deductible against the FMV on conversion.
Additionally, the difference in timing of taxing asset-converted-to-inventory (in year of sale) and inventory-converted-to-asset (in year of conversion) creates inconsistency and results in an immediate tax outgo on notional income.
The said change has impacted real estate players in case where they have decided to monetize unsold apartments/offices by letting them out since this may be construed as conversion of inventory to capital asset. With no clear guidance on when inventory would be considered to have been converted, factors such as duration for which such unsold apartments / offices are let out and tenancy termination clauses may play a major role. For instance, it is not clear whether apartments let out for even a few months with the builder having a short notice to terminate tenancy would be treated on a different footing as compared to fixed long-term tenancy contracts with not tenancy termination rights with the builder.
Another question which has puzzled the realty business is whether revenue in the books of real estate developers should be recognized on percentage completion method or project completion method (prescribed under Ind AS 115 as well) or completed contract method.
Budget 2018 introduced Section 43CB in the Income tax Act to provide that business income in case of construction contract and service contracts in specified cases, shall be determined on the basis of percentage completion method, which is in line with the provisions of Income Computation and Disclosure Standard (‘ICDS’).Indirect taxes
The Government issued a much needed Press Release reiterating that GST shall not be applicable sale of complex/ building and ready to move-in flats where sale takes place after issue of completion certificate by the competent authority. The said Press Release helped in clearing doubts, if any, in the minds of the buyers, which emanated from the fact that some builders were demanding GST even when consideration was paid after issuance of completion certificate.
The Press release also explained through an example that the overall tax costs have not gone up and have perhaps reduced on account of availability of additional input tax credits.
Further, an important ruling concerning anti-profiteering under GST was pronounced in the latter half of the year by National Anti-profiteering Authority. In the said case, the Applicants had filed an anti-profiteering complaint against the builders on the ground that benefit of input tax credit (available to the builder under GST regime) was more than the output tax liability and accordingly, the builder should have reduced the prices on account of availability of credit. The Hon’ble authority held that the builder shall reduce the price to be realized from the buyers of the flats as per the benefit of ITC received by him.
Though the said ruling has been challenged before High Court, it is clear that the Government intends the builders to pass on the benefit to the buyers on account of increased input tax credits.
Joint Development Agreements (JDAs) are a common feature wherein the land owner transfers the land to the real estate developer for construction. The builder/developer receives consideration for the construction service provided by him by way of land development rights (from landowners) and cash (by other buyers) and deposits GST with the treasury, wherever applicable.
A notification was issued by the Government on taxability of JDAs. In terms of the said notification GST is to be collected from the landowners for transfer of land development rights to the builders. Given that the notification goes against the essence of GST framework that excludes sale of land and building from its ambit, the sector has challenged its constitutional validity and the matter is presently sub-judice before High Court.Conclusion
From taxation standpoint, 2018 was a mixed bag for realty sector. While the Government’s intention to provide relief to the sector cannot be questioned, issuance of timely clarifications to address practical difficulties faced by taxpayers and taking a more pragmatic approach to taxing issues are two areas where Government may look to improve in the coming year.The author is, Partner, Indirect Tax, KPMG. Views are personal.