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Will homebuyers return anytime soon?

Apr 12, 2010

The latest Union Budget brought construction services under the service tax domain. Realty companies were obviously not happy. They condemned this move. This was as they believed that imposition of additional tax, for an industry which is already paying an indirect tax in the range of 14-16%, will dampen real estate demand and impact the recovery process. The budget had proposed a service tax of 10% on 33% of the price of the apartment. This would have resulted in an increase in home prices by 3-4%. Assume you bought an under construction property for Rs 5 m. As per the recent budget proposal, you are required to pay service tax of 10% on Rs 1.65 m (33% of the price of the apartment). Hence your total outgo for the purchase (post-tax) will now be Rs 5.165 m.

There were recommendations from across the industry to rollback the imposition of service tax. This is because such a tax was not viable for the developers due to their foray into affordable housing. Affordable housing is a low margin venture. As such, a higher tax would have meant a further dent in profits.

However, it seems that the protest of real estate developers has finally paid off. The government plans to exclude the land value from the construction tax ambit. This will effectively lower the tax rate for the purchase of an under construction property. As per a leading property developer, the resultant move will bring down the net service tax rate to 1.75% from 3-4% as envisaged earlier. We believe the exclusion of land cost from the service tax ambit should bode well for both the real estate developers and home buyers. This will effectively bring down the home prices and help in improving demand.

However, a worry could be to separate land prices from construction cost in multi-storey apartments. The problem is bigger in cities like Mumbai where land cost forms a major part of the total construction cost.

The government is currently working on various options like using floor prices for areas set by states to compute land cost. We believe even this move will prove to be a challenge to accurately compute land cost. This is because applying land value to apartment complex is a difficult task. This problem is compounded by inconsistent practices to value land in different parts of the country.

We believe that removing land cost from the service tax ambit is a welcome move for realty companies. Since most of them would have passed on the hike to the end consumer, it is the buyer who would have been axed. Although the final outgo after the levy of tax was not huge for the consumer (could have absorbed the increase due to widening of tax slabs), we believe the timing was not right.

Higher tax at a time where the industry was in trouble and consumer sentiment was low was not what the doctor ordered. However, with the proposal to exclude land cost from tax ambit and signs of revival in the real estate market, homebuyers might return to the real estate market soon.

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