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Real estate: 'Taxed' growth

Dec 17, 2007

Over a period of time the taxes and the regulatory environment in the real estate sector has become very important. The construction industry is already subject to a number of taxes and is considered as one of the overburdened tax segments. Any further tax burden on this sector would affect its orderly growth and development. In this article, we take a look the nature of taxes an individual or a corporate pays in the real estate sector and why liberalisation in case of some of these taxes is necessary to sustain the growth of real estate in India. India has one of the highest levels of property taxes and stamp duty among the major countries in the world. This has lead to high levels of non-registration of property transactions as well as transfers through the 'power of attorney' (POA) route. Moreover, high stamp duties, registration charges and capital gains tax leads to high incidence of cash transactions leading to an increase in black money in the economy. These cash transactions are typically routed through various covering companies.

Then the real estate developer has to take number of approvals from different agencies, which in turn increases the costs and time to development. These factors have led to corporate governance issues within real estate companies regarding transparency and disclosure. Common areas where there is a lack of clarity include the number and size of projects being executed by any given company and its group, the end use of customer advances, and the nature of consolidated indebtedness and fund flows within the group.

Stamp duty: It is tax, similar to sales tax and income tax collected by the government, and must be paid in full and on time. If there is delay in payment, it attracts penalty. In India, in some states, the stamp duty is as high as 14% (Tamil Nadu) of the value of the transaction. Surprisingly, the government does not feel that the rates are high but also justifies that the levy of stamp duty is applicable in every subsequent transaction, be it the initial transfer or purchase of land or on further sale of the same land after development or any other succeeding transaction. If the rates of stamp duty were bought down, it would avoid the resultant cascading effect of stamp duty, thereby reducing the cost of a property.

Service tax on lease rent: This is the latest 'reform' in this space by the government. The government has imposed service tax of 12% on the lease rentals paid by the lessee. As per real estate industry estimates, approximately 80% of the ITES-BPO companies in most of the cities have a policy of using only leased properties to carry out their functions. Many banks, MNCs, malls, restaurants and multiplexes also use leased properties and are caught in the crossfire.

Property tax: Property tax is an ad-valorem tax, which the owner of the property has to pay on the market value of the property assessed. Property tax in India is levied on residents by local municipal authorities to upkeep the basic civic services in the city. As always is the case with India, the owner of the property is liable to pay the property tax as against in UK where the tenant pays the property tax. As the market value of the property rises, the property tax also increases.

Capital gains tax: Lastly, when individuals or corporate sells their property after a holding period of 3 years, they have to pay long-term capital gains tax of 20% on the net gain from the property (30% tax in case of property sold in less than 3 years). So, in short, right from purchasing the property till the time of selling it, the investor is caught in the tax web.

A few days back, the stock market regulator, Securities and Exchange Board of India (SEBI) had mentioned of this being the tight time to bring in REITs (real estate investment trusts) into India. What we believe is that bringing REITs into India is different from their long run sustainability or success. If the real estate sector has to sustain the growth, which it has shown over the last few years, then there has to be big liberalisation on the tax front and also in bureaucracy involved in the property development field.

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