In the last couple of years, apart from India’s two biggest passions of cricket and cinema, if there is one topic that has dominated the news cycle, it is the Goods and Services Tax (GST). Touted as the biggest taxation reform in the country’s history, the path towards acceptance and the eventual implementation of GST has been through numerous twists and turns already, with more in store. This video will give you a better insight about it:
As things stand, the constitutional amendment that allows for such a pan-India tax to be imposed has been cleared by the national Parliament. However, the various modalities of the tax, along with the final tax rate are yet to be determined. With the central government having set a target of 1st July 2017 for GST’s rollout, one can expect things to move quickly on this front. As GST’s introduction seems inevitable, it is indeed of great importance to analyze its impact on the broader economy in general and the real estate sector in particular. In this article, we attempt to make sense of what we know about the GST and assess what it means to all parties involved in real estate.
The Current Taxation Structure
In general, taxes come under two categories: direct taxes and indirect taxes. Direct taxes are those directly paid by an entity to the government, such as income tax and corporate tax. Indirect taxes, however, are paid indirectly on every item purchased or consumed or on any service utilized, by the consumer to the provider and by the provider to the government. When it comes to real estate, the indirect taxes are the ones to be concerned about.
If one looks at the price sheet provided by a builder or any project, one’s attention will be drawn to the line items indicating Value Added Tax (VAT), Service Tax, Stamp Duty etc., all of which are indirect taxes. However, these are not the only taxes that are to be paid. Included in the price of the property are various hidden taxes such as tax on construction materials, tax on inter-state transport of materials, octroi etc. Each of these taxes are levied by different governments: Service Tax by the central government; VAT and Stamp Duty by state governments; Octroi by local municipal bodies. In general, the cost of a home includes taxes on items (raw materials), services and on the land (Stamp Duty).
The multiplicity of these taxes proves to be a major headache for developers, who have to keep track of which payments are to be made to which body. Different tax rates at the state and local level complicate matters further, with major variations across states and cities within the same state. Transport of raw materials across state boundaries also attracts taxes. Apart from the taxes themselves, the time and paperwork involved (referred to as the cost of compliance) is yet another burden on the developer. To make matters worse, there is the issue of cascading of taxes (taxes to be paid later are imposed on the base price + earlier taxes), resulting in multiple taxation of the same item and massive cost escalation, which is often passed on to the final home buyer. The existing system ends up encouraging tax evasion, which is where the much talked about black money in real estate comes in.
Introduction to the Goods and Services Tax (GST)
It is in this scenario that the GST comes in as a breath of fresh air. GST is meant to be a comprehensive indirect tax that will subsume most of the existing indirect taxes on goods and services (such as VAT, transportation taxes, sales tax, any surcharges or cesses and Octroi). For each good produced or each service availed, a central GST (CGST) will be paid to the central Government and a state GST (SGST) to the respective state Government.
In case of inter-state movement of goods, an integrated GST (IGST) will need to be paid. In case GST has already been paid on the item earlier in the supply chain, those later in the chain can claim tax credit for it and only need to pay tax on the value added by them. However, it’s only once the GST Council, comprising the central and state governments, notifies the final GST rates applicable to various sectors can one conclusively determine how it will affect the economy.
Impact of GST on Real Estate
To assess the impact of the GST on the real estate sector, knowing the final tax rate to be imposed was important. With the GST Council setting a rate of 12% on under-construction and new projects, any tax increase is likely to be minimal, if any. Also, there are likely to be a lot of teething troubles in the initial 1-2 years post implementation of the GST, which are likely to be rectified in due course. As of now, we see the following areas where the GST will leave its mark on the real estate sector:
With GST, multiple taxation on construction raw materials, brought about by tax cascading, will disappear. This should significantly bring down the cost of goods.
Taxes imposed on transport of construction raw materials, while crossing state boundaries or entering cities, will be subsumed by GST. This should reduce transportation costs significantly, which should reflect in lower construction costs.
Delays caused during inter-state transport of raw materials, due to payment of taxes, will become a thing of the past. This should help marginally reduce construction time.
Similarly, the amount of paperwork required to be filed due to multiple taxes payable to different parties will greatly reduce, bringing down the cost of compliance drastically. This should, in theory, reduce tax evasion instances greatly and bring in greater transparency into this sector.
Current tax rates payable on services are lower than the GST rates being considered. As a result, the cost of services in real estate is likely to go up, following the implementation of the GST. Whether this increase in cost of services outweighs the decrease in the cost of goods or vice versa remains to be seen and depends on the final GST rate. The interplay of these two elements will determine the final cost to be paid by the home buyer.
The GST will not be applicable to homes already constructed, but to those which are under construction at the time. It will also be applicable to renting out of homes.
The GST is expected to add greatly to the country’s GDP and to the purchasing power of individuals. This should boost demand in the economy, a part of which shall reflect in the real estate sector.
Taxes payable on the land, such as Stamp Duty, will be out of the ambit of the GST and will need to be paid separately.
Similarly, registration charges too will not form part of the GST and must be paid separately.
Now that the final taxation rate of 12% under the GST is known, it appears that prices of homes should either remain the same or may increase marginally. Even here, considering a marginal impact on the developer’s margin and with the real estate sector currently in the midst of a prolonged slowdown leaving developers saddled with excess unsold inventory, they could well absorb this increase in order to push sales and come out of the red.
Other Unclear Aspects
When it comes to the GST, there are a few other aspects regarding its applicability to real estate that remain unclear:
Currently, ready reckoner rates for properties are fixed by state governments, on which stamp duty is paid by developers. Will state governments continue to retain this discretionary power remains to be seen, with greater likelihood being that this will indeed be the case.
There is no clarity on how Transfer of Development Rights (TDR), which is widely used for land acquisition, will be treated under the GST.
The GST is one of the most significant reforms undertaken since independence and will impact every aspect of economic activity in the country. At the same time, it remains a step into the unknown and one can expect confusion and some changes to the law in the early stages, as its full import becomes known.
Nonetheless, by bringing greater transparency to the real estate sector, reducing unnecessary paperwork and delays and bringing in order to the complex tax system followed currently, the GST should lead to major improvements in this sector. While some short term pain is expected, in the medium to long run, the GST should benefit all stakeholders, be it the developer, home buyer or indeed the governments and the wider economy.
The scope and impact of the GST goes far beyond the real estate sector. The intent behind it is to bring about a behavioural change among all stakeholders, with greater transparency in taxation on the government side and reduction in tax evasion by individuals and corporations, which is indeed laudable and helps build trust among them. This alone should help form a strong base for the country’s growth and development for years to come.