It has been trumpeted as the biggest tax reform since Independence. It probably is. The Goods and Services Tax, or GST, is a tax reform that has been on the cards for more than a decade. A feather is Modi's cap is that it will become a reality under his leadersip.
In the current tax regime, state governments tax sale of goods but not services. The central government taxes manufacturing and services but not wholesale and retail trade. GST is a destination-based tax that brings all indirect taxes under one roof.
(Indirect taxes can be either origin based (levied where goods and services are produced) or destination based (levied where goods and services and consumed). The former is also known as production tax and the latter as consumption tax.
In other words, all indirect taxes levied by the central and state governments across the country get subsumed into a comprehensive GST.
Let's look at the impact on GST when dealing with real estate.
Taxes paid when buying a house
1) Service Tax
Payable to the central government. This charge is only applicable for under construction properties. It is levied on the total price paid for the purchase of an under-construction property.
2) Value Added Tax, or VAT
Payable to the state government. This charge is only applicable for under construction properties. VAT is typically levied on the sale of goods and is applicable for house property, as it involves the transfer of ownership rights from the seller to the buyer.
3) Stamp Duty
Payable to the state government.
Understanding abatement in service tax
When buying a property, the purchaser pays the builder for the cost of the land as well as the construction service provided. But service tax can only be levied on services and not on the sale of goods or property. So service tax cannot be levied on the value of land but only on the construction cost.
In case it is difficult to show the cost of immovable property separately from the cost of services, there is an abatement scheme wherein tax is levied only on a small portion of the total amount.
For houses under Rs 1 crore and less than 2,000 sq. ft. in area:
- Abatement: 75%
- Service Tax levied on: 25% of the total purchase price (cost of land + construction)
- Service Tax of 15% on 25% = 3.75%
- This is levied on the total price paid for the purchase of an under-construction property.
For houses Rs 1 crore and above, and above 2,000 sq. ft. in area:
- Abatement: 70%
- Service Tax levied on: 30% of the total purchase price (cost of land + construction)
- Service Tax of 15% on 30% = 4.5%
- This is levied on the total price paid for the purchase of an under-construction property.
Service Tax and VAT will be replaced by Central GST and State GST whereas stamp duty stays unchanged as it is out of purview of GST.
Once GST gets implemented, whether the cost of houses will come down or increase, will depend on two factors:
- The rate at which GST is charged
- Whether there will be any abatement or not. If the abatement rules do not apply under the GST regime, the applicable tax rate could shoot up dramatically.
The consensus is that the rate will be around 12% (under the new indirect tax regime, there will be four slabs: 5%, 12%, 18%, 28%).
According to a report in Mint, real estate lobby group National Real Estate Development Council (Naredco) and Confederation of Real Estate Developers’ Associations of India (Credai) recommended to the finance minister that the GST rate should not be kept higher than 12% for the real estate sector: “The GST rate on the consideration excluding value of land should not be more than 12% covering both CGST (central GST) and SGST (state GST) after providing credit for all the inputs... Anything above this rate would only result in continued deceleration of this industry and also compromise GDP (gross domestic product) growth.”
So what will be the ultimate impact of GST?
(The views below are of Anuj Puri, Chairman - JLLR - JLL Residential)
Though the goods and services tax (GST) tax structure has been announced, there is still a lot of conjecture about which tax rate will be applicable to the real estate and construction industry.
The tax rate is not decided yet and it would be premature to comment on it at this point. The expectations are for real estate to be in the 12% bracket. However, the GST rate is not the only important factor. The abatement rules as applicable under the service tax regime and the input tax credit facility for developers will determine if the effective tax incidence on real estate is lower or higher under GST.
The government has offered some clarity on the abatement rules for under-construction houses and input tax credit benefits for developers.
Impact on residential real estate
Sales are not just impacted by tax rates but also by sentiment, and also on account of the trust deficit which the Real Estate Regulation & Development Act - or RERA - now seeks to address. That said, if costs do go higher under GST, the lower prevailing current home loan rates could assuage the impact to some extent.
Buyers, investors and developers are understandably worried that the final ticket size of homes will increase even if the government levies GST at 12%, when compared to the existing service tax rates.
Developers are still awaiting further clarity on this, but they know that it is in the interest of their business to keep ticket sizes range-bound. Evolving market dynamics have already brought about a change in the manner in which developers work. Staying customer-centric and delivery-focused to create a differentiated identity will be the most logical and likely method for them to adopt.
Impact on rental housing
Rental housing would naturally be impacted if the government were to tax residential leases under GST. The common apprehension is that if this were to happen, the rental housing segment may see a huge slump over the medium-term, since residential leases are currently not taxed at all.
Here, it is pertinent to note that residential leasing is an inherent demand which will not evaporate merely by higher taxes. Certainly, we may be looking at a rental stagnation or marginal decline as the market readjusts to the new dynamics which GST will infuse. However, rental housing demand is sticky and end-user-driven in nature, so we are definitely not looking at a major slump in this segment because of GST even if it does tax residential leases.
That said, rental yields in major cities could certainly moderate if GST is levied on rental housing. In India, rental yields in housing are quite modest at around 2-4% on an average. Rents may either hold steady or decline marginally due to increase in housing stock.
However, it is also true that most investors in the residential sector do not invest for rental yields but rather for the capital value appreciation, so reduced rental yields would not independently impact sentiment.
Impact on commercial real estate
With the existing service tax for commercial leases at 15%, GST would be likely neutral overall (at 12% slight savings, and at 18% slight increase).
Impact on affordable housing
Affordable housing is currently exempt from service tax. It is likely that the government may come out with a clarification regarding the applicability or continuing exemption under the GST.
Impact on renters
(The views below are of Ramesh Nair, CEO and country head at JLL India)
The Central GST (CGST) bill states that any tenancy, lease, license to occupy land, or easement will be considered as supply of service. Any lease or letting out of a residential, industrial or commercial building for commercial purposes – wholly or partly – will also constitute a supply of services.
Simultaneously, the sale of land or building (except the sale of under-construction buildings) will not be treated as either supply of goods or services. The sale of land and buildings will be out of the purview of GST, and such transactions will continue to attract stamp duty.
Once GST comes into effect, the leasing of land and buildings - as well as home loan EMIs paid by those who purchase under-construction apartments - will attract the applicable tax rate. Depending upon the tax rate that gets announced for real estate, the effect could be higher or lower than today.
Similarly, the final applicable tax rate would define whether those living in rented residential properties end up with much higher or slightly higher rental outgo, as the additional tax to be paid by the landlord will get passed onto the lessee. Under the current regime, service tax is levied on rents paid for commercial and industrial units, and not for residential units.
