Issues faced by the real estate industry under the realm of goods and services tax

Shammi Kapoor(Heads the Indirect Tax practice of Vaish Associates) - October 27, 2019 - - 0 |
Issues faced by the real estate industry under the realm of goods and services tax

The real estate industry is the second greatest employment generator in India. In the earlier tax regime, when property under construction was purchased; the buyer was subjected to payment of Value Added Tax (‘VAT’), service tax, stamp duty, and registration charges. Property purchased after completion was exempt from VAT and service tax, and only stamp duty and registration charges were payable.

Additionally, in the previous tax regime, service tax and VAT was to be levied on the purchase of residential unit when booked before their completion, therefore developers were required to pay excise duty, customs duty, CST, and Entry tax which was non-creditable and were added to the cost side which was factored in the price of units.

The introduction of Goods and Services Tax (‘GST’); was expected to bring in transparency in the functioning of the real estate sector and reduce the cost of buying houses for buyers. Under GST, the tax rates were to be rationalized and with a uniform tax rate, credits would be available to developers against GST paid for services and goods purchased reducing the cost resulting in such benefit being passed on to the buyers.

Although GST is aimed at alleviating the concerns of the real estate sector, the same has also resulted in a very contrived solution to an already complicated issue.

Some key issues faced by the real estate industry under GST are highlighted:

  • Increased effective tax rate as compared to the tax rate in the previous regime;
  • Levy of stamp duty over and above GST;
  • Valuation of supply;
  • Input tax restrictions and reversal;
  • Taxability of development rights;
  • The ambiguity of JDA transactions as to whether such collaborations are to be treated as an unincorporated AOP requiring separate registration under GST;
  • Taxation of naturally bundled supplies i.e. parking spots etc.;
  • Taxability of liquidated damages;
  • Taxability of compensation amount; and
  • Taxation of works contracts

What is the effective tax rate vis-a-vis the effective tax rate in the erstwhile regime?

GST is applicable on the sale of under-construction properties i.e. before receiving the Occupancy Certificate (‘OC’). Under GST, the tax rate had been fixed at 18% (or 12% for specified affordable housing projects), with a standard 33% abatement being provided towards the value of the land. However, vide Notification No. 3/2019-C.T. (Rate) the tax rates were revised as under:

Sr. No. Construction Service Rate Effective Rate (i.e. excluding valuation of land at 1/3 rd of consideration)
Units in a Residential Real Estate Project[2] (RREP)
1. Affordable residential apartments[3] 1.5% 1%
2. Residential apartments[4] other than affordable residential apartments 7.5% 5%
3. Commercial apartments[5] 7.5% 5%
Units in a Real Estate Project other than an RREP
4. Affordable residential apartments 1.5% 1%
5. Residential apartments other than affordable residential apartments 7.5% 5%
6. Commercial apartments 18% (No change) 12%

As GST is levied on under construction between over and above the stamp duty this may differ state-wise but, usually varies between 4% to 9% payable on the agreement value. Additionally, stamp duty may differ based on gender, and location i.e. rural or urban etc. In totality, under the GST regime, there is an overall tax burden of around 6% to 17%. Whereas, in the previous tax regime, the effective tax rate was 5.5% (i.e. 4.5% Service Tax and 1% VAT under the composition scheme but with limited credits).

In essence, there is a vast difference in the effective tax rate which results in increased costs for the final consumer; mitigating the reasons for the introduction of GST. Moreover, GST promised rate rationalization however, there exist multiple GST rates even on procurement of inputs and input services which tends to add to the already existing complexity of classification disputes.

What is the impact of the levy of stamp duty over and above GST?

With the introduction of GST which was publicized as ‘one nation, one tax’; it was expected to subsume all indirect and allied taxes however, the government excluded stamp duties from within the purview of GST. This exclusion of stamp duties has led to an additional cost which averages around 5%-9%; varying state-wise.

What are the pros and cons of rebates for the value of land provided under GST?

Schedule III provides for the activities or transactions which are not to be treated as a supply of goods or services and the list includes the sale of land i.e. excluding the sale of land from the levy of GST. On this principle, 1/3rd of the contract value is treated as the value of land and as a consequence, a standard abatement of 33% of the total contract value is given.

Although the abatement was introduced as a positive step for beneficial interest to the real industry; the government failed to take into account the ground-level reality and prices of land in metropolitan cities where in some cases the value of land may even exceed the contract value. In such scenarios, the actual value of land is much higher than the abatement provided leading to a higher levy of taxes; which is then factored into the cost leading to a higher tax burden on the final consumer.

What are the restrictions for availing of input tax credit and conditions for reversal of input tax credit?

In the earlier indirect tax regime; credit was restricted to only works contract services whereas, under GST, a registered person is allowed to claim Input Tax Credit (‘ITC’) of tax paid on inputs, input services and capital goods against the construction/works contract services provided by developers. But, at the same time; Section 17(5)[6] of the Central Goods and Services Tax Act, 2017 (the ‘CGST Act’) restricts credit of tax paid on goods and services procured for the construction of a building which is used on one’s account.

Additionally, credit is also not available against works contract services when supplied for construction of immovable property other than for plant and machinery except where it is an input service for further supply of works contract service. Both these restrictions go against the basic principle of a seamless flow of credit under GST resulting in higher costs.

In a practical sense, in cases where the property is sold after receipt of the Occupancy Certificate; the same would be outside the ambit of GST, thus requiring developers to reverse the proportionate credit of tax paid.

How is the transfer of development rights taxed under the provisions of GST?

Transfer of Development Rights (‘TDR’) is the case where the land owner allows the builder to develop the land. In the erstwhile regime; service tax was not levied on TDR as the same was excluded from the definition of ‘service’ same being the transfer of ‘title’ in ‘immovable property’, by way of sale, gift or in any other manner. On the introduction of GST, the sale of land and…sale of buildings were included in the negative list. The confusion remained as to whether development rights could be treated as a “sale of land/building” and would continue to be exempt from payment of GST. However, the Notification no. 4/2019 dated 29.03.2019 clarifies that GST is not payable on TDR/FSI provided; all of the following conditions are met:

  1. The transfer takes place on or after 1st April 2019;
  2. Development rights are transferred for the construction of residential apartments by a promoter in a project (both terms as defined under RERA), intended for sale to a buyer, wholly or partly; and
  3. Consideration or part thereof for the residential apartments has been received before issuance of the Completion Certificate (‘CC’) or before its first occupation, whichever is earlier.

The issue further arises in cases where the property remains unsold even after the occupation, thereby in such cases; the exemption becomes unavailable leading to reversal or payment of GST at the applicable rate by the promoter.

What is the ambiguity surrounding the taxability of Joint Development Agreements under the provisions of GST?

A Joint Development Agreement (JDA) is such, wherein the landowner contributes his land for the construction of a real estate project and the responsibility for the development of the property, obtaining approvals, launching, and marketing the project is undertaken by the developer. The landowner transfers certain rights to the developer against which the developer either gives a fixed share of the developed area or revenue from the sale of the developed area to the landowner. The taxability of this amount paid instead of land to the landowner is ambiguous and unsettled. However, Notification no. 4/2019 dated 29.03.2019, clarifies that the transfer of development rights from the landowner to a developer is taxable. The same stance was upheld by the Authority of Advance Ruling in the case of Maarq Spaces Pvt. Ltd[7]., wherein the authority held that the activities envisaged under the JDA are tantamount to a supply of service and not a supply/sale of land therefore, the transaction is liable to be taxed under the provisions of GST.

How are naturally bundled supplies, i.e. parking spots etc., taxed under the provisions of GST?

GST Act deals with the concepts of mixed and composite supply which means a supply consisting of two or more goods or services or a combination of goods or services which are naturally bundled and supplied in conjunction with each other in the ordinary course of business. In composite supplies, the supply is taxed as per the rate of the principal supply. In addition to the basic sale price, the consumer is charged for preferential location, car parking etc which tend to form part of a composite supply in which the principal supply is the construction of a complex.

The charges like preferential location, right to use car parking space, common areas and facilities etc., are provided in conjunction with construction services, thereby, the said services would come under the purview of composite supply as defined under Sec. 2(30) of the CGST Act. Further, in a recent AAR ruling by the West Bengal Authority for Advance Ruling Goods and Services Tax, in the matter of Bengal Peerless Housing Development Company Limited[8], it has been specifically held that providing the service of construction of a dwelling unit in a residential complex, bundled with services relating to the preferential location of the unit and right to use car parking space and common areas and facilities amounts to a composite supply where the construction service is the principal supply. Therefore, for taxation under the provisions of the CGST Act, the entire value of the composite supply would be treated as a supply of construction service.

What is the treatment of compensation amount under the provisions of GST?

Compensation amount would include within its ambit expenses like rental reimbursement, displacement compensation, transportation and brokerage allowances, etc. In the cases of redevelopment projects, in most scenarios- the landowners are made to relocate to alternate accommodation and any expense incurred for the same is compensated/reimbursed to the landowners by the developers. The confusion about the taxability of such an amount remains unanswered although various advance ruling authorities are holding that the same is exigible to tax under the provisions of the CGST Act. Under these circumstances, the landowners would be required to register under GST and make compliance.

What is the treatment of liquidated damages under the provisions of GST?

One of the most litigated matters even under the erstwhile regime has been the taxability of liquidated damages/ cancellation charges. In layman’s terms, liquidated damages are such amounts specified in a contract that is to be paid to the injured party on account of some specific breach by the other party. In the real estate sector, liquidated damages may be recovered from sub-contractors on account of performance issues, delays etc by the developers. Such an issue is contentious as the principle of cum-tax comes into play. As per the principle, the compensation amount would always be inclusive of taxes unless the taxes are recovered separately thereby, the burden of the tax would be cast upon the developer at a later stage.

GST has been a revolutionary change in the real estate sector which tends to bring a conglomerate tax system which will help the sector to evolve and prosper. However, there remain certain unresolved issues which require the immediate attention of the government.

[1] Central Board of Indirect Taxes and Customs <https://www.cbic.gov.in/resources//htdocs-cbec/gst/notfctn-3-2019-cgst-rate-english.pdf;jsessionid=5895F41436E28C56851EF4EFFC85BA45> accessed 04 August 2020

[2] “Residential Real Estate Project (RREP)” shall mean a REP in which the carpet area of the commercial apartments is not more than 15 per cent. of the total carpet area of all the apartments in the REP

[3] a residential apartment in a project which commences on or after 1st April 2019, or in an ongoing project in respect of which the promoter has not exercised an option in the prescribed form to pay central tax on construction of apartments at the rates as specified for the item (ie) or (if) against serial number 3, as the case may be, having carpet area not exceeding 60 square meters in metropolitan cities or 90 square meters in cities or towns other than metropolitan cities and for which the gross amount charged is not more than forty-five lakhs rupees

[4] “Residential apartment” shall mean an apartment intended for residential use as declared to the Real Estate Regulatory Authority or competent authority

[5] “Commercial apartment” shall mean an apartment other than a residential apartment

[6]Central Board of Indirect Taxes and Customs < https://www.cbic.gov.in/resources//htdocs-cbec/gst/cgst-act.pdf;jsessionid=15A973E2618D0B5C7A8542FE1621BE49 > accessed 04 August 2020

[7] Advance Ruling No. KAR ADRG. 119 / 2019 dt. 30 September 2020

[8] Advance Ruling No. 07 of 2019 dt. 08 February 2019

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