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Legal Capsule by Economic Laws Practice

GST rate reduction to 5% in the real estate sector: A winning stroke or a run out?

Authors: Rohit Jain, Gaurav Sogani

The real estate sector in India has faced several headwinds over the past few years. Demonetization in 2016, the introduction of GST in 2017 and the NBFC crisis in 2018. The question now is whether the revised scheme of GST will be a similar event in 2019.


At the outset, sale of a property pre and post construction, by a developer, has been treated differently for the purpose of levy of indirect taxes.  This basic issue still bothers the sector as both the transactions eventually entail the sale of an immovable property.


Be that as it may, the scheme of taxation for this sector has been continuously changing. With this recent change, this sector is evidencing the 5th regime of taxation, within a decade. The facts are presented in the table below.

Period
Taxability
ITC (Input tax credit)
Taxation on development rights
Prior to 2005
Not liable
Not available
Not liable
2005 - 2010
Disputed but finally held to be liable for VAT and Service Tax
VAT – allowed
Service Tax- not allowed
Not liable but disputed by VAT authorities
2010 - June 2017
Taxable to VAT & Service Tax
VAT – not allowed
Service Tax – allowed
While not liable but disputed not only by VAT but also Service Tax authorities
July 2017- March 2019
Liable to GST
Full ITC available
Taxable
April 2019 onwards
Liable to GST
No ITC
Exempt to the extent of sale prior to Completion Certificate


The basic ethos underlying the implementation of GST was revenue neutrality which means that the tax burden essentially pre and post GST regime remains the same.However, Real Estate sector stands out in revenue neutrality approach not being maintained, as evidenced from the fact that up to March 31, 2019, the GST rate of an under-construction property was 12% (effective tax rate). This proved to be a massive jolt to the real estate industry which was anyway struggling to stay afloat. 

Post several representations made by the industry and based on the recommendations of the GST Council, the Ministry of Finance finally notified a revised scheme whereby a GST rate of 5% without ITC, would be applicable to the sale of an under construction residential unit.

However, we need to carefully consider whether this revised scheme of 5% GST without ITC is more beneficial than 12% with ITC?  Though the optics seem very good, on analyzing the finer details, one can infer that this move does not actually tilt the balance favorably to the sector or the consumer. The government has effectively retained the same tax burden and, in fact, developers and consumers might be worse off in many instances.

To understand the real impact of the GST rate reduction, it is important to understand the hidden effects of denial of input tax credits on the costs of construction and on the marketing costs. In the extended suburbs of metros and in Tier II and Tier III cities, the ratio of cost of construction and marketing (Cost) to Sales Price (SP) is high as 45% to 50%. Consequently, the overall tax burden borne by the customer will now under the revised scheme is in the range of 14-15% (in metro suburbs, Tier II and Tier II cities).  Illustrating this with an example.

Sale price (SP)
COC
Total tax cost
Effective tax cost
Additional tax burden
A
B
C = A*5%
D= B*20%
E= C+D
Till March 31, 2019
[F=A*12%]
(E-F)
100
45
5
9
14
12
2









Note: Most of the construction related goods and services fall in 18% rate slab however cement continues to be under 28%. For the sake of calculation, ITC is computed on an average rate of 20%.

In a nutshell, the tax costs in the transaction is likely to be more and not less as would be expected.

Adding to the industry woes, the states of India have increased stamp duty by 1%. For example, in Maharashtra the  stamp duty has been increased to 6%.At best, this move of reduction to 5% has achieved certainty for the industry. While the customer is correct in expecting  a lower price of housing, developers are facing their own set of woes – while they need to meet customers’ expectations and pass on the lower rate of GST, the denial of ITC has squeezed them from both ends of the spectrum. Is this rate reduction, therefore, a winning stroke or run out?


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