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?