tax in real estate

7/31/2019 Tax in real estate

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Real Estate Tax and Regulatory regime

Contents

1. Introduction

2. Overview of Relevant regulations

3. FDI in Real estate

Conditions

Issues for consideration

Funding options

4. Affordable housing sector

5. Listing of properties outside India

6. Income tax aspects

7. Indirect tax aspects

8. Accounting issues

Slide 2


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Real estate in India Key drivers

Economicgrowth &

prosperity isdriving demand

for real estatein India alongwith a large

and growingurban & youth

population

669769

8821,001

1,146

1,344

-

400

800

1,200

1,600

FY06 FY07 FY08 FY09 FY10 FY11

USD

perannum

Per capita income

Economic growth and prosperity to drive demand forreal estate

1,153

1,843

2,738

-

500

1,000

1,500

2,000

2,500

3,000

2007 2011 2015

USD

BN

India's GDP* Growth

Source: Datamonitor, US Census Bureau, Of fice of the Registrar General & Census Commissioner

(India), IMF W orld Economic Outlook

Slide 3

Real estate in India :Demand is expected to be strong across residential,commercial office and retail space

Source: CRISIL, Cushman & Wakefield, PwC research & analysis

Growth drivers Economic growth,

population expansion, increasingincome levels and the rapid growthin organized retail

Indias retail market size isexpected to grow at a CAGR of 15 -20% over the next 4 years to reachover USD 850 BN

Indias Organised Retail Penetration isexpected to increase from 6.5% to 9.2%

by 2015

2.6

3.9

-

1

2

3

4

5

2011 2015

MNunits

India Residential

Growth drivers Population growth,rapid urbanization, decreasinghousehold size, increase in working agepopulation and increase in income levels

Widening demand supply gap -Urban housing shortage expected toincrease from 20.5 Mn in 2010 to 21.7MN units in 2014

Localized, fragmented marketpresents opportunities forconsolidation

Residential Space

127

160

-

40

80

120

160

200

2010 2014

Mnsq.

ft.

Commercial Office Space Demand

Growth drivers Global and Indian

economic growth, domestic demand,export growth and increase in workingpopulation skill sets

IT/ITeS and BFSI would continue to

account for 60-70% of the officedemand

Labour force estimated at ~490 MN(2011); expected to grow at a CAGR

~2.3% to reach ~550 MN by FY16

Commercial Office Space Commercial Retail Space

16

57

-

10

20

30

40

50

60

2011 2015

dd

Commercial Retail Space Demand

CAGR- 11% CAGR

- 6% CAGR- 37%

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Overview of Indian Regulatory & Tax Regime

Slide 5

Key Relevant Legislations

ForeignInvestment &

Exchange Control

Foreign DirectInvestment

Policy

ForeignExchange

ManagementAct

Related Rules,Regulations and

procedures

CorporateLaws

Companies Act

Related Rules,Regulations and

procedures

Fiscal Laws Direct Taxes

Income-tax Act

Wealth Tax Act

Fiscal Laws Indirect

Taxes

Customs Act

Central ExciseAct

Service Taxlegislation

Value AddedTax (VAT)legislation

Central SalesTax Act

Other keylegislations

Indian StampAct

Intellectualproperty right

laws

Labour laws

Environmentallaws

IndustrialLicensing Policy

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FDI in Development & Construction Activity

Slide 7

Background

Historically highly regulated FDI permitted in limited sectors

Recent policy measures opened up the sector for FDI

March 2005 FDI guidelines allowing 100% in few real estatesegments

Currently, FDI in real estate is allowed 100% through automaticroute subject to conditions to be satisfied

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Real Estate Sector

Real

estatesector

Development ofSEZ

Educationalinstitutions andold age homes

Industrial Park andinfrastructure

facilities for thepark

Hotels, resorts,Hospitals

Residential townships,

housing

Commercial

premises,Recreational

facilities

Conditions to be satisfied

100% FDI permitted

Slide 9

Construction development Conditions for FDI

Serviced housing plots min 10 hectares; Construction-Development projects 50,000 sq.mts Combination project any one of the above

Minimum Hectarerequirement

USD 10M for WOS USD 5M for JV

MinimumCapitalizationrequirement

Funds should be brought in within 6 months from thedate of commencement of business

Realisation

3 yrs from minimum capitalisation 3 yrs applied from date of receipt of each tranche of FDI

and completion of min cap Which ever higherLock-in-period

50% should be completed within 5 yearsCompletionpercentage

Bye-laws, rules and regulations of StateGovernment/Municipal/Local bodies

Responsible for obtaining all necessary approvals

Compliance tonorms/standards

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Industrial Park Conditions for FDI

Plots of developed land+built up space or combination with common facilities developed and allotted for ind ustrial activity

Industrial Park -Meaning

Means manufacturing, electricity, gas and water supply, post andtelecommunications, software publishing, consultancy and supply, dataprocessing, database activities, and distribution of electronic content, othercomputer related activities, basic and applied R&D on bio-technology,pharmaceutical sciences/life sciences, natural sciences, and engineering, businessand management consultancy activities, and architectural, engineering and othertechnical activities

Industrial activity

Plots of developed land net area excluding common facilities Built up space floor area and built up space for common facilities Combination site area and floor area available for allocation excluding site area

and built up space for common facilities

Allocable Area -Meaning

Minimum of 10 units No single unit shall occupy more than 50% of allocable area

Minimum unitsrequirement

Minimum 66% of allocable area to be allocated for Industrial activityAllocation for Industrial

Activity

Slide 11

Issues for consideration

Minimum area Built up area definition Super built up or carpet area?

Minimum Capitalizations with funds to bebrought within 6 months - Clarity on

definition, start, end of 6 months

Restriction on repatriation of originalInvestment restriction on investment orinvestor

Timeline for development of the project consequence and remedy?

Commercial complexes Vs. IndustrialParks

FDI in company with Mixed projects

Lock-in-period Investor or Investment?

Exit to another non-resident

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Funding options

Instrument Feasibility Profitrepatriation

Capitalrepatriation

Equity Extensivelyused

Dividend Nocap

Restrictive Buyback/CapitalreductionCompulsorily

ConvertiblePreferenceShares(CCPS)

Dividend Subject to cap

Compulsorilyconvertible

debentures (CCD)

Interest Subject to cap

ExternalCommercialBorrowing(ECB)

Permitted onlyfor IndustrialPark

Interest- Subjectto cap

High flexibility

Non ConvertibleDebentures(NCD)

For FIIs onlyMust be listed

Interest subjectto cap

High flexibility

Slide 13

Affordable housing sector key aspects

Key focus by the Government in India

Regulatory initiatives through Finance Act, 2012

ECB opened up for this sector Capital/funding

Credit guarantee Trust Fund continuation of interest subventionscheme for another year

Tax incentives through Finance Act, 2012

Enhancing Investment linked deduction of capital expenditure 10150%

Service tax exemption specified construction services and low costmass housing

Interest payments on ECB - Lowering tax rate to 5%

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Listing of Commercial properties outside India

Management

&

Performance

Fee

Mgmt Co.

IHC

SEZ Projects

Sponsor

Project SPV1

Investors

BusinessTrust

Project SPV 2

Singapore

India

Listed onSGX

Listingoptions

Debt

Instruments

REITs / Business Trusts

(for certain typesof assets)

Private Offering (Funds / GDR)

Offering to institutions & highnet worth individuals

Public offering of shares (shares /SDR)

Offering to institutions, high networth & retail investors

Slide 15

Taxation of Real Estate Sector

Direct Tax

Indirect Tax

Stamp duty

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Direct Tax

Tax incentivesunder Income Tax

Act:

1. SEZ Developers

2. Housing projects

3. Industrial Park

Tax issues faced by industry:

1. 14A disallowances

2. Income Characterization

Business Income Vs. House Property BusinessIncome Vs. Capital Gains

3. Joint Development Agreements Issues andplanning avenues

4. AOP taxation

New issues in lightof Finance Act,

2012:

1. Domestic TP

2. GAAR

Slide 17

Tax incentives for real estate sector

Sec 80-IABSEZ developer

Conditions Profits and gains from the business ofdeveloping a SEZ notified on/after 1st April 2005

Tax incentives - Deduction of 100% of the profits andgains for 10 consecutive yrs out of 15 yrs

Sec 80-IB -Developingand building

housing project

Conditions :

Approved by a local authority before 31st March 2008 Min area 1 acre of land ; Residential unit min bui lt up 1000 1500 sq ft Built up area of shops and commercial eshtablishment not more than 3% of

aggregate built up or 5000 sq ft which ever higher Conditions on allotment of residential houses

Tax incentives: 100% of profits from such housing project

Sec 80-IAIndustrial Park

Conditions:

Develops,operates,maintains and industrial park

After 1st April 1997 and before 31st March 2011

Tax incentives: 100% of profits for 10 consecutive years

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Tax issues faced by Real Estate Industry

Disallowances u/s14A

Characterization ofIncome

AOP Taxation

Joint DevelopmentAgreements

Slide 19

Disallowances under section 14A

Section 14Ainsertedin 2001, with

retrospective effect fromAY 1962-63

No deduction to beallowed for expenditure

relating to exemptincome

(14A disallowance)

Disallowance to becomputed as per

prescribed formula^(Rule 8D)#

The

Present

Hon'ble SC* held thatif exempt & taxable

income earned fromindivisible businessthen expenditure not

to be apportioned

Contentious issue subject matter of

substantial litigation

Assessees claimedexpenses relating to

exempt income

The

Past

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Sec 14A contd.

Rule 8D

* Only those investments, income from which does not / shall not form a part of the total income

Aggregate

Disallowance

Expenditure havingdirect nexus withexempt income

Interest cost

(as per the formulaprescribed)^

0.5 % of avg. ofinvestments*

Notification dated 24.03.2008 amended the Income-tax Rules by insertion of Rule 8D

Interest expense of the current year X Avg. value of investments *

Avg. Total Assets appearing in the Balance Sheet

^ Prescribed formulato determine interest

cost

Slide 21

Sec 14A contdConcern for Real estate business run through SPVs

Results indisallowances

and highertax outflow

Expendituredisallowedeven if no

incomeearned?!

May be aconcern whenbusiness isnecessarily

run throughSPVs

Balance Sheet

Approach

No flexibilityto exclude

investmentsout of owned

funds

Blanketminimum

disallowanceof 0.5% of

investments

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Income Characterization:

Real estate developer

Residential complex Commercial complex

Held as stock-in-trade

Profits taxed asBusiness Income

Held as Capital asset

View 1 : Developerin the business of

leasing out

Profits taxed asBusiness Income

View 2 : Rent frombuilding / land to be

taxed under HouseProperty

Profits taxed asHouse Property

All costs & depreciation allowed Only 1/3rd standard deduction

Taxability of units leased out > 12 years?

Slide 23

Joint Development Agreements

Taxation onentering JDA

Drafting of JDA Granting of

License toDeveloper

Sec 53A ofTransfer of

Properties Act

Transfer taxed asCapital Gains in

the hands ofDeveloper on

date of JDA

Taxation on saleof completed

residentialapartments

Taxed in the yearin which sale takes

place

Normally taxed asCapital gains

Taxed asBusiness Incomeif Land owner is in

business ofdeveloping

Taxation in the hands of Land Owner

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Joint Development Agreements

Taxation on sale ofcompleted units

Taxed in the yearin which revenue

is recognized

Taxed asBusiness Income

Taxation of SPVs for

commercialcomplexes

Income taxed asCapital gains

Lease rentals maybe taxed as House

Property incomedepends on drylease/wet lease

Taxation in the hands of Developer

Slide 25

AOP Taxation issues

existence of two or morepersons

coming together for acommon purpose

common action on part ofthe constituent members

Joint and several liability

common object ofproducing income by thecommon action

Fundamental tests for determinationof AOP

Risk of AOP between Landownerand Developer triggered

Tax issues of AOP: Developer/SPV isCompany MAT

would be applicable Results in doubletaxation ???

Slide 26


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Finance Act, 2012 - Tax issues for Real Estate

Domestic TransferPricing

General Anti-Avoidance Rules(GAAR)

Slide 27

Domestic Transfer Pricing

Transactions between related parties

As referred in section 40A(2b), transfer ofgoods/services as per 80A, 80-IA(8),80-IA(10),10AA

Where aggregate of such transactions exceeds 5crores

Computation of Arms length price As specified u/s92C

Real estate sector SPV model impacts intercompany transactions

More documentation and procedural formalities

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GAAR - Overview

GAARnotapplicable

Does the arrangement contain any of 4tainted elements

Arrangement is Impermissible Avoidance Arrangement

No

No

No

Yes

Yes

Is there an Arrangement to obtain taxbenefit?

Was the main purpose or one of the mainpurpose to obtain tax benefit?

Not at arms length

Misuse or abuse of the Act

Lacks commercial substance

Not for bona fide purposes

Disregard/recharacterise

Lift corporateveil

Treaty overrideChange place of

residence or situs

Reallocateincome/expenses

accrual/ receipt

Recharacteriseequity-debt,

income-expense

Yes

Consequences thereof includes:

Yes

Slide 29

GAAR Issues for real estate sector

JDA StructuringCharacterization

of IncomeAvailing Tax

incentives

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Treaty provisions relating to sale of immovable

propertyMeaning as per Domestic LawPlus : Certain inclusionsMinus: Certain exclusions

Direct Use, letting, use in any other formIP used for the performance of Independentpersonal services

May be taxed in the state in which the

Immovable property is situated

Definition of ImmovableProperty

Taxability of Income

Income derived fromImmovable property

Income derived from alienation of shares assets of which consist wholly/principally ofImmovable property taxed in the state in

which Immovable property is situated

Taxability of Capital gain

Slide 31

Real estate Indirect Tax Issues

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Real Estate Indirect Tax Issues

Value Added Tax (VAT)

Three options fordetermining the sale priceof the goods andcomputation of VATpayable:

OPTION I : DEDUCTIONMETHOD

OPTION II : IF THEVALUE OF LABOURCANNOT BE IDENTIFIED

OPTION III :COMPOSITION SCHEME

Construction Contracts could be classified as aworks contract

Works contract essentially means a compositecontract involving both the supply of service as

well as the supply of goods

- VAT is generally discharged on the sale price ofthe goods. In the case of a works contract, thesale price or taxable turnover is arrived at bydeducting certain labour and other element

from the bill amount- There are basically three options for

determining the sale price of the goods andcomputation of VAT payable

Slide 33

Real Estate Indirect Tax IssuesService Tax

In the Union Budget 2012-13, it is proposed to exemptservice tax on services of

erection, construction ormaintenance of pipeline,conduit or plant for

drinking water supply

water treatment

Sewerage treatment ordisposal

Service tax is levied on specified services renderedor received in India.

In case of construcation contracts, the designingand drawing, civil works, installation andcommissioning, site testing, training services,operation & maintenance would be taxable underservice tax

The tax rate at present is 10.30% and will be12.36% from 1-04-2012

In Union Budget 2012 13 ,it is proposed to levyservice tax on all activities except specifiedservices in the negative list. This would impact thetax consideration for the construction projects

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Accounting issues guidance notes

ICAI has recently issued guidance note on Accounting for Real Estate Transactions

Revenue recognition as per percentage of completion method AS 7 on satisfyingfollowing conditions:

Significant risk and rewards transferred

Handed over possession

No significant uncertainty on amount of consideration

Not unreasonable to expect ultimate collection

Additional conditions to be satisfied for revenue recognition:

All critical approvals and clearances are obtained

Expenditure incurred on construction and Development is more than 25% oftotal cost

At least 25% of saleable project area is secured by contracts or agreementswith buyers

At least 10% of the total revenue are realized at the reporting date reasonable to expect that the parties will comply with payment terms

Slide 35

QUESTIONS & ANSWERS

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Thank You

2012 PricewaterhouseCoopers Private Ltd. All rights reserved. PwC, a r egisteredtrademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or,as the context requires, other member firms of PwC I nternational Limited, each of which is aseparate and independent legal entity.

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