Impact of Goods and Services Tax (GST) on the Indian real estate sector

Goods and Services Tax(GST) is a unified indirect tax which replacing all the other indirect taxes present in India such as sales tax, Value Added Tax (VAT), entertainment tax and service tax. The taxation system of India so far has been a complex web of different corporate, property and personal income taxes which made it seem opaque and vague. Until recently, different states followed different indirect tax rates for managing the movement of goods. Not only did the tax rates differ from state to state, but the types of tax were also inconsistent. The country’s complex taxation system has often been attributed as one of the barriers to not only growth of the real estate sector but overall economic growth.

Furthermore, growing enterprises and even large-scale firms and multinational companies faced difficulty in managing the tax payables. They would end up paying unrelated taxes and sometimes even paying the same tax twice. To add to the government’s woes, many individuals and firms have mastered the art of tax evasion. Therefore, to tackle these issues, the Indian government undertook the mammoth task of replacing the current tax structure with a single unified system known as the GST. The new system will come into effect on 1st July 2017. In this article impact of GST on the real estate sector is assessed. The GST for the construction sector has been set at 12% (ET Realty, 2017).

The benefit to both buyers and sellers with a single tax system

The real estate sector of India has been fraught with several issues such as:

  • lack of transparency in the purchase of property demand and supply imbalance,
  • rising input cost and difficulty in raising the funds for construction,
  • constant delays in possession of property (CommonFloor.com 2013).

Apart from this, buyers have to directly or indirectly pay different taxes on the purchase of a property. VAT which varies from state to state, excise duty, stamp duty, and service tax which is fixed at 15%. As a result, buyers pay double taxes for the purchase of under construction house.

Consequently, the implementation of GST serves a dual benefit for buyers as well as sellers of properties who can now reduce their construction costs considerably. In other words, sellers or builders of a property will no longer have to shell out excessive amounts of money to pay taxes on raw materials used in construction, which will bring down property prices. This buyer-seller tax saving regimen will eventually lead to the clearing of the stock which has piled up since the recession hit the globe (MarketExpress 2017).

But how exactly is GST affecting different types of property in India and what is its impact in exact terms?

Residential properties to become cheaper with lower GST

Typically, a buyer of the residential property is expected to pay for two main requirements; the land and the construction of the house. The current system levies a service tax and stamp duty on the construction while providing for 75% abatement. Service Tax and VAT will be replaced by Central GST and State GST whereas stamp duty stays unchanged as it is out of the purview of GST. The abatement rate on property is yet unclear under GST. However, if removed, housing prices are expected to rise considerably.

Implementation of GST will help to revive the real estate sector which is currently stagnant for last few years

Figure: Taxes replaced by GST in the real estate sector

Let us examine the difference from an example.

  • Current taxes and charges borne by the builder on construction= 15-16% (4.75% service tax + 2% VAT + excise duty)
  • Current abatement rate= 75% on total value of the property
  • Service tax= 15% on the remaining 25% value of the property
  • VAT % differs from state to state (between 1% and 5%), so let us assume VAT at 2% of the ‘agreement value’.
  • GST rate of  12%

*stamp duty is likely to remain unchanged even after implementation of GST, therefore it is not taken into consideration in this case.

Assuming the house is of Rs. 100, the owner has to pay the following charges:

Abatement of 75% means that the buyer has to pay service tax on only 25% of the property, i.e. 15% service tax on Rs. 25. Therefore,

  • Service tax= Rs. 3.75.
  • VAT @ 2%= Rs. Rs. 2
  • Total= Rs. 5.75.

Now after implementation of GST @12%, the builder would be able to save 3-4% on taxes, bringing down the property price to Rs. 96.

Therefore now the buyer will have to pay only the following charges on Rs.96:

Assuming abatement remains same @ 75%,

GST @ 12% of Rs.28 = Rs.3.36

As the above example clearly shows, property buyers now stand to gain from India’s new taxation system. Residential housing which has seen turmoil due to low demand driven by demonetization and construction delays will receive a huge boost. In the case of affordable housing segment, there is a further advantage as the state and territory-level Ministry of Housing and Urban Poverty Alleviation (MHUPA) has suggested rationalization of stamp duty. If that happens then the prices of affordable houses are likely to reduce even further.

Mixed-effect of GST on rental property and commercial property

In India, 2-4 per cent rental yields are generated and the dynamics of the rental property works whenever there is an increase (decrease) in the stock of rental property. Another way of increasing revenue from the rental property is through capital value appreciation rather than leasing. In the latest version of the GST bill, the leasing of a building, in part or whole which might include a residential and commercial building, would be viewed as a service rendered as per the GST bill (Housing.com 2017 a).

Currently, service tax is levied only on the commercial and industrial units which are rented out. On the other hand, property rented as residential housing is not considered to be charged the service tax. If GST is applied to the residential rental property then a certain degree of impact is expected in the short-run. Especially, for residential housing because of the fact that rental property currently does not come under the ambit of service tax but after GST implementation it will become expensive due to a levy of tax.

In addition, even for commercial and industrial rental property, the tax would be higher causing a negative sentiment in the market (Business Standard 2017; Proptiger.com 2017). However, residential leasing has an inherent demand and this will not diminish considerably merely by higher taxes. Since rental housing demand is sticky and end-user-driven in nature, it will adjust slowly to the environment of GST in future.

GST on other related sectors and revival of demand in the real estate sector

The impact of the GST will not be seen restricted to only on the real estate sector but also can be seen on related sectors such as on the financial sector and the overall infrastructure sector which acts as the pillars of the real estate sector. The financial sector is largely impacted by the changes as lending credit to property buyers is one of their main businesses. Most of the buyers avail loans to purchase constructed and under-construction properties, whether for residential or commercial use. Improvement in the tax regime due to GST will alter the demand of property and hence the need for finance.

Also, the overall infrastructure sector includes numerous civic projects such as building the commercial office space, metro, roads, hospitals, shopping complexes and so on which will receive a boost due to the decrease in construction costs. Not only will this bring about a balance on demand-supply dynamics of the real estate sector, but will also uplift the overall economy. One simplified tax rate would encourage buyers to purchase the property in a hassle-free manner and will help the developers also to clear the piled up stock of construction.

References

Priya Chetty

Partner at Project Guru
Priya is a master in business administration with majors in marketing and finance. She is fluent with data modelling, time series analysis, various regression models, forecasting and interpretation of the data. She has assisted data scientists, corporates, scholars in the field of finance, banking, economics and marketing.

Related articles

  • Challenges faced by the Indian real estate sector The Indian real estate sector has come a long way since the 1990s' by becoming one of the fastest growing markets in the world. It is not only successfully attracting domestic real estate investment but foreign investments too.
  • Real estate market in Mumbai and Pune In the past five years, there has been an undeniable slump in India’s real estate. This was due to reasons such as after-effects of the recession, inflation, inventory pile-up, etc. However the same has not been majorly felt in India’s two metropolitan cities, Mumbai and Pune.
  • Changing phases of growth of the real estate sector in India The real estate sector is one of the most recognised sectors of India. It is the second largest employer in the country after agriculture. India’s skylines consists of housing, retail, commercial and hospitality establishments.
  • Impact of demonetization on India’s real estate sector The announcement of demonetization and implementation of the Benami Properties Act for unregulated properties took place in the same year. Economists predicted the growth rate of the real estate sector to slow down more than ever as a result.
  • Digital India initiative brings new hope to the real estate industry The Indian real estate sector is the second largest employer after agriculture in India. The strength of the Indian real estate market can be attested from the fact that it is expected to touch US $180 billion by 2020 (IBEF, 2015).

Discuss

We are looking for candidates who have completed their master's degree or Ph.D. Click here to know more about our vacancies.