Tax experts react to 34th Council Meeting announcements on implementation of new tax structure for real-estate

The GST Council has addressed many of the concerns that the real estate industry had voiced in terms of transitioning to the new regime of lower tax rates including credit transition for ongoing projects which opt for new rate.

The exemption of TDR etc. for projects commencing after April 1 2019, providing for reverse charge mechanism in situations where the liability to pay tax on TDR fastens and determination of time of supply in such cases will also bring a great relief and address the cash flow issues faced by industry.

The mixed project issue where a project has both commercial and residential accommodation has been deftly handled as well.

While an option has been provided in respect of ongoing projects to continue to pay tax at old rates, it could however prove to be illusory as optically the new rates appear more attractive to a buyer and ability of the real estate players to take a call within the prescribed period about their ability to collect taxes at old rates appears uncertain.

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“With some of the key inputs for construction such as bricks, stone, hardware etc. coming from sectors which are largely unorganised, meeting the condition of 80% procurement from registered dealers for concessional GST rate could be challenging, specially in Tier-2 and smaller cities” 

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“With the option to under-construction properties for transitioning to new rates, it is time to go back to spreadsheets and undertake a quick input tax credit vs. lower tax rate cost-benefit analysis.”

The 34th GST Council meeting has brought some positive news for the Real Estate sector.

In a welcome move, the GST Council has provided an option to ongoing projects (where construction has already started prior to 1 April 2019) to choose normal rate of 12% (with credit) or 5% (without credit) - in case of affordable housing such rate would be 8% (with credit) and 1% (without credit). The reduced rate of 1% shall also apply on projects currently covered under 8% GST (e.g. Pradhan Mantri Awaas Yojna).  Such option has be exercised within a period which would be specified. Providing such option would be beneficial for those developers who had already factored the entire input credits of the project while arriving at the sale price and in many cases these benefits may already have been passed on to customers.

Further, the new composition rates would be mandatory for all projects for which construction starts after 1 April 2019 and hence, such tax blockage would need to be factored at time of budgeting. In such case, the Council has mentioned that the credit reversal would need to be done proportionate to area space, the details of which are awaited. The developers would need to work out the amount of input credit for various projects (where certain projects are covered under composition and certain under normal scheme or projects having both residential and commercial segments).

Another important aspect clarified by the Council is to treat projects with up-to 15% commercial space as residential property. This is important in cases where buildings have commercial amenities such as clubs, restaurants etc. as well as in case of residential-cum-commercial projects. However, in certain cases it may not be possible to determine the exact percentage of commercial area upfront or the ratio of residential and commercial area might undergo a change after the project has started. Tax treatment in such cases may need to be analyzed in detail.

Additionally, a condition has also been imposed that 80% procurement by developers should be from registered dealers to avail the composition scheme. On the shortfall, GST has to be paid at 18% under reverse charge by the developers (except cement which will continue to attract 28% GST). This would required increased vendor control and the fine print would need to be analyzed to determine whether the condition is only limited to vendor registration or also the vendor compliances like payment of tax and filing of returns.

Transfer of development rights, which is generally exempt for residential projects, would become taxable under reverse charge to the extent the property is sold after obtaining the completion certificate, for which a separate valuation mechanism is proposed.

These changes would have substantial impact on Real Estate sector. Industry will have to work out which option works best and come up with the revised price structure quickly. It is important to undertake changes in IT systems, documentation and processes at earliest considering the 1 April 2019 cut off date. Timely engagement with the customers would also be important, as they would expect overall reduction in prices and may want to understand the basis of revised pricing. Industry would need to be cautious of anti-profiteering provisions as well and need to do a detailed analysis for the ongoing projects.

The approval of the scheme as an optional one for construction projects underway, was one of the key asks of the real estate industry. It's go ahead by the GST Council brings quite a relief for this sector in handling transition issues in specific.

GST Council meeting has assumed importance for real estate developers. Post announcement of reduction in the rate of tax, lot of uncertainty prevailed in relation to applicability to the lower rate of tax for transition projects. The decision by the Council in today’s meeting, will bring significant breather to the Developers as the option is provided to opt for lower rate without ITC for under construction projects. The another important decision is providing the methodology for reversal of ITC. This will bring clarity on the availability of tax credit the real estate developer. The detailed Notification is still awaited and hopefully there should not be any devil in the detailing this time for the real estate developer.

On a whole, it is disappointing to see as to how the GST on real estate sector is panning out. The whole scheme of taxation for this sector is against two fundamental principles of GST viz. seamless flow of credit and ease of tax compliances. It is also doubtful if these new rates will bring any benefit to the consumers at large or will only increase the cost of doing business at builder’s end. For sure, the proposals are bound to make taxation complicated as well as likely to invite multifarious litigation.

The GST Council in its 34th meeting, has prescribed the modalities of implementing the new scheme. My thoughts on key proposals are:

- The qualifying criterion of Rs.45 Lakhs value cap for a house to be “affordable” is meagre considering the present prices of residential properties in metro cities.

- The applicability of reduced tax on commercial spaces like shops, offices etc. in real estate projects to the extent of 15% of carpet area, is unwarranted. If the objective is to reduce the tax burden on residential properties, its benefit should not be extended to non-residential properties.

- The condition of mandatory procurement of 80% inputs and input services from registered taxpayers and applicability of tax on reverse charge mechanism (if not procured), is onerous and likely to invite disputes.

- The applicability of old scheme of taxation for ongoing projects is welcome, however, it needs to be seen whether the government is able to clearly define what an “ongoing project” will constitute to be.
The issue of taxation and credit aspects relating to sub-contractors is yet to be clarified. Further, looking at an overall complex taxation scenario and in light of recent news reports of lapsing of ITC lying with builders, the amendment to ITC provisions are not expected to be any simpler.

The certainty on date for reduction of rate will boost the sentiments of all stakeholders of the sector. The huge ambiguity with respect to real estate projects with commercial space upto 15% has been resolved and these projects shall be treated as residential property for GST purposes.

The need for number crunching arises for the existing under-construction projects which have an option to either shift to new rates or continue with old rates. To keep a check on unregulated procurements, it is announced that 80% procurement of material should be from the registered dealers. Credit reversal shall be proportionate to area space and may give rise to constitutional challenges.

In view of the denial of ITC under the new tax rate of 5% and 1% on under-construction residential properties under affordable and other than affordable segments respectively, there was apprehension in the industry on the eligibility of ITC already claimed by builders. This GST Council decisionto provide a one-time option to realtors of under construction projects seeks to address such issues during the transition phase. Realtors would have to undertake a cost-benefit analysis based on the factual scenario in each case to determine their preferred option. It would not be surprising to see builders prefer different option for different projects, or even for different buildings within the same project. The Council is also attempting to prevent revival of black economy in the sector by requiring builders to pay tax under RCM for inward supplies from unregistered persons if they exceed 20% of total purchases. Clarity is required to understand at what stage of a project is a builder required to check for the fulfilment of this condition, and how the Revenue intends to track any non-compliance. The council has also sought to ease the cash flow issues of realtors by shifting the time of supply of supplies such as TDR, FSI, long term lease premium, etc. to the date of issue of completion certificate rather than the actual date of supplies. However, the real impact of these decisions will be known once the fine print of the amendments in rules is made available.

There were several unanswered questions after the last GST Council meeting, many of which have been answered today. This will partly mitigate the uncertainty apropos GST on real estate. However, the following ambiguities continue to remain (at least, basis perusal of the press release; the rules haven’t been perused at the time of writing these comments):

(i) The cap of Rs 45 lakhs for qualification as ‘affordable housing’ – does it include the basic value of the flat only or does it include charges for common amenities (like common parking etc in mixed projects) too?

(ii) In an welcome clarification, it has been elucidated that the concessional rate of 5% GST shall apply for residential real estate projects with upto 15% of total carpet area earmarked for ‘commercial’ purposes. But where the ratio exceeds 15%, the question arises as to whether separate records are to be maintained for claiming credit by a developer? It may be difficult to apportion credits especially vis a vis common facilities like lift, parking or other shared infrastructure.

(iii) Will this lead to new type of anti-profiteering complaints? It is instructive to remember that in the National Anti-profiteering Authority (NAA) order against Hardcastle Restaurants [TS-680-NAA-2018-NT], profiteering was upheld since “base price was increased by 12.38% which is more than the ratio of denial of ITC of 9.11%.” Builders who intend to increase prices to set off incremental costs on account of ITC denial, will need to calculate the extent of loss very carefully to avoid anti-profiteering complaints.

(iv) Accepting representations filed by several industry bodies, it has been specified that for ongoing projects, entire input credit will not be lost – credit in proportion to booking of the flat and invoicing done for the booked flat will be available subject to a few safeguards. However, it is a settled law that credit eligibility has to be evaluated at the time of receipt of inputs/input services. Can a subsequent change in law take away a vested right of input credit which has been validly availed? This issue may lead to writ petitions challenging the loss of credit as per the new transition formula.

(v) A bunch of welcome measures have been mentioned in the press release to address the problem of cash flow in the sector, including exemptions and deferments in point of tax on TDRs, FSI etc. But, the following questions arise therefrom:

(a) Can TDR’s be made liable to GST at all since they are included in ‘land’?

(b) JDAs may also be in the form of revenue sharing arrangements and thus qualify as ‘joint ventures’ with no ‘supply’ thereunder. Can there be GST on development rights obtained under such JDAs anyway?

(c) Development rights (whether in the form of TDR, FSI, lease or JDA) may not always be a ‘supply’ – it may be ‘consideration’ for supply of construction services by developers and thus not liable to GST per se. Can the new exemption/newly deferred point of tax apply at all in such cases?

The GST Council has approved today the transition in respect of rate of GST on real estate sector. The residential project is likely to be defined specifically and it is likely that each building would be regarded as distinct unit for this purpose. The option to choose, within the time limit to be specified, the current rate of GST or the new rate of GST is likely to be available qua each building separately. Hope this will help builders to use the input tax credit balance existing on March 31, 2019.  It is not clear, where the residential project has shops, offices etc. cover more than 15% of total carpet area, whether the current rate of GST (12%) would continue to apply.

On commercial portion in the ongoing projects, GST will be payable at 12 percent with ITC even after April 1, 2019.

On the day of choosing the new GST rate, input tax credit would be allowed to be transitioned as per the prescribed method. The method would be better understood from the Notification.

For projects commencing after April 1, 2019 having paid for TDR, FSI, long term lease premium, and the flats are sold after issue of completion certificate, GST would be payable on 5 per cent of value of the flat, in case of other than affordable houses and GST would be 5 per cent on such value. This GST would be under reverse charge mechanism on the exemption initially availed on receipt of supply of TDR, FSI, long term lease premium.

The time of supply for the builder to pay GST on construction of houses given to land owner in a JDA is being shifted to the date of completion.

The ball has been put in the court of the builders to make complex computations and, possibly, choose the option which is more beneficial. The price of properties being market driven, should not be impacted by such complex computations.

GST was introduced as an ultimate solution to eliminate cascading effect of taxes. The concept of GST as known to the world is slowly getting distorted in the form of regular aberrations by way of lower rates without ITC.

When this format was first implemented for hotels and restaurants, the small hotels did not see a big impact as most of theinputs used in preparation of food were exempt. The same is not the case for construction.

A Builder selling at a sq. ft. rate of 3000 to 4000 would suffer in the absence of ITC. Cement attracts 28% GST and various services involved attract 18%. Added to this, are the statements appearing in the Press that price increase should not happen. Price increase is a natural corollary if costs go up due to non-availability of ITC. 

Real estate is dealt with differently in different parts of the country as land is a state subject. While in the west there is a single conveyance through a society, down south in Tamil Nadu there is no such concept. The undivided share of land is conveyed through a sale deed and the construction of a flat is through a construction agreement.

To assume that the entire country follows 12% itself is incorrect. Land is outside GST. There are precedents to the effect that TDR is immovable property. The press release assumes it is taxable and seeks to exempt it under circumstances.

The Notification is likely to weave a complex web as it seeks to deal with different scenarios, different conditions, different periods, taxability, formulas, which may even affect vested rights.