How will GST impact the various segments of Indian real estate?

The Goods and Services Tax (GST) is, beyond doubt, the most revolutionary tax-related reform to be seen in India in several decades. It will eliminate the conflicting and cascading...

The Goods and Services Tax (GST) is, beyond doubt, the most revolutionary tax-related reform to be seen in India in several decades. It will eliminate the conflicting and cascading taxation structures, which have confounded several industries over the past few decades. It will most certainly have a profound effect on India’s economic prospects.

A single, indirect tax, which covers all goods and services will, in the long run, increase tax collection by making it easier for retailers and several other businesses to comply and also moderate overall taxation levels. That said, it should be remembered that the favorable effects of this new taxation regime, will become evident only within 2-3 years of its implementation.

Although the GST tax structure has been announced, there is still a lot of uncertainty about which tax rate will be applicable to the real estate and construction industry. The expectations are for real estate to be in the 12 percent bracket. However, the GST rate is not the only important factor. The abatement rules, as applicable under the service tax regime and the input tax credit facility for developers, will determine if the effective tax incidence on real estate, is lower or higher under GST.

Effectively, the composition scheme allowing for abatement against a cost of land to the extent of 75 percent of the house cost, for residential units priced under Rs 1 crore and less than 2,000 sq ft, makes the effective rate at 3.75 per cent. In other cases, the abatement goes down to 70 percent, making the effective rate at 4 per cent. This will go a long way, in determining whether GST is tax neutral or tax adverse for real estate. The government has offered some clarity, on the abatement rules for under-construction houses and input tax credit benefits for developers.

GST’s impact on residential real estateIf we look at the residential property sector, sales are not just impacted by tax rates, but also by sentiment and also on account of the trust deficit which the Real Estate (Regulation and Development) Act (RERA) now seeks to address. That said, if costs do go higher under GST, the lower prevailing current home loan rates could assuage the impact to some extent.

Buyers and investors, as well as developers, are understandably worried that the final ticket size of homes will increase, even if the government levies GST at 12 percent when compared to the existing service tax rates.

Developers are still awaiting further clarity on this but they know that it is in the interest of their business, to keep ticket sizes range-bound. Evolving market dynamics have already brought about a change in the manner in which developers work. Staying customer-centric and delivery-focused, to create a differentiated identity,  will be the most logical and likely method for them to adopt.

GST’s impact on rental housingOther doubts pertain to the rental housing market, which would naturally be impacted if the government were to tax residential leases under GST. The common apprehension is that if this were to happen, the rental housing segment may see a huge slump over the medium-term since residential leases are currently not taxed at all.Here, it is pertinent to note that residential leasing is an inherent demand which will not evaporate merely by higher taxes. Certainly, we may be looking at a rental stagnation or marginal decline, as the market readjusts to the new dynamics, which GST will infuse. However, rental housing demand is end-user-driven in nature. So, we are definitely not looking at a major slump in this segment, even if residential leases are taxed under GST.

Here, it is pertinent to note that residential leasing is an inherent demand which will not evaporate merely by higher taxes. Certainly, we may be looking at a rental stagnation or marginal decline, as the market readjusts to the new dynamics, which GST will infuse. However, rental housing demand is end-user-driven in nature. So, we are definitely not looking at a major slump in this segment, even if residential leases are taxed under GST.

Nevertheless, rental yields in major cities could certainly be moderate, if GST is levied on rental housing. In India, rental yields in housing are quite modest at around 2-4 percent on an average. Rents may either hold steady or decline marginally, due to increase in housing stock. However, it is also true that most investors in the residential sector, do not invest for rental yields but rather for the capital value appreciation. So, reduced rental yields would not independently impact sentiment.

GST’s impact on commercial real estateWhen it comes to GST’s impact on the commercial office real estate market, with the existing service tax for commercial leases at 15 per cent, GST would be likely neutral overall (at 12 per cent slight savings, and at 18 per cent slight increase).

GST’s impact on affordable housingAffordable housing is currently exempt from service tax. It is likely that the government may come out with a clarification regarding the applicability or continuing exemption under the GST.

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