Remove GST inefficiency to boost real estate

The current slowdown in the country owing to Coronavirus outbreak, will leave its impact on Indian economy for months. Industries would be forced to knock on government’s door for bailout to tide over the crisis. Global scenario also seems gloomy with developed countries struggling to cope up with COVID-19. Fears of recessionary conditions for the world economy can spell doom for Indian economy too if steps are not taken proactively. Though every sector will need some government help the real estate sector has to be a priority due to its size and contribution to GDP.
With just one step, the government would be able to provide a big breather to the ailing real estate sector. Bringing under-construction properties at par with ready units under GST is the most plausible step which needs to be considered at the moment.
In the past NBFCs (Non-banking financial companies) and HFCs (Housing finance companies) have been forced to shut shop since real estate buyers have refrained from entering the market. Industry stakeholders cannot escape the blame, since they kept pushing the prices upward way beyond the earning capacity of an average buyer over the past one decade. Time and again the mismatched demand, supply dynamics and price points have been discussed but this crucial point (of GST mismatch) has not been debated as much.
A blog cum write up by real estate data analytics firm Liases Foras provoked me to dig deeper and highlight how imposition of GST on only under-construction segment has resulted into inefficiencies in the sector. So spend three to five more minutes with me on this blog and in all likelihood the two of us shall be on the same page on the subject.

1) The existing framework / rules

Currently GST is applicable only on under-construction apartment unit. No GST is charged if you buy a flat in a ready apartment (the ones which have secured occupation certificate from concerned authority). GST is levied only once. No set off is offered to an individual buyer. Ready units are exempted from GST because of exemptions provided to immovable properties ( As per paragraph 5 of schedule III of GST act activities or transaction relation to sale of land and subject to clause b of paragraph 5 of schedule II, sale of building shall not be treated as supply.
Rolled out with a belief that GST exemption on land transaction is needed since it does not entail supply of goods, the exemption has been affecting the overall sector negatively. Without getting much into the legal aspects, I would like to focus on the financial aspects of this decision. Under-construction market segment does not seem lucrative to buyers since apart from GST, income tax deductions under section 80C and section 24 on interest component are also lower. The entire scenario pushes buyers toward ready products. Since real estate is usually one-time transaction, a setback of 5% in the form of GST is enough to influence decision of a large number of end-users.

2) No change in final price

The rule seems extremely amusing to me. It is as good as saying a ready car in a showroom would attract no road tax, but the one which is being pre-booked would be available at a higher cost, after a gap of few months. Bear in mind, both the vehicles have same colour and specifications. GST charges on units costing more than Rs 45 lakh was decreased from 12% to 5% two years back. While units priced under Rs 45 lakh attract 1% GST instead of 8% that was being charged earlier. While the changed regime seemed like a big development initially. But it came with a rider – developer will not be entitled to claim input tax credit. Again bear in mind that on an average developers cough up about 7% of project cost as input GST. Hence the changed GST regime has failed to provide monetary relief to end-buyers since developers have to add the input benefits to their cost.

3) Incentivising cash payments

The high cost of property transaction (11%) creates a strong incentive for buyers to pay in cash. If we can reduce the GST rate and create uniformity we will reduce the incentive to pay in cash. We can also giving some GST benefit when a customer sells so that the incentive for cash reduces.

There was an attempt to reduce the GST gap between ready and under construction units by lowering it from 12% to 5%. The changed GST regime (12% to 5%) has incentivised the use of cash in the developer ecosystem yet again. As a result developers can now save a lot by paying in cash to their vendors and suppliers due to lack of input credit. For instance a major component like cement attracts 28% GST. Hence there is a huge incentive to pay such suppliers in cash from the time the input credit was removed.

This goes totally against the spirit of GST introduction where everyone is incentivised to escape tax evasion because of lower taxes or input credits.

4) Working capital squeeze and drop in transparency

With developers facing funding crunch, the best way for developers to raise working capital is by selling under construction units. The shift of sales towards ready apartment segment has also squeezed the working capital for the industry.
According to Liases Foras, close to 13.20 lakh units worth Rs 9.40 lakh crore of inventory is available for sale at present. The unsold inventory includes both finished and under-construction units. Among the total 13.20 lakh units that remains unsold, more than 90% units are in various stages of construction. Which means that the industry is heavily dependent upon selling under construction units. Delay in sales of under construction units, will only add to the financing costs which will in turn force the developer to jack up prices instead of bringing them down.
The transparency of the industry has improved a lot after the introduction of RERA. The confidence of buyers has increased due to scores of historic orders in the favour of end-buyer. With states like Maharashtra imposing the RERA efficiently, buyers are now feeling safer with the under-construction segment as well.
The industry can see green shoots of revival if end-buyers are incentivized for buying under-construction units as well.
The disparity between ready and under-construction segments has especially delayed the projects which are just 3 to 6 months away from completion. Since prices are not increasing the customers are willing to take a chance to save 5% in 3 months.

5) Maximising GST collection by maximising ptotential

Between June 30, 2018 and June 30, 2019 sale of ready and under-construction units generated Rs 7.31 lakh crore. Assuming 5% GST on the sale value the government could have collected Rs 36,546 crores compared to the Rs 7,635 crores collected. This would mean extra Rs 28,935 crore GST income for the government (source: Liases Foras previous blog). The government has recently announced a corpus worth Rs 25,000 crore to complete the stuck projects. But unless under-construction and ready segments are brought at par, the recovery will not take place soon. In case GST is levied on ready projects as well, the excess revenues could be diverted in the form of similar last mile funds for stuck projects.
Ironically if a project funded by the last mile funding of government obtains occupation certificate before units are sold, the government would miss out on huge amount of GST collection in the projects funded by them.

The government has recently announced a corpus worth Rs 25,000 crore to complete the stuck projects. But unless under-construction and ready units are brought at par, the recovery will not take place soon. In case GST is levied on ready units as well, the excess revenues could be used as similar last mile funds for stuck projects. Ironically today if a project funded by this fund obtains occupation certificate before the remaining unsold units are sold, the government would miss out on huge amount of GST collection.The government can consider lowering the GST rate for real estate if it wants to help the industry. By lowering the GST rate and levying it equally on all properties, the government will ensure positive sentiments without hitting GST collections.

6) Conclusion

Real estate is one of the largest source of employment and contributors to GDP in India. The sector is dealing with multiple challenges latest being Coronavirus, leading to a major financial crisis in the financial sector. While the government is proactively trying to kick start the sector through multiple initiatives, cementing the wide gap between the two segments, will certainly help in the recovery of sector along with generating a sizable amount of GST.

About the authorAbhishek Kumar Choudhary is a finance professional with keen interest in real estate. He is a finance professional who has worked with investment banks, developers and also runs his own startup. He is a graduate of IIT Bombay and currently works with a real estate firm.