First Thing First, What is GST
Goods and Services Tax or GST is a destination-based tax that brings all indirect taxes under one roof. In the current tax regime, state governments tax sale of goods but not services while the central government taxes manufacturing and services but not wholesale and retail trade. With GST all indirect taxes including Excise and VAT levied by the central and state governments across the country get subsumed into a comprehensive GST to create a single market across India.
There are four different tax slabs in GST – 5%, 12%, 18% and 28%. Majority of daily consumable items have been kept under 5% tax slab while luxury items will attract 28% GST. Everything in between will be taxed at either 12% or 18%. Before we get into effect of GST, let us understand how real estate is taxed in the current tax regime.
Current Tax Structure on Sale of Residential Property
As per the current tax structure buyers have to pay both Service Tax (ST) and Value Added Tax (VAT) on the acquisition of under-construction property. However, there is no uniformity in these applicable taxes which varies from builders to builders and states to states. This is how it works now: Though the service tax rate including cess is 15%, builders get abatement (sort of subsidy) on land and other services. This leads to an effective service tax rate of only 4.5% on the sale value. Additionally, VAT is applicable on the sale of property, which varies between 3% and 5%, depending on the state. However, on an average, VAT is around 4.5% of the sale value. So there is a net tax of around 9% on the sale of property in the current regime. There is no service tax or VAT applicable on ready to move-in properties.
Tax Structure in GST
In GST, sale of under-construction real estate properties would be classified as a supply of services and would be liable for the payment of GST. The government has fixed a GST rate of 12% for work contracts i.e. sale of real estate properties will attract 12% net tax which is much higher than the current 9% effective tax rate. This might give you an impression that the prices of properties might go up because of GST. However, a closer look suggests that the actual tax incidence under the GST regime would be lower than the existing one, thanks to the facility of input tax credit (explained below) on raw materials.
Just like the current tax regime, the sale of completed real estate properties and land are exempted from GST as well.
What is Input Tax Credit?
Input Tax Credit means that at the time of paying tax on output, you can reduce the tax you have already paid on inputs (purchases of raw materials). Say, you are a builder –
1) Tax payable on output (apartment) is Rs 400,000/-
2) Tax paid by you on the purchases of inputs i.e. raw materials such as cements & steel is Rs 300,000/-
In GST, you can claim an input credit of Rs 300,000, which you have already paid, and deposit only Rs 100,000 in taxes. This facility of input credit is not available in the current tax regime. Hence, the builder will be able to pass on the savings from input credit to buyers.
Revised Rates on Raw Materials
The below table provides a comparative table of effective tax on major raw materials used in real estate construction under current tax regime and GST. Even though tax on few raw materials have gone up, the savings on simplified tax regime in GST and input credit not only will negate those increase in taxes but will also reduce prices in long run.
Earlier, builders paid excise on cement, steel, fittings etc. But they did not get input credit on the purchases of these raw materials. Usually, the excise cost is around 2% which can enable builders to actually cut prices to that extent. Now, the entire input credit – Excise duty and Central sales tax – on construction materials that are paid by builders, will be allowed unlike earlier.
Why will Builders pass on Input Credit Benefits
As per the clause 171 of the GST bill, it is mandatory to pass on the benefits due to reduction in rate of tax or from input tax credit to the consumer by way of commensurate reduction in prices. There would be a liberal credit regime under GST and builders are required to pass on the benefits of increased credits to the buyers, according to the anti-profiteering clause of the GST law!
Hence, any increase in effective tax rate on raw materials or finished products should get negated by the benefits accrued by way of input credit and increased efficiency in the logistics of manufacturing sector.
We expect the impact of GST on real estate prices to be neutral and positive for the entire real estate in the long run under GST. It will bring much required transparency and accountability in the real estate industry because to avail input tax credit, the raw materials have to be sourced from GST registered vendors only. It will provide a thread for audit and checks for better control and monitoring of the sector which will bring transparency and higher tax collection in the economy. Additionally, the GST regime will reduce the cash component in the construction industry.
The implementation of GST will further enhance India’s reputation as a promising investment destination by encouraging greater transparency and ease of operations in all property deals. We expect even higher private equity investments in the real estate sector going forward. Barring few quarters of teething troubles with GST implementation, we are quite positive on the impact of GST on real estate sector.