Get a grip on the grey areas before you purchase real estate abroad

Apart from proving to that taxman that the value of the property is commensurate with your income and that you've complied with FEMA, there are other RBI-related issues to be considered

The income-tax (I-T) department has launched a major operation to investigate cases of illegal funds and properties stashed abroad by Indians. There were recent reports that the I-T department has launched investigations against at least 7,500 Indians who have bought properties in Dubai in the last few years.

Purchasing a property abroad can get complex depending on the structure that a buyer uses for the transaction. “The tax department may want to know the source of funds and the Reserve Bank of India (RBI) wants to know whether the individual stuck to the Liberalised Remittance Scheme (LRS) regulations,” says Ashok Shah, partner, N A Shah Associates.

The simplest way is to remit the money in a foreign bank account up to the permissible annual limit and buy a property in your name. But the rules can get complicated if you are borrowing money or if you are planning to form a company abroad to buy and hold property. 

Grey areas cause problems 

Under the LRS, any Indian can remit up to $250,000 abroad in a financial year. A family of four can remit $1 million. The regulator has specified the restrictions on the use of these funds. The money, for example, cannot be used for buying lottery tickets, betting, or other speculative trades. The individual can, however, use it to purchase property, provide for maintenance of relative, invest in stocks, bonds, mutual funds, buy art, set up a company, and so on.

Tax experts feel that many of the individuals who are under scrutiny may have used the grey areas in the law to buy property abroad. Other than inquiring about the sources of funds, the investigating agencies will also probe whether the buyers have stuck to the Foreign Exchange Management Act guidelines.

Around a decade ago, a few remitted the funds, set up a company and bought real estate through the firm. RBI later clarified in the 'frequently asked questions' of its website  that an entity set up to buy real estate is not allowed. After the clarification, experts took the view that an individual should be able to buy equity in a company that already holds real estate. A few Indians started buying stakes in such firms.

The key reason for routing the purchase through the company structure was to take a loan to buy property. Indian laws don’t allow individuals to borrow money outside the country. Following these developments, the banking regulator started initiating compounding proceedings against individuals who used the company route for real estate. Under compound proceeding, RBI levies penalties and may even order the person to wind up his business within a stipulated time. “The regulator wants LRS to be used primarily for portfolio investment. It doesn’t favourably look at transactions where the individual controls a company or is the key part of the management of a firm where he has invested,” says Shah.

There are still grey areas that exist today. No one yet knows whether they can pass the regulator’s muster. What if a person is setting up a commercial real estate business abroad, wherein he buys properties through a company and leases them out to earn rental income? Bankers and tax experts feel that RBI has specified that individuals can set up “bona fide business”. Commercial real estate business should be able to pass the muster of the regulator.

Similarly, banks in India cannot lend to the individual to remit money abroad. But what if a person privately borrows from another person in the country, and remit the funds to an overseas location? There’s no clear answer to this.

In case members of a family pool their remittances to purchase a property, the regulator has also made it mandatory that the said property should be in the name of all the members who make the remittances.

Mandatory tax compliances 

The primary compliance that a person needs to do is declare his foreign assets when filing returns. In Schedule FA of income tax returns, the person needs to report his bank accounts, financial interest, immovable property, accounts in which individual has signing authority, trusts, any other capital asset held by the individual outside India. The assets need to be reported irrespective of value, and the values are to be reported in Indian Rupees. Jointly owned assets are to be disclosed at their full value by each of the joint owners. 

Apart from the value and cost of assets, the income earned from the asset along with nature of income and head of income under which such income has been offered to tax in the return, it needs to be reported in relation to each asset. A foreign house is usually a second home for most Indians. According to I-T laws, whether the house is let out or not, the owner has to pay tax on the actual rent or notional rent.

If you are among the people who have received a tax notice for property purchase outside the country, the primary information that the sleuths want is the source of income. “The department would ask for I-T return of the year during which the property was purchased outside India, documents with respect to compliances undertaken in FEMA at the time of purchasing such property, and whether amount spent to purchase property is commensurate with the income of the taxpayer reported in the tax return. If not, the source of income from which the property was purchased,” says Neha Malhotra, Executive Director, Nangia Advisors.

Beyond these, there are no general tax requirements for those who have purchased properties abroad. The onus lies with the acquirer to prove that he has acquired the property with general or specific permission of Reserve Bank of India. “If any person acquires immovable property outside India which is in violation of the Foreign Exchange Management Act, 1999 or contravenes any rule, regulation, notification, direction etc, he shall be liable to a penalty up to thrice the sum involved in such contravention where such amount is quantifiable, or up to Rs 200,000 where the amount is not quantifiable, and where such contravention is a continuing one,” says Malhotra. "Further, the penalty which may extend to Rs 5,000 for every day after the first day during which the contravention continues.” 

If the property is acquired through funds that were not offered to tax, the department may also invoke Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015. Under this, the person needs to pay 30 per cent tax and up to 90 per cent penalty, and in some instances can also face prosecution.

Purchase of property overseas by Indians
Outward Remittances under LRS	FYTD*	2017-18	2016-17	2015-16	2014-15	2013-14
Total ($ mn)	5,605.8	11,333.6	8,170.7	4,642.6	1,325.8	1,093.9
Purchase of immovable property ($ mn)	35.7	89.6	92.9	90.8	45.5	58.7
* Financial year-to-date (between April and August); Source: RBI

Changes in LRS Limits
Date	Feb 4, 2004	Dec 20, 2006	May 8, 2007	Sep 26, 2007	Aug 14, 2013	Jun 3, 2014	May 26, 2015
LRS limit*	25,000	50,000	100,000	200,000	75,000	125,000	250,000
* Amount in US dollars; Source: RBI