Tax boost for real estate

But selective exemptions distort the GST regime

The Goods and Services Tax (GST) Council has provided a big relief to the real estate industry by cutting the rate on under-construction housing to 5 per cent from an effective 12 per cent, providing relief to homebuyers ahead of the Lok Sabha elections in May. The Council has given an even deeper cut, of 700 basis points, for the affordable housing segment by reducing the effective GST rate to just 1 per cent from 8 per cent. The rate cuts should lead to real estate prices coming down by as much as 6 per cent, according to industry calculations. The dip in prices is expected to boost overall demand by improving affordability and convincing fence-sitters to finally take the plunge and buy a house. The decisions will surely give the much-needed breathing space to the real estate sector, which has been struggling since demonetisation and the introduction of the GST.

Lack of demand in the sector meant the unsold inventory of under-construction houses kept piling up. What made the situation worse was that properties where construction was completed attracted stamp duty, but no GST. According to industry estimates, close to 600,000 under-construction houses are lying unsold in India’s top seven cities at present. The cut in the GST rates changes the scenario substantially, especially in the affordable housing space. The Council made liberal changes in the definition of carpet area in affordable housing. So properties costing up to Rs 45 lakh will now be considered “affordable”. Those with a carpet area of 60 square metres in the metros and 90 square metres in non-metros will now come under this category. The effect will be wide, as the government has asserted that about 95 per cent of the flats in small cities and about a third in the metros will now fall in the “affordable” category.

All this is good news. What is not is that real estate builders in this space will not be eligible to claim input tax credit. At one level this means that the construction costs of the builders would rise, thus hitting their profitability. More importantly, the absence of input tax credit will make it difficult to trace the invoicing trail. In other words, it opens up the possibility of the generation of black money in the sector. Also, in effect, the Council has turned the clock back to the earlier indirect tax regime with its share of ad hoc exceptions and exemptions. The concept of input tax credit has a critical role in making sure that there is an economic incentive for everyone in the chain to pay tax. It also reduces the distortionary impact of the tax regime in economic decision-making. The new tax regime was designed to eliminate the cascade of indirect taxes that products bear now and allow manufacturers to claim credit for all the taxes paid on inputs across the value chain. Exemptions break the GST chain, raise the chances of evasion, and create systemic inefficiencies. There is no rationale to exempt some sections from the GST because it leaves the scope for others to make a similar demand. The need is to move to a clutter-free tax system. But selective exceptions from the input credit system distort the entire architecture and undermine India’s most ambitious tax reform.