The steep reduction proposed in the GST rates on real estate has led to considerable euphoria among builders and consumers. The sector that has had its fair share of challenges in recent times, with a slowdown in sales, delayed bank loan repayments, working capital issues, compliance with RERA, etc., now appears to have one challenge less, as low GST rates are being considered as the panacea for many of the issues facing the sector. The 33rd meeting of the GST Council, held on February 24 2019, has proposed to lower the rate of GST from 12% to 5% in the case of normal housing and crash the rate on affordable housing from 8% to 1%, from April 1, 2019. In both the cases, there would be no Input Tax Credit (ITC) eligibility for the builders after the lower rates come into force.
In order to put things in perspective, we need to bear in mind that GST is applied only on under-construction apartments where the payment is normally made in installments, leading to a tax inference of the builder providing a service to the home buyer. This payment of GST is in addition to the stamp duties levied by each state, as these were not subsumed into GST. Sale of apartments in buildings that have obtained an Occupancy Certificate (OC) does not attract GST and the buyer would be paying only the stamp duties and related charges. It is therefore clear that, after the introduction of GST in July 2017, there was a distinct preference for completed apartments compared to under-construction apartments. In addition to paying only stamp duties and related charges, home buyers were also assured of immediate possession and hence the market saw a shift to completed apartments. This, however, did not aid builders, who were used to the buyers financing their working capital by making construction-linked payments. The lower rate of GST of 5% on under-construction apartments can now possibly revive that market and ease some of the working capital pressures of builders.
From an indirect tax standpoint, most countries move from a sales tax system to a VAT system and, from there, to a GST system. The GST system is, at present, considered to be the ultimate frontier from an indirect tax perspective. The key feature in the GST system is the ability of each supplier of goods and services to obtain ITC on the basis of the GST paid by their vendors. This is a feature that is normally absent in a sales tax system where the tax is levied usually at the first stage of emergence of a product or, in some cases, at the last stage. GST is a multi-stage value added tax system where each entity pays GST only on the value added by it, considering ITC of the taxes paid up to the preceding stage. The denial of credit with a lower rate of GST of 5%/1% in respect of under-construction apartments goes against the basic architecture of a good GST system.
A similar step was taken in the past in case of restaurants, where an 18% rate was brought down to 5% without input tax credits. However, in case of restaurants, a majority of the key inputs such as grains, pulses, vegetables, milk, etc, in any case did not attract GST. Hence, the resultant input tax credit loss was quite low. The key inputs used by the real estate sector are cement, steel, tiles, bath fittings, etc. These attract GST at varying rates with cement taxed at 28% and most of the other items taxed at 18%. The denial of credit could actually increase the cost for builders and they may seek to pass on the same in the form of a base price increase. There have been various estimates of the quantum of input tax credit availed by builders, but, depending on the proportion of land cost, etc, it could be in the range of 6-8% of the project cost. Any input tax credit loss may now get added to the base price of the apartment with a lower GST, provided the same does not violate the anti-profiteering provisions.
We have already seen a real estate player like Pyramid Infratech approach the Delhi HC for relief in an anti-profiteering matter that was prompted by a complaint that the benefits were not being passed on to the buyers of apartments. In the present situation, where the GST rates have been lowered, but the input tax credit has been denied, it should not so happen that an increase in the base rate to overcome the loss of credit in the hands of the builder is considered to be a method of circumventing Section 171 of the CGST Act dealing with anti-profiteering.
The denial of ITC to builders also means that introducing traceability of purchases by the sector, which would have led to the rapid formalisation of the sector, would now take a backseat. Most of the sectors covered by the GST now have a very clear traceable purchase/sale, input/output chain, which can be tracked by the tax authorities. Any breakage or leakage in the chain can be detected by using the data provided by businesses as part of the return filing requirements. The real estate sector, which is a large consumer of manufactured products such as cement, steel, tiles, and sanitary fittings, etc, could have been tracked as part of the input tax credit availment process. However, the fact that builders would not be eligible for ITC would mean that the sector cannot be tracked like other sectors, even if we have additional requirements such as having to purchase major inputs from registered dealers.
It is also necessary to consider the transition issues that would emerge once the new rates come into force on April 1. Home buyers who have booked an under-construction apartment and have paid a few installments would now be considering delaying further payments until the new rates come into effect. This may not be very helpful if the builder has already issued an invoice before the effective date. Builders could have to forego the proportionate ITC that is relatable to the work completed after the effective date in addition to losing the ITC on those apartments that are sold after the effective date. It is essential to provide clarity on these and other transition issues and all stakeholders would hope that the committee tasked with detailing the transition provisions in respect of under-construction apartments adopts a pragmatic approach.
The real estate sector, being a large employment generator and a sector with multiple linkages to many critical parts of the economy, has been in need of revitalisation. The GST rate reductions have the potential to fire up the sector once again, however, it is also necessary to take care of the issues that are expected to emerge on account of these reductions.
-The author is Partner, Deloitte India