REAL ESTATE SECTOR IN INDIA

Transcription

1

2

3 REAL ESTATE SECTOR IN INDIA - Certain Tax And Regulatory Aspects Includes The Real Estate (Regulation and Development) Bill, 2013 Accounting Standards (including Guidance Note issued by ICAI) Foreign Investment Guidelines in Real Estate Sector Direct Tax (including impact of recent changes) Indirect Tax (including Service Tax Amnesty Scheme) Real Estate Sector In India

4 REAL ESTATE SECTOR IN INDIA - Certain Tax And Regulatory Aspects CONTENTS CHAPTER 1 : BACKGROUND 1 CHAPTER 2 : PROPOSED REGULATORY BILL FOR REAL ESTATE SECTOR 7 CHAPTER 3 : COMPLIANCE CALENDAR 11 CHAPTER 4 : INCOME TAX & WEALTH TAX 19 CHAPTER 5 : SERVICE TAX REGULATIONS 35 CHAPTER 6 : VAT AND WORKS CONTRACT REGULATIONS 53 CHAPTER 7 : STAMP DUTY REGULATIONS 67 CHAPTER 8 : FOREIGN INVESTMENT REGULATIONS 69 CHAPTER 9 : FINANCIAL REPORTING STANDARDS 77 CHAPTER 10 : CERTAIN PROPERTY RELATED LAWS 94 ABBREVIATIONS 102 Real Estate Sector In India

5 CHAPTER 1: BACKGROUND 1.1 Real Estate Industry In India The sustained growth of the Indian economy in the past few years has resulted in a phenomenal growth of the real estate sector in India as evident from the changing skylines of all Indian cities and townships. The hub of industrial parks, high-rise residential complexes, sprawling malls, huge commercial complexes and brightly colored cranes, rubble, construction and hordes of workers scurrying up and down the towering skyscrapers, are the testimony of the explosion of real estate sector in India. Currently, contribution of realty sector to Indian GDP is about 5% and its market size is expected to touch US$ 180 billion by The demand of affordable housing by lower income group was estimated at 19 million households in 2012 and expected to reach 900 million by As such, it is expected that residential real estate sector will witness a steady demand rise in future US$ in Billions GDP Real Estate Mkt Size (*5.4%) (*9.1%) (*5%) 92 USA Eurozone India GDP and Real Estate Contribution * Represents % of GDP (Source: Trading Economics, OECD, IBEF & useconomyabout.com. Data for YE Dec '12) Real Estate Sector In India 1

6 The real estate sector is the second largest employer in the country next only to agriculture. The growth in demand has resulted in emergence of several organized real estate developers and intermediaries. In certain segments of real estate, there is an influx of investments by private equity firms, overseas investors, domestic financial institutions and speculators, which is adding to the hype and frenzy created in the concrete world of real estate in India. 1.2 Regulatory Framework Foreign investment Flying high on the wings of booming real estate, property in India has become a dream for every potential investor looking forward to earn profits. The relaxed FDI guidelines have invited more foreign investors, and accordingly real estate in India is seemingly the most lucrative ground at present. The revised investor-friendly policies allowed foreigners to own property and dropped the minimum size for housing estates built with foreign capital to 25 acres (10 hectares) from 100 acres (40 hectares). The overseas investors can now develop real estate projects as long as the project surpasses 50,000 square meters (538,200 square feet) of floor space. Recently, the government has announced its intention to reduce this limit to 25,000 square meters. The organized retail project completion rate will witness more than 100% rise in year-on-year basis in million square feet of additional mall space will be added in Of the total mall space absorption in the country, Mumbai, Delhi NCR, Chennai and Bangalore will have the major share, around 70%. Other cities like Hyderabad, Kolkata and Pune will absorb the rest 30%. Government s approval of FDI into multi-brand retail is set to be the most influencing factor on the retail scenario of the country. As per recent reports, India has replaced USA as the second most-preferred FDI destination in the world. The relaxation of FDI will open up portals to major MNC retail brands in India, which will be instrumental in increasing the retail space absorption in the country. 2 Real Estate Sector In India

7 Government policy now permits FDI of up to 51% into multi-brand retail, which will invite products, practices and technologies to Indian retail sector. Along with it, 50% of total FDI will be directed towards infrastructural facilities like warehousing and logistics, which will further boost the retail growth in the long run. Recently, the Union Cabinet has approved certain relaxation in the conditions attached to the opening of FDI in multi-brand retail trading US$ in Billions Total FDI Recd. by India FDI Equity Recd. By Real Estate Sector (%age of total FDI recd.) 10 (7.8%) (3.5%) 3.1 (6.7%) (3.6%) FDI vis-à-vis Real Estate Sector in India (Source: DIPP) The proposed real estate regulatory bill Realty sector in India has seen an unprecedented growth after liberalization in However, there was no direct regulatory supervision on real estate sector by any authority similar to Telecom Regulatory Authority of India or Insurance Regulatory & Development Authority. To overcome this, the Government has proposed The Real Estate (Regulation and Development) Bill 2013, which provides certain protection to customers and helps real estate sector to grow in an orderly way. However, this would be effective only upon passing of the Bill in Parliament. Real Estate Sector In India 3

8 1.2.3 Levy of service tax Service tax was introduced in Indian tax regime in the year Further, subsequent amendment brought construction activity in service tax regime. However, there was a controversy between service tax administration authority and real estate developers as to the applicability of service tax to real estate developers. This has been settled by introducing amendment in service tax law from 1 July 2010 by amending the definition of services under construction or industrial construction and construction of complex. Further, under negativebased taxation approach from 1 July 2012, certain services, which include construction of complex, works contract and renting of immovable property, have been covered under declared services. This has brought real estate developers into service tax net. Service tax law provides option to real estate developers to choose abatement method to arrive at service tax liability on 25% or 30% of accrued revenue depending upon the value and area of real estate transaction as the case may be. Recently, service tax law has provided a scheme called Service Tax Voluntary Compliance Encouragement Scheme. Under this Scheme, the assesse can declare service tax liability for the period October 2007 to 31 December 2012 and submit a declaration before 31 December 2013 and pay service tax liability in installments i.e. 50% before 31 December 2013 and 50% before 30 June This will enable waiver of interest and penalty under service tax law Levy of VAT Levy of VAT is a State subject. The majority of states in India levy VAT on transfer of property involved in the execution of works contract. There has been a controversy whether activity of real estate developers attracts VAT and whether State has power to levy tax on real estate developers. This controversy has been settled by the constitutional amendment empowering states to levy works contract tax (WCT). Further, the issue relating to levy of VAT on sale of a unit under construction has been upheld by the Honourable Bombay High Court in a writ petition filed by the Maharashtra Chamber of Housing Industry. While the issue is to be finally settled by the Honourable Supreme Court, presently, VAT is collected 4 Real Estate Sector In India

9 by the State Governments on the transfer of goods involved in the execution of works contract. The different States have different rates of VAT on goods involved in execution of works contract. As the determination of VAT in real estate transaction is a complex issue, the VAT law provides option to the assesse to choose composition method Widening of direct tax ambit The direct tax law regulations have been recently amended to provide for more stringent regulations for real estate transactions. The measures taken by the government in this regard include levy of withholding tax at 1% on certain real estate transactions of Rs.50 lakhs or more, taxation on the differential amount in case of transfer of real estate at a value below stamp duty valuation, levy of withholding tax on renting of immovable property for a rent exceeding certain limit, etc. Hence, the Government of India expects a rise in collection of revenue from real estate transactions in future Financial reporting framework There was no uniformity within the accounting fraternity in respect of accounting of income in case of real estate developers. It was a controversy whether Project Completion Method or Percentage Completion Method is to be considered as a valid method of accounting. The Accounting Standards i.e. AS-7 or AS-9 issued by the ICAI in the past provided limited guidance on this aspect. In the year 2012, the ICAI has issued a guidance note on Accounting for Real Estate Transactions, which is intended to apply to enterprises dealing in real estate as sellers or developers. This would be applicable in case of real estate projects commencing on or after 1 April This will bring uniformity in accounting of income on certain parameters such as receipt of minimum revenue, execution of sale of real estate up to a certain level, incurring of construction expenses upto a certain level, etc. This will help in booking of revenue in advance or deferring of revenue to subsequent accounting periods. 1.3 Real Estate Going Forward Going forward, while the real estate sector will continue to grow, there will be Real Estate Sector In India 5

10 greater focus on transparency and improved governance. There will be a much higher level of overview by the regulatory authorities (after the enactment of Real Estate Regulatory Bill) and greater ability for foreign investors and NRIs to invest in the Indian real estate. The compliances with service tax, VAT and the income-tax authorities will result in substantially higher level of tax incidence and exposure. 6 Real Estate Sector In India

11 CHAPTER 2: PROPOSED REGULATORY BILL FOR REAL ESTATE SECTOR 2.1 Background The Real Estate (Regulation and Development) Bill, 2013 ( the Bill ) approved by the Union Cabinet on 4 June 2013, is an initiative to protect the interest of consumers, to promote fair play in real estate transactions and to ensure timely execution of projects. Currently, the real estate and housing sector is largely unregulated and opaque, and consumers are often unable to procure complete information or enforce accountability against builders and developers in the absence of effective regulation. This Bill seeks to create a regulator for the real estate sector to protect interests of buyers by providing a uniform regulatory environment. The Bill necessitates establishment of one or more Real Estate Regulatory Authorities in every State/UT, to oversee real estate transactions. The Bill is also expected to promote regulated and orderly growth through efficiency, professionalism and standardization. It seeks to ensure consumer protection, without adding another stage in the procedure for sanctions. However, the Bill will be effective upon passing of the Bill in Parliament and subsequent notification in Gazette. 2.2 Applicability Of The Bill The proposed Bill is limited in its applicability to residential real estate i.e. housing and any other independent use ancillary to housing. 2.3 Key Highlights Of The Bill The Bill directs developers to sell their properties only on a 'carpet area' basis, thus doing away with all other concepts prevalent in the market at present. Carpet area is the actual net usable floor area of a residential unit and does not include the area covered by walls and common area. Mandatory registration of real estate projects and real estate agents who intend to sell any immovable property, with the Real Estate Regulatory Authority. The Bill proposes that all residential projects with plot areas of Real Estate Sector In India 7

12 4,000 square meters or more need to be registered with a regulator, which will be possible after the developer submits all necessary clearances. Each project and phase has to be registered separately and non-compliance of this provision is a penal offence. The Bill seeks to safeguard buyers against misleading advertisements, pertaining to the quality of services or amenities proposed that the developer has not secured. Buyers are entitled to get refund with interest or compensation in case it is found that the advertisements and promotions were false or misleading. The Bill mandates that 70% or such lesser percentage, as notified by the appropriate state government of the money raised for a project should be deposited in a separate account. By ensuring that developers do not divert funds meant for a particular project to their other projects, the Bill seeks to curb delays in project completion, due to shortage of funds. The Bill also protects buyers against project delays by requiring that developers refund the amount paid along with interest in the event of a delay. Both these factors are expected to ensure timely completion and handover of projects to the buyers. Punitive provisions including de-registration of the project and penalties in case of contravention of the provisions of the Bill or the orders of the Authority or the Tribunal. Mandatory public disclosure norms for all registered projects, including details of the promoters, project, layout plan, plan of development works, land status, carpet area and number of the apartments booked, status of the statutory approvals and disclosure of proforma agreements, names and addresses of the real estate agents, contractors, architect, structural engineer, etc. All these details will be maintained in a public database which can be assessed by general public. The system is very similar to what we have at present in case of Registrar of Companies. The Bill also mandates registration of real estate agents with the authority, to ensure that agents only facilitate sale of registered properties. Functions 8 Real Estate Sector In India

13 of Real estate agents: Real estate agents not to facilitate the sale of immovable properties, which are not registered with the Authority required under the provisions of the Act, obligation to keep, maintain and preserve books of accounts, records and documents, obligation to not involve in any unfair trade practices, obligation to facilitate the possession of documents to allottees as entitled at the time of booking, and to comply with such other functions as specified by rules made in that regard. Duty of promoters towards disclosure of all relevant information and adherence to approved plans and project specifications, obligations regarding veracity of the advertisement for sale or prospectus, responsibility to rectify structural defects, and to refund moneys in cases of default. No amount can be received by the promoter without first entering into a written agreement. Establishment of one or more Real Estate Regulatory Authority in each State/UT, or one Authority for two or more States/UT, by the Appropriate Government, with specified functions, powers, and responsibilities to exercise oversight of real estate transactions, to appoint adjudicating officers to settle disputes between parties, and to impose penalty and interest. The regulatory authority shall have extensive powers under the Act and can interfere with the project at any stage if the rules and regulations are not complied with the promoter. It provides for establishment of fast-track dispute resolution mechanisms for settlement of disputes, through adjudicating officers and Appellate Tribunal. Further, Civil Courts will have no jurisdiction in such matters. Establishment of Central Advisory Council to advise the Central Government on matters concerning implementation of the Act, with a mandate to make recommendations on major questions of policy, protection of consumer interest and to foster growth and development of the real estate sector. Appropriate Government to have powers to make rules over subjects Real Estate Sector In India 9

14 2.4 Conclusion specified in the Bill. The Bill, when enacted by the Parliament, will bring about standardization in the sector leading to healthy and orderly growth of the industry through introduction of definitions such as apartment, common areas, carpet area, advertisement, real estate project, prospectus, etc. 10 Real Estate Sector In India

15 3.1 Background CHAPTER 3: COMPLIANCE CALENDAR This chapter deals with compliances under certain laws. In India, there are numerous laws enacted, which provide compliances on regular basis. Below is the list of significant compliances under Income- Tax Act, FEMA, Service Tax, VAT, etc. Sr. Particulars Due Date No FEMA compliances: i. Annual performance report in 30 June every year Form APR ii. Annual return of foreign liabilities and 15 July every year assets (FLA) in Form FLA iii. ECB returns in Form ECB -2 7 days from the close of the month iv. FDI in Advance Reporting Form 30 days of receipt of money v. Non-resident person acquiring 90 days from the date of acquisition property in India in IPI Form of immovable property Income tax compliances: A TDS/ TCS compliance i. Return cum challan in Form 26QB for 7 days from end of the month in 1% TDS on transfer of immovable which deduction is made property under section 194 IA ii. TDS/TCS statements for other 15 days from the end of quarter for payments in Form 24Q/ 26Q/ 27Q/ 27EQ 1st, 2nd and 3rd quarter of the year and 15 May for the last quarter of the year iii. Issue of TDS/TCS certificate in Form 16/16A/16B/27D Form 16 by 31 May annually Form 16B - 15 days from the due date for furnishing the challan-cum-statement Form 16A/27D- 15 days from the due date of furnishing of TDS/TCS statement Real Estate Sector In India 11

16 Sr. Particulars Due Date No iv. Filing in Form 15G/ 15H/ 15I for 7 days from the date of receipt non deduction of tax at source B Return of Income / Return of Wealth / Tax Audit Report / Transfer Pricing Report i. Person covered under tax audit 30 September (other than those to whom transfer pricing is applicable) ii. Person covered under Transfer pricing 30 November (including those covered by domestic transfer pricing) iii Other persons Corporate assesse - 30 September Others - 31 July C Annual information return i. Annual information return in case of 31 August of the following year certain specific transactions to be reported under section 285BA by specified persons Service tax compliances: i. Payment of service tax under Rule 6(1) 5th of the month (6th in case of of the Service Tax Rules, 1994, in e-payment) subsequent to the GAR 7 Challan month/quarter for which the tax is to be paid. (For the month/quarter ending March, the due date is 31 March) ii. Half yearly service tax return under For the period April to September - Rule 7(2) of the Service Tax Rules, 1994, 25 October in Form ST VAT compliances: A Maharashtra For the period October to March - 25 April i. MVAT return (in Forms ) / CST 21 days from the end of the month Returns ( in form IIE) ii. MVAT audit in Form January of succeeding year 12 Real Estate Sector In India

17 Sr. Particulars Due Date No iii. a b Profession tax return: If tax liability during P.Y. > Rs.50,000 PTRC return in Form III B PTRC payment in Form MTR 6 If tax liability during P.Y. < Rs.50,000 PTRC return in Form III B PTRC payment in Form MTR 6 Last day of next month 30 days from end of the month 31 March of succeeding year 31 March of succeeding year iv. WCT TDS return in Form June of that year B WCT TDS payment in Form MTR 6 Gujarat 21 days from the end of the month i. GVAT return (in Forms 201, 201A, 201B, 30 days from the end of the month 201C ) to which return relates ii. GVAT audit in Form months from the end of the year i.e. 31 December iii. Annual return in Form 205, 205A 30 June of succeeding year iv. TDS return in Form days from the end of the quarter v. Profession tax return: C PTRC in Form 5 Profession tax return PTEC (payment to be made online) Delhi 15th of the next month/ quarter, depends on periodicity 30 September of that year i. DVAT return in Form DVAT days from the end of the month VAT / CST Payment in Form DVAT days from the end of the tax period ii. TDS certificate in Form DVAT days after the end of the month in which the deduction is made iii. Profession tax return Not applicable iv. DVAT audit in Form AR-I 7.5 months from the end of the year i.e. 15 November D Tamil Nadu i. TNVAT return in Form I and Form L Before 20th of the succeeding month ii. TVAT audit in Form WW 7 months from end of the year i.e. 31 October Real Estate Sector In India 13

18 Sr. Particulars Due Date No iii. TDS payment in Forms R and 20 day of the succeeding month in TDS certificate in Form S which the deduction was made iv. Profession Tax Return PTRC and PTEC in Half yearly April to September and Form 2 for October to March, return should be filed on first day of the half year E Karnataka i. KVAT return in Form 100 ii. TDS certificate in Form 156, 20 days after the end of the Monthly statement in Form VAT 125 and relevant month Payment in Form 152 or 153-Challan iii. Profession Tax Return PTRC a) in, Form 5A 20 days from the end of the month in which deduction was made b) in, Form 5 30 days of subsequent year a) PTEC in Form 4-A in respect of a person who stands enrolled before the commencement of a year 30 April of that year b) PTEC in Form 25-Certificate in respect of a person who is enrolled after the commencement of a year within 1 month from the date of enrolment iv. KVAT Audit in Form months from end of the year i.e. 31 December F West Bengal i. WBVAT return under Rule 34(1) in Within the next English calendar Forms 14 and 15 month from the date of end of each quarter WB VAT Audit in Form 22, Form December of succeeding year ii. TDS: TDS certificate of payment of tax in 25 days from the end of English respect of works contract in Form 18 calendar month during which deduction is made TDS Payment in Form days from the date immediately after the date of end of the calendar month reckoned according to the English calendar during which such deduction is made 14 Real Estate Sector In India

19 Sr. Particulars Due Date No iii. G Profession Tax Return PTRC in Form III PTEC under section 8 in Form III Andhra Pradesh 30 days from end of each quarter Tax payable: a) for first 2 months of each quarter within 21 days from the expiry of each month b) last month of quarter before filing of the return On or before 31 July of that year i. APVAT return in Forms 200, 200A, 200B 20 days after the end of the tax and CST VI period ii. TDS Return in Form 501A 15 days after the end of the month in which the deduction is made iii. Profession Tax Return PTRC in Form V PTRC in Form V Labour law compliances: 10 days of the month succeeding the month for which the return has to be filed 30 June of the year Sr. Particulars Relevant Relevant Due Date No. Provision Form i. Annual return under Building Rule 242 Form XXV On or before And Other Construction of The Building 15 February Workers (Regulation Of and Other Employment and Conditions Construction of Service) Act, Workers (Regulation of Employment and Conditions of Service) Central Rules, 1998 Real Estate Sector In India 15

20 Sr. Particulars Relevant Relevant Due Date No. Provision Form ii. Every occupier of an establishment shall maintain a register in respect of children employed or permitted to work, in Form under The Child Labour (Prohibition And Regulation) Act, Section 16 Form A Continual basis iii. Under the Inter State Migrant Section 23 As may Continual basis Workmen (Regulation of be Employment and Conditions prescribof Service) Act, 1979 every ed principal employer and every contractor shall maintain such registers and keep exhibited in such a manner as may be prescribed within the premises of the establishment where the inter-state migrant workmen are employed, notices in the prescribed form containing particulars about the hours or work, nature of duty and such other information as may be prescribed. iv. Annual return under the Rule 5 Form D 30 days after the Payment of Bonus Act, 1965 expiry of the time limit i.e. within a period of 8 months from the close of the accounting year v. Nomination form under the Rule 6 (1) & (2) Form F Within 30 days of Gratuity Act completion of 1 year of services 16 Real Estate Sector In India

21 Sr. Particulars Relevant Relevant Due Date No. Provision Form vi. Annual return by principal employer Reg 82(2) of Contract Form XXV (in On or before 15th February following Labour duplicate) the end of the year (Regulation & to which it relates Abolition) Central Rules, 1971 vii. Under Employee s Provident Para 36(2)(a), Form ECR Within 30 days of Funds and Miscellaneous Para 10(1A)(a) (filed close of each month Provisions Act, 1952 every of EDLI online) employer shall send to the Commissioner, return of consolidated EPS & EPF, employee qualifying to become members of the fund for the first time along with declaration in the Form 2, resigning during the preceding month. Payment of provident fund contribution into the account. 15 days of every succeeding month (plus grace period of 5 days) viii. Maharashtra Shops And Sec 7 (2-A) & Form B Not less than 15 Establishment Act, 1948 (2-B) days before the date of expiry of the registration certificate Renewal of Registration Rule 5 Certificate: A registration certificate is generally valid up to the end of the year for which it is granted. However, the same may, at the option of the employer, be granted or renewed for a period of 3 years at a time, on payment of the fees for that period. Real Estate Sector In India 17

22 Sr. Particulars Relevant Relevant Due Date No. Provision Form An application for the renewal of a registration certificate should be submitted accompanied by such fees in such form, as may be prescribed. If the application for the renewal of a registration certificate is submitted after the expiry of the specified period but within 30 days after the dale of expiry of the registration certificate, such application shall be accompanied by an additional fee as late fee equal to half the fee payable for the renewal of a registration certificate. ix. Employees State Insurance Rule 51 As may Within 21 days of the Act, 1948 be month following, in prescrib- which the wages ed fall due Rates of Contribution Employer 4.75% Employee 1.75% Of wage payable to employee x. Under Equal Remuneration Section 8 Form D Continual basis Act, 1976, Register of male and female workers xi. Under Maternity Benefit Act, Section 20 Form 10 Continual basis 1961, Register of female workers who have taken benefit under the Maternity Benefit Act xii. Register of wages under the Sec 22A Form X Before the date on Minimum Wages Act which the wages for such wage-period fall due 18 Real Estate Sector In India

23 CHAPTER 4: INCOME TAX & WEALTH TAX 4.1 Background Income-tax regulations play a very crucial role in any business scenario, real estate being no exception to it. The real estate sector has unique business characteristics or business practices from accounting and tax regulatory perspective. For example, real estate projects extending beyond one financial year could result in option to opt either project completion method or percentage completion method. Further, tax implication may vary depending upon the use of estimates for revenue / expenditure, cost incurred for land / FSI available at different point of time including transferrable development rights, arrangement on joint development agreements, uncertainty of receipt of sale proceeds over a period of time, execution of agreement for sale, cancellation of sale agreements, components of sale proceeds not in align with activity, claim of certain expenditure as a period cost, claim of certain incentive, character of certain income as capital gain or business income, etc. Further, in case of an individual assessee, there are different sets of taxation issues on capital gains, exemptions, deductions, etc. In this Chapter, we have attempted to cover recognition of revenue, incentives, deductions / exemptions and recent judicial pronouncements relating to the real estate sector. 4.2 Revenue Recognition AS-7(old) had provided two methods of accounting i.e. project (contract) completion method and percentage completion method, and further it did not differentiate between the applicability in case of real estate developers and construction contractor. In project completion method, revenue is recognized only when entire project is completed thereby helping businessman to defer the accounting of income in books resulting in postponement of payment of tax. However, in percentage completion method, the income is recognized in each year based on percentage of work completed. It has always been debated by the tax Real Estate Sector In India 19

24 authorities that completed contract method shall not be adopted as it results in deferring of tax liability to future period rather than on year-on-year basis. However, based on the AS-7(old), certain real estate developers adopted project completion method and the same had been accepted in certain judicial decisions. However, in case of Champion Construction Co. Vs. ITO (1983) 5 ITD 495, the Honorable Tribunal held partially against the assessee stating that when the work was substantially complete, the assessee cannot postpone recognition of revenue. The revised AS-7 applicable in case of a construction contractor provides for percentage completion method. Hence, the issue arose that in absence of AS- 7(old), whether project completion method is still valid method of accounting for tax purposes. The Guidance Note on Accounting of real estate transactions discussed in Chapter 9 (Accounting Aspects) recommends that the percentage completion method will be appropriate in the accounting of real estate transactions where the project is having attributes or character of construction contract. AS-9 provides for recognition of revenue only when substantial risk and rewards are transferred to the buyer of the property The Guidance Note referred above provides for its applicability in respect of revenue recognition for a real estate project which commences on or after 1 April It is pertinent to note that the Guidance Note emphasises that percentage completion method will be applicable in the accounting of all real estate transactions where the economic substance is similar to construction contracts. The indicators which decide whether a transaction is a construction contract are as under: The period of the project is in excess of 12 months. Most features of the project are common to construction contract i.e. land development, structural engineering, architectural design, construction etc. Individual units in the project are dependent upon or interrelated to completion of common facilities/amenities, 20 Real Estate Sector In India

25 The construction and development activities form significant proportion of the project activity The notes attached to the audited accounts of a leading real estate developer is reproduced below, for reference purpose: The Group follows the percentage completion method for its projects. The revenue recognition policy is as under: Project for which revenue is recognized for the first time on or after 1 April 2012 The ICAI has issued a Guidance Note on Accounting for Real Estate Transactions (Revised 2012) in connection with the revenue recognition for a real estate project which commences on or after April 1, 2012 and also to real estate projects which have already commenced but where revenue is being recognized for the first time on or after 1 April In this scenario, the Group recognizes revenue in proportion to the actual project cost incurred (including land cost) as against the total estimated project cost (including land cost) as well as area sold, in line with the Guidance Note and depending upon the type of project. Project for which revenue recognition has commenced prior to 1 April 2012 In this scenario, the Group recognizes revenue in proportion to the actual project cost incurred (excluding land cost) as against the total estimated project cost (excluding land cost) subject to completion of construction work to a certain level depending on the type of project. Revenue is recognized net of indirect taxes and on execution of either of agreement or letter of allotment. The estimates relating to percentage of completion, costs to completion, area available for sale, etc. being of a technical nature are reviewed and revised periodically by the management and are considered as change in estimates and accordingly, the effect of such changes in estimates is Real Estate Sector In India 21

26 recognized prospectively in the period in which such changes are determined. Land cost includes the cost of land, land related development rights and premium. The construction work in progress is valued at lower of cost or net realizable value. Cost includes cost of land, development rights, rates and taxes, construction costs, other direct expenditure, allocated overheads and other incidental expenses It is observed that generally, accounting method followed is also considered for tax purposes to compute taxable income although there is no legal bar in following one method for accounting and another method for tax purpose. However, in such a case, litigation from tax authorities cannot be ruled out. 4.3 Transferable Development Rights (TDR) TDR is issued by the local authority in the form of a certificate called Development Right Certificate granting to the holder of the certificate the right to certain area of construction on a plot of land. The Guidance Note issued by ICAI (detailed discussion in Chapter 9) does not recommend any accounting entry when TDR is received from the local authority. The accounting entry is passed on sale of TDR and cost thereof is determined based on actual cost of land area given up. However, if the entire land cost is already claimed as deduction then, the issue arises whether receipt of TDR is to be recorded at the time of receipt of TDR certificate or at the time of sale of TDR or use of TDR in another project. In case of a slum redevelopment project, the issue arises whether TDR received against free construction is to be accounted on completion of free construction area or on sale of area constructed on the basis of TDR received. 4.4 Deemed Consideration On Transfer Of Asset (Other Than Capital Asset) Being Land Or Building Or Both Finance Act, 2013, introduced a 22 Real Estate Sector In India

27 new section 43CA in the Income Tax Act, 1961 ( the Act ) with a view to consider deemed sales consideration in respect of transfer of assets (other than those held as capital assets) being land or building or both if actual consideration received or accrued is less than the value adopted or assessed or assessable by any authority of a State Government for the purpose of stamp duty in respect of such transfer. In such case, the deemed sales consideration shall be the value adopted or assessed or assessable for stamp duty by any authority of a State Government for the purpose of computing income from business or profession.. The following points are relevant to consider the impact on taxable income: In case of distress sale also, the above provisions will be covered, since no specific exceptions have been provided in the Act. The section does not have mention about the tolerance limits which can be permitted. Hence even a minor variation would invoke provisions of section 43CA. The above section will be applicable in all cases even if the sale of land or building is not registered with the government authorities. If advance is received against property and agreement is registered at a later date, then as per provisions of section 43CA (3), the stamp duty value as on the date of agreement be considered as deemed consideration. However, this would be applicable only where the amount of consideration or a part thereof has been received by any mode other than cash on or before the date of agreement. Transfer defined under section 2(47) of the Act does not apply to this section. Accordingly, reference to the term transfer has to be understood as provided in Transfer of Property Act, Deemed Income In Case Of Individual Or HUF On Transfer Of Immovable Property For A Consideration Less Than Stamp Duty Value Section 56(2) (vii) of the Act provides for taxation of deemed income under the head Income from Other sources in the hands of individual or HUF who receives immovable property. In case receipt of Immovable property is Real Estate Sector In India 23

28 without consideration, the stamp duty value of which exceeds Rs.50,000, the stamp duty value of such property is treated as deemed income. In case, receipt of immovable property is for inadequate consideration which is less than stamp duty value of the property by an amount exceeding Rs.50,000, the stamp duty value of such property as exceeds such consideration is treated as deemed income. However, this section also provides for certain exceptions which include transaction with relatives, property received under a will or by way of inheritance, on the occasion of marriage, etc. 4.6 Deemed Consideration In Case Of A Transfer Of A Capital Asset Being Land Or Building Or Both Section 50C of the Act provides that in case the consideration received or accrued as a result of the transfer of a capital asset being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government for the purpose of payment of stamp duty, the value adopted or assessed or assessable shall be deemed to be full value of the consideration received or accruing as a result of such transfer. Certain relevant judicial pronouncements are provided hereunder for ready reference: It has been held that the provision of section 50C of the Act would also be applicable to depreciable assets for computing gain under section 50 of the Act. It has been held that provisions of section 50C of the Act are not applicable on grant of leasehold rights. Section 50C of the Act will not be applicable in case of a transfer of shares of a company having immovable property in its balance sheet. Section 50C of the Act would be applicable in case of a development agreement whereby land owner transfers development rights to real estate developer. 24 Real Estate Sector In India

29 Section 50C of the Act will be applicable even if exemption is claimed to the extent of actual sales consideration received. 4.7 Deemed Short-Term Gain On Transfer Of Depreciable Asset Section 50 of the Act provides for computation of capital gain as under: Sr. No Particulars Amount A Full value of consideration received or accruing as a result of transfer or transfers of asset falling within the concerned block of assets during the previous year less expenditure incurred B Less: Actual cost of any asset falling within the concerned b block of assets acquired during the year C Less: Opening written down value of the block of assets c Resultant Figure (see note below) a-b-c Certain relevant judicial pronouncements are provided hereunder for ready reference: If the resultant figure is positive, the same is chargeable as deemed short term capital gain under section 50 of the Act. If the resultant figure is negative and the entire block of assets ceases to exist as such, the resultant figure indicates deemed short term capital loss. However, if the resultant figure is negative and the block continues to exist (for the reason that at least one asset in the block continues to be owned by the assesse) then there will be no gains or losses and the assesse will be entitled to claim depreciation on the resultant figure. 4.8 Capital Gain In Case Of Slump Sale Section 50B of the Act provides that profit arising on slump sale of one or more undertakings would be chargeable to tax as long-term capital gain in the year of transfer if such undertakings a Real Estate Sector In India 25

30 have been owned and held by the assesse for more than 36 months or as shortterm capital gain if held upto 36 months. The net worth of the undertaking would be regarded as the cost of acquisition and improvement. The net worth shall be the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as per books of account. For computing the value of assets in case of depreciable assets, the written down value of the block of assets shall be as per the Income-tax Act i.e. subitem (C) of section 43(6) (c) (i) of the Act. 4.9 Incidence Of Gain On Transfer Of A Capital Asset The profits or gain arising from the transfer of a capital asset effected in the previous year shall be chargeable to income-tax under the head Capital Gain and shall be deemed to be the income of the previous year in which the transfer took place. Hence, the incidence of gain is dependent upon the transfer. The term transfer as defined in section 2(47) of the Act includes : the sale, exchange or relinquishment of the asset ; or the extinguishment of any rights therein; or the compulsory acquisition thereof under any law; or in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment; or any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882) ; or any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the 26 Real Estate Sector In India

31 effect of transferring, or enabling the enjoyment of, any immovable property The issues arising from the above definition of term transfer are as follows: Whether joint development agreement results in transfer of land from the owner to real estate developer? At what point of time is the joint development agreement liable to tax under the Act? At what point of time is the compulsory acquisition of asset liable to tax under the Act? From the definition of term transfer, it is necessary to examine the arrangement / agreements to ascertain whether it is a sale or exchange or relinquishment of any rights in asset or possession given to developer in part performance of agreement under the Transfer of Property Act, 1882 or arrangement has effect of transferring, or enabling the enjoyment of, the immovable property. There are various judicial verdicts based on the facts of each case Gain arising from sale of rural agricultural land-not taxable: Gain arising from sale of agricultural land situated in a rural area in India is not taxable under the provisions of the Act. From the assessment year , the meaning of rural area has been amended. After modification, the rural area means any area which is outside the jurisdiction of a municipality or cantonment board having a population of 10,000 or more and also which does not fall within distance (measured aerially) given below- 2 kilometers from the local limits If the population of the municipality municipality /cantonment board /cantonment board is more than 10,000 but not exceeding 1,00,000 6 kilometers from the local limits of If the population of the municipality municipality /cantonment board /cantonment board is more than 1,00,000 not exceeding 10,00,000 8 kilometers from the local limits of If the population of the municipality municipality/cantonment board /cantonment board is more than 10,00,000 Real Estate Sector In India 27

32 4.10 Income From House Property The annual value of property (as defined in section 23 of the Act) consisting of any building or lands appurtenant thereto owned by the assesse other than such portions of such property used for business carried on by him shall be chargeable to income tax under the head Income from House Property after reducing certain deduction as provided in section 24 of the Act. The annual value of one house which is in the occupation of owner for the purpose of his own residence is considered as nil. If assesse owns more than one residential house, then one house according to assessee s choice is treated as self occupied and annual value of another house is to be calculated considering it deemed to be let out. Deduction for municipal taxes levied by any local authority and paid by the assessee would be made while determining annual value. Further, income chargeable under the head Income from house property shall be computed after making following deductions: 30% of annual value (this is irrespective of whether actual expenditure is incurred or not) Interest on borrowed capital where the property has been acquired, constructed, etc. with borrowed capital Property Owned By Co-Owners Where the buildings or building and land appurtenant thereto is owned by two or more persons and their respective shares are definite and ascertainable, then the share of each such person in the income from the property as computed shall be included in his total income Component Of Cost To Be Considered For Work In Progress In real estate sector, the controversial issue is regarding what component of cost to be considered for valuation of work in progress. In normal scenario, the real estate developer incurs various expenditures such as interest cost, selling and marketing cost, general administration and 28 Real Estate Sector In India

33 overhead cost, research and development, depreciation of idle plant, cost incurred in securing the contract, cost such as material set aside but not used and applied, etc. The question arises as to whether above costs are to be considered as a period cost and charged to profit and loss account and claimed as expenses for tax purpose or the same to be capitalized as part of project cost in various scenarios such as when revenue is not recognized or when revenue is recognized on percentage completion method. The Guidance Note issued by ICAI for real estate transactions provides that above cost (excluding interest cost) should not be considered as part of construction costs and development costs if they are material Tax Accounting Standard On Construction Contracts (Discussion Paper Proposed) In terms of section 145(2) of the Act, the CBDT has issued a discussion paper on Tax Accounting Standard (TAS) in respect of accounting for construction contracts. It is relevant to note that this TAS is applicable in case of a construction contractor and not to the real estate developers. Some of the points of TAS are as under: Construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. During the early stage of a contract, where the outcome of the contract cannot be estimated reliably, contract revenue is recognized only to the extent of costs incurred. The early stage of a contract shall not exceed beyond 25% of the stage of completion. Contract revenue shall comprise of i) the initial amount of revenue agreed in the contract, including retentions; and ii) variations in contract work, claims and incentive payments. Where contract revenue already recognized as income is subsequently written off in the books as uncollectible, the same shall be recognized as an expense and not as an adjustment of the amount of contract Real Estate Sector In India 29

34 revenue. The taxation of retention money is in contradiction to charging section 4 of the Act and several judicial decisions. The above TAS is still at discussion stage and will be effective only on its notification Tax Incentives: The taxation laws provide for certain exemptions / deductions as incentives to corporate or other specified entities i.e. Individual, HUF, etc. Some of the exemptions / deductions are mentioned briefly as under: Section 35AD of the Act provides for deduction of capital expenditure incurred for the purpose of specified businesses. The specified businesses include a) developing and building a housing project under a scheme for slum redevelopment or rehabilitation framed by the Central or State Government in accordance with the guidelines prescribed and; b) developing and building a housing project under a scheme for affordable housing framed by the Central Government or State Government in accordance with the guidelines prescribed. It is provided in this section that capital expenditure shall not include any expenditure incurred on the acquisition of any land or goodwill or financial instrument Section 54G of the Act provides for exemption in respect of a capital gain arising from transfer of assets (being machinery or building or land) in cases of shifting of industrial undertaking from urban area if the assesse fulfills certain conditions, which include the reinvestment of capital gain in similar assets or incurs expenses on shifting of original assets within 1 year before or 3 years after the date of transfer of assets Section 54GA of the Act provides for exemption in respect of a capital gain arising from transfer of assets (being machinery or building or land) in cases of shifting of industrial undertaking from urban area to any specified economic zone if the assesse fulfills certain conditions which include the reinvestment of capital gain in similar assets or incurs expenses on shifting of original assets within 1 year before or 3 years after the date of transfer of assets. 30 Real Estate Sector In India

35 Section 80-IB(10) of the Act provides for deduction in respect of a profit of an undertaking developing and building a housing project approved by a local authority after 1 October 1998 but before 31 March 2008 subject to certain conditions as mentioned below : such undertaking completes such construction within 5 years from the end of the financial year in a case where the housing project has been approved on or after 1 April 2005 (within 4 years if project is approved on or after 1 April 2004 but before 31 March 2005) and before 31 March 2008 in other cases; the project is on the size of a plot of land which has minimum area of 1 acre; the residential unit has a maximum built-up area of 1,000 square feet where such residential unit is situated within the city of Delhi or Mumbai or within 25 kilometers from the municipal limits of these cities and 1,500 square feet at any other place; the built-up area of the shops and other commercial establishments included in the housing project does not exceed 3% of the aggregate built-up area of the housing project or 500 square feet, whichever is higher; not more than 1 residential unit in the housing project is allotted to any person not being an individual; and in a case where a residential unit in the housing project is allotted to a person being an individual, no other residential unit in such housing project is allotted to any of the following persons, namely: the individual or the spouse or the minor children of such individual, the HUF in which such individual is the karta, any person representing such individual, the spouse or the minor children of such individual or the HUF in which such individual is the karta. Real Estate Sector In India 31

36 Section 54D of the Act provides for exemption in respect of a capital gain arising from compulsory acquisition of land or building forming part of an industrial undertaking subject to certain conditions, which include that the assesse has purchased any other land or building within a period of 3 years Section 54GB of the Act provides for exemption in respect of a capital gain arising from a transfer of a long-term capital asset being a residential property (a house or a plot of land) if the assesse (individual or a HUF) fulfills certain conditions, which, inter-alia, include utilizing the net consideration for subscription in the equity shares of an eligible company Section 54 of the Act provides for exemption in respect of capital gain arising from transfer of a long-term capital asset being a residential house if the assesse (individual or HUF) fulfills certain conditions which include utilization of capital gain for purchase of a residential house. In this scenario, the controversy arises as to whether investment in more than one residential house (which are adjacent to each other) is eligible for deduction or not. Similarly, Section 54F of the Act provides for exemption in respect of a transfer of a long term capital asset (other than residential house) if the assesse (individual or HUF) fulfills certain conditions which include utilization of net consideration for purchase of a residential house Section 80EE of the Act provides an additional benefit for first-time home buyers by allowing an additional deduction up to Rs. 1,00,000 in respect of interest on loans obtained up to Rs. 25,00,000 for the acquiring residential house property. This additional deduction is to be claimed in AY and if the limit is not exhausted, the balance may be claimed in AY Section 24 of the Act provides for deduction of interest on borrowed funds (from a specified person) utilized for purchase of an immovable property. However, in respect a self-occupied residential property, the deduction is restricted to Rs. 1,50,000. Interest of pre-construction period is deductible in 5 equal installments Form Of Entities: There are no standard rules for selecting the form of entities for acquiring real estate properties. The option to select form of entities namely individual or HUF or Trust or a Company or association of persons depends upon the intention of a person and long-term needs of perpetual 32 Real Estate Sector In India

37 succession, purpose of acquiring assets, etc. Generally, immovable property like residential house is purchased in the name of an individual. However, in certain cases, the residential property is purchased in the name of Private Trust so as to provide perpetual succession. Further, business premises are purchased in the name of either a partnership firm or a company so as to claim depreciation on cost of a property TDS On Transfer Of Immovable Properties Section 194-IA of the Act provides the obligation to deduct tax at source on all buyers, whether resident or non-resident, and includes firm, company, etc. in case of transfer of immovable property if consideration amount is Rs. 50,00,000 or more and paid to a resident transferor. The term immovable property means land or building or both but excluding certain agriculture land. The rate of TDS shall be 1% of amount paid or credited and shall be deposited before 7th of next month. It is relevant to note that in case of seller being a non-resident, the purchaser has to consider TDS under section 195 of the Act Wealth Tax Wealth-tax is applicable in case of individuals, HUFs and all companies in respect of value of those assets as specified in section 2(ea) of the Wealth Tax Act after reducing therefrom the debts incurred in relation to such assets. The taxable wealth (assets) includes the following: Any building or land appurtenant thereto, residential or commercial but excluding House (residential or commercial) held as stock in trade, House occupied for the purpose of business/ profession carried on by the assesse, Residential property let out for at least 300 days in a previous year, Real Estate Sector In India 33

38 Commercial establishment or complexes, In case of a company, a house meant exclusively for residential purpose and allotted to an employee, officer or a whole time director whose gross annual salary is less than Rs. 10,00,000 (1 million), Land on which construction is not permissible. Urban Land as defined but excludes the following: Unused land held for industrial purpose for a period of 2 years from the date of acquisition, Land held as stock in trade for a period of 10 years from the date of acquisition, Land occupied by any building constructed with the approval of appropriate authority, Land classified as agriculture land in the record of the Government and used for agriculture purposes. Urban land means land which is not situated in a rural area. The meaning of rural area has been discussed in para no Exemption Of Assets From Wealth-tax Includes The Following: In case of an individual or HUF - One house or part of a house or a plot of land not exceeding 500 square metres belonging to the individual or HUF. Assets brought within 1 year prior to return/ at any time after return to India by a returning NRI for 7 successive assessment years. Balances in NRE account on the date of return and assets purchased therefrom 1 year prior to return/ at any time within 7 successive assessment years. Any assets held by public charitable trust. 34 Real Estate Sector In India

39 CHAPTER 5: SERVICE TAX REGULATIONS 5.1 Background The Government of India, vide the Finance Act, 1994 introduced service tax with effect from 1 July The ambit of services which were covered under the tax net was increasing year on year. The real estate sector was brought into the service tax net for first time on 10 September 2004 by introducing a category titled Commercial Services. Thereafter, the coverage was extended vide introduction of several other categories such as Construction of Complex Services, Works Contract Services, Preferential Services provided by Builder to Prospective Buyers. Date Various Developments and Changes in the Service Tax Law 10 September 2004 Category Construction Services was introduced 16 June 2005 Category Construction Services was omitted and new categories Commercial or Industrial Construction Services and a new category Construction of Complex Services were introduced 1 June 2007 New categories Renting of Immovable Property Services and Works Contract Services were introduced 1 July 2010 The explanation was inserted to the definition of taxable services Construction or Industrial Construction and Construction of Complex so as to bring sale of flats by builders under service tax net With effect from 1 July 2012, the Government of India has adopted the negative listbased taxation approach as against the positive list approach which was prevailing since the introduction of service tax. In this Chapter, the implication of service tax on real estate sector under the negative list regime is discussed. Real Estate Sector In India 35

40 5.2 Service Tax Vis-À-Vis Real Estate The broad framework of applicability of service tax can be explained through the below diagram: Whether activity covered within a definition of service? Yes No Not Taxable Whether Provided in Taxable Territory? No Yes Whether covered under negative list? Yes No Whether Exemped? Yes No Taxable Definition of Service (A) SERVICE MEANS Any Activity Carried out by a person for another For a Consideration 36 Real Estate Sector In India

41 (B) SERVICE INCLUDES Service includes declared services. The list of services covered under declared services is provided in section 66E of the Act. Section 66E(_) (a) (b) Declared Services Renting of immovable property service Construction of a complex, building, civil structure or a part thereof (including additions, alterations, replacement or remodeling of an existing civil structure), including a complex or building intended for sale to a buyer wholly or partly except where the entire consideration is received after issuance of completion certificate by the competent authority. The term competent authority means the government or any authority authorized to issue completion certificate under any law for the time being in force. In case of non requirement of such certificate from such authority, any of the following (a) (b) (c) architect registered with the Council of Architecture constituted under the Architects Act, 1972; or chartered engineer registered with the Institution of Engineers (India); or licensed surveyor of the respective local body of the city or town or village or development or planning authority. (h) Service portion in execution of a works contract Works Contract is defined under section 65B(54) of the Act to mean a contract wherein transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods and such contract is for the purpose of carrying out construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, alteration of any moveable or immovable property or for carrying out any other similar activity or a part thereof in relation to such property. Real Estate Sector In India 37

42 (C) SERVICE EXCLUDES Exclusions from the definition of Service Any activity which constitutes Mere transfer of title in goods or immovable property, by way of sale/ gift or any other manner Deemed sales under article 366(29A)of the constitution of India Mere transaction in money or actionable claim Service by an employee to his employer, in relation to employment Fees taken by court/ tribunal Issues that arise from the definition of services: How the service tax liability is to be determined in case of joint development agreements? How the consideration is to be determined in case of barter transaction, i.e. sale of flats against receipt of development rights on land? Whether service tax liability arises on various charges collected by builders such as society maintenance charges, recreation facility charges (both one time and recurring), legal charges, water charges, etc. 5.3 Principle Of Interpretation Of Service (Nature Of Service) It is essential to determine the nature of services which are provided since the applicability of various provisions, exemptions, abatement, etc. depends upon the nature of services provided. General rule The reference to main service shall not include a service which is used for providing main service. If the services provided are capable of differential treatment for 38 Real Estate Sector In India

43 any purpose Most-specific description would be preferred over and above the general description. Bundled Services - Bundled Service means a bundle of provision of various services wherein an element of provision of one service is combined with an element or elements of provision of any other service or services. Interpretation of Bundled Services Bundled Services Services that are naturally bundled Services that are not naturally bundled Single Service based on its essential character Service which attracts the highest amount of Service Tax 5.4 Exemptions Exemption has been granted from the whole of Service Tax on providing of certain services vide notification no. 25/2012 ST dated 20 June 2012, as amended from time to time. The list of exemptions in relation to real estate sector is given in the following table: Clause No. Exempted Services 12 Services provided to the Government or local authority by way of erection, construction, maintenance, repair, alteration, renovation or restoration of - Remarks Governmental Authority means a board, or an authority or any other body established with 90% or more participation by way of Real Estate Sector In India 39

44 Clause No. Exempted Services (a) a civil structure or any other o r i g i n a l w o r k s m e a n t predominantly for use other than for commerce, industry or any other business or profession; (b) a h i s t o r i c a l m o n u m e n t, archaeological site or remains of n a t i o n a l i m p o r t a n c e, archaeological excavation, or antiquity specified under Ancient Monuments and Archaeological Sites and Remains Act, 1958; (c) a structure meant predominantly for use as (i) an educational, (ii) a clinical, or (iii) an art or cultural establishment; (d) canal, dam or other irrigation works; (e) pipeline, conduit or plant for (i) water supply (ii) water treatment, or (iii) sewerage treatment or disposal; or (f) a r e s i d e n t i a l c o m p l e x predominantly meant for self-use or the use of their employees or other persons specified in the Explanation 1 to section 65B(44) of the said Act Remarks equity or control by Government and set up by an Act of the Parliament or a State Legislature to carry out any function entrusted to a municipality under a r t i c l e 24 3 W o f t h e Constitution. Residential Complex means any complex comprising of a building or buildings, having more than one single residential unit. Construction of hospitals and educational institutions for Government or local a u t h o r i t y a r e o n l y exempted. In case the same are constructed for others, there is no exemption. Original Works has the meaning assigned to it in Rule 2A of the Service Tax (Determination of Value) Rules, Real Estate Sector In India

45 Clause No. Exempted Services 13 Services provided by way of c o n s t r u c t i o n, e r e c t i o n, commissioning, i n stallation, completion, fitting out, repair, m a i n te n a n ce, re n ova t i o n o r alteration of - (a) a road, bridge, tunnel, or terminal for road transportation for use by general public; (b) a civil structure or any other original works pertaining to a scheme under Jawaharlal Nehru National Urban Renewal Mission or Rajiv Awas Yojana; (c) a building owned by an entity registered under Section 12AA of the Income tax Act, 1961 and meant predominantly for religious use by general public; (d) a pollution control or effluent treatment plant, except located as a part of a factory; or (e) A structure meant for funeral, burial or cremation of deceased. 14 Services by way of construction, e re c t i o n, commissioning o r installation of original works pertaining to - Remarks General Public means the body of people at large sufficiently defined by some common quality of public or impersonal nature. Single Residential Unit means a self-contained residential unit which is designed for use, wholly or principally for residential purposes for one family. Real Estate Sector In India 41

46 Clause No. Exempted Services (a) an airport, port or railways, including monorail or metro; (b) single residential unit otherwise as a part of a residential complex; (c) low-cost houses up to a carpet area of 60 square meters per house in a housing project approved by competent authority empowered under the Scheme of A f f o r d a b l e H o u s i n g i n Partnership framed by the MHUPA, Government of India; (d) p o s t - h a r v e s t s t o r a g e infrastructure for agricultural produce including cold storages for such purposes; or Remarks agricultural produce means any produce of agriculture on which either no further processing is done or such processing is done as is usually done by a cultivator or producer which does not alter its essential characteristics but makes it marketable for primary market. No exemption is granted to repair, maintenance of airports, ports and railways. (e) mechanized food grain handling system, machinery or equipment for units processing agricultural produce as food stuff excluding alcoholic beverages. 29 Services by the following persons in respective capacities (h) sub contractor providing services by way of works contract to another contractor providing works contract services which are exempt 42 Real Estate Sector In India

47 5.5 Place Of Provision Of Services Rules, 2012 (Where The Services Are Rendered) As per charging section, section 66B of the Act, only those services which are deemed to be provided in the taxable territory, by one person to another are liable to service tax. Place of Provision of Services Rules, 2012 ( PPSR, 2012 ) has been notified under section 66C of the Act to determine the place where the services are deemed to be provided. Rule 14 of the PPSR, 2012 provides that notwithstanding anything stated in any rule, where the provision of service is prima facie determinable in terms of more than one rule, it shall be determined in accordance with the rule that occurs later among the rules that merit equal consideration. General rule - The place of provision of a service shall be the location of the service receiver. In case the location of the service receiver is not available in the ordinary course of business, the place of provision shall be the location of the service provider. (Rule 3 of PPSR) Specific Rules: Rule No. Nature of Services 5 Related to immovable property Determination of Place of Provision Types of Services / Remarks Place where the Services provided by experts and immovable property estate agents, provision of hotel is located or intended accommodation by a hotel, inn, to be located guest house, club or campsite, by whatever, name called, grant of rights to use immovable property, services for carrying out or coordination of construction work, including architects or interior decorators Real Estate Sector In India 43

48 Rule No. Nature of Services 7 Services referred to in Rule 5 and provided at more than one location 8 Service provider and receiver both are located in taxable territory Determination of Place of Provision The location in the taxable territory where the greatest portion of the service is provided Types of Services / Remarks Any service referred to in rules 4, 5, or 6 is provided at more than one location, including a location in the taxable territory Location of service Any service other than listed in receiver negative list or specifically excluded 5.6 Point Of Taxation (When The Services Are Rendered) Point of Taxation Rules, 2011 ( POTR, 2011 ) is notified to determine the point of taxation (POT) of service. Point of Taxation means the point in time when a service shall be deemed to have been provided. Determining point of taxation of any service is essential as relevant exemption notifications, rules, etc. as applicable on that date, will be made applicable. Further, the due date for payment of service tax is also aligned to the point of taxation rules. Overview of Point of Taxation Rules, 2011 Point of Taxation General Rule (Rule 3) In case of change in effective rate of Service Tax (Rule 4) In case of services taxed for first time (Rule 5) In case of liability under Reverse Charge Mechanism (Rule 7) Copyright Services (Rule 8) 44 Real Estate Sector In India

49 5.6.1 General rule The General Rule of Point of Taxation - Rule 3 of POTR, 2011 Advance receipt No Yes POT will be date of receipt of advance Invoice raised within time prescribed in Rule 4A of STR, 1994 Yes POT will be date of issuance of Invoice No POT will be Completion of Service In case of continuous supply of services, (i.e. any service which is provided continuously or on recurrent basis, under a contract for a period exceeding 3 months with the obligation for payment periodically, or from time to time) the date of completion of each event which requires the service receiver to make any payment to service provider, shall be deemed to be the date of completion of service. In case the advance receipt is up to Rs. 1,000/-, in excess of the amount indicated in the invoice, the service provider is having option to determine point of taxation to the extent of such excess amount as and when the invoice is raised within the time prescribed or completion of service, as the case may be Change in effective rate of tax In case of change in effective rate of tax in between the date of provision of service, issuance of invoice or receipt of payment, point of taxation is required to be determined as per Rule 4 of POTR, Real Estate Sector In India 45

50 Change in effective rate of tax also includes a change in the portion of value on which tax is payable in terms of a notification. The summary of Rule 4 is given here below: Provision of Service Before change of rate After change of rate Issue of Invoice After change of rate Payment After change of rate Point of Taxation Date of invoice or payment, whichever is earlier (new rate) Before change of rate After change of rate Date of invoice (old rate) After change of rate Before change of rate Before change of rate After change of rate Before change of Date of payment (old rate rate) After change of rate Date of payment (new rate) Before change of Date of invoice or rate payment, whichever is earlier (old rate) Before change of rate Date of invoice (new rate) Services taxed for the first time When a service is taxed for the first time, Point of Taxation is required to be determined as per Rule 5 of POTR, In view of Rule 5, no tax is required to be charged/paid in case of following scenarios: Where invoice as well as payment is received against such invoice before such service became taxable. Where payment is received before such service became taxable and the service provider has issued invoice within the period of 14 days from the date when the service is taxed for the first time Liability under reverse charge mechanism In view of Rule 7 of POTR, 2011, in respect of services on which person is 46 Real Estate Sector In India

51 required to pay tax as recipient of service (Reverse Charge Mechanism), point of taxation shall be the date on which payment is made by service receiver to service provider. If such payment is not made within a period of 6 months of the date of invoice, the point of taxation shall be determined as per rule 3, 4, 5 or 8 as applicable. In case of Associated Enterprises, where the service provider is located outside India, the point of taxation shall be the date of debit in the books of accounts of service receiver or date of making payment, whichever is earlier. Associated Enterprises shall have the meaning as assigned to it in section 92A of the Income-Tax Act, Person Liable To Pay Tax Generally, the person who provides the taxable service (service provider) is responsible for paying the service tax to the Government. Service provider has an option of charging and collecting service tax from the service receiver. However, in respect of certain notified taxable services, service tax is required to be paid to the Government, by such person as may be notified. In general parlance, the said services are said to be services liable under Reverse Charge Mechanism ( RCM ). Notification No. 30/2012-ST dated 20 June, 2012, as amended from time to time, read with section 68(2) of the Act and Rule 2(1)(d) of STR, 1994 provides for RCM in the following scenarios: Real Estate Sector In India 47

52 Sr. No. Description of Service 1 By an insurance agent to any person carrying on the insurance business 2 Good transport agency services in respect of transportation of goods by road, where the person liable to pay freight is notified person 3 Sponsorship services to any bodycorporate or partnership firm located in the taxable territory 4 By director of the company to the said company 5 Services provided to any business entity:- % Payable by Service Provider NIL NIL NIL NIL % Payable by Service Receiver 100% 100% 100% 100% 5.1 By an Arbitral tribunal NIL 100% 5.2 Legal Services by an advocate or firm of advocates NIL 100% 5.3 Support services by Government except renting of immovable property and services specified in 66D(a)(i) to (iii) 100% 6 Services provided by any individual, Hindu Undivided Family or partnership firm, whether registered or not, including association of persons, located in the taxable territory to a business entity registered as body corporate, located in the taxable territory: 6.1 Renting of motor vehicle designed to carry passengers to any person who is not in similar line of business NIL At Abated value: NIL At Non Abated value: 60% At Abated value: 100% At Non Abated value:40% 6.2 Supply of manpower for any purpose 25% 75% 6.3 Security services 25% 75% 6.4 Service portion in execution of Works Contract 50% 50% 48 Real Estate Sector In India

53 Sr. No. Description of Service 7 Services provided by any person located outside the taxable territory to any person located in the taxable territory % Payable by Service Provider NIL % Payable by Service Receiver 100% Business Entity is defined under section 65B (17) of the Act to mean any person ordinarily carrying out any activity relating to industry, commerce or any other business or profession. Legal Services is defined under rule 2(cca) of the STR, 1994 to mean any service provided in relation to advice, consultancy or assistance in any branch of law, in any manner and includes representational services before any court, tribunal or authority. Supply of Manpower is defined under rule 2(1)(g) of STR, 1994 to mean supply of manpower, temporarily or otherwise, to another person to work under his superintendence or control. Security Services is defined under rule 2(1)(d)(FA) of STR, 1994 to mean services relating to the security of any property, whether movable or immovable, or of any person, in any manner and includes the services of investigation, detection or verification, of any fact or activity. Works Contract is defined under section 65B(54) of the Act to mean a contract wherein transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods and such contract is for the purpose of carrying out construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, alteration of any moveable or immovable property or for carrying out any other similar activity or a part thereof in relation to such property. 5.8 Value Of Taxable Service Service tax is payable on the value of all services (i.e. taxable services). The Value of Taxable Service means, the gross amount charged by the service provider for the taxable service provided or to be provided by him. Taxable value has to be determined as per the provisions under section 67 of the Real Estate Sector In India 49

54 Act, read with Service Tax (Determination of Value) Rules, 2006 ( Valuation Rules ). The valuation provisions can be summarized as follows: Value of Taxable Service: Where consideration for service is Wholly in Money Not Wholly / Partly in Money Not ascertainable The Gross Amount Charged Such Amount in Money Add Service Tax Charged Gross amount charged to provde similar service to any person If cannot be determined in accordance with above, then, equivalent money value of such consideration which shall, be at least equal to the cost of provision of such taxable service When the gross amount is inclusive of service tax payable, Gross Amount Charged * 100 Value of taxable service = rate of Service Tax The term consideration, money and gross amount charged are defined for the purpose of valuation of taxable services Inclusion / exclusion of certain expenditure or cost When certain expenditure or costs are incurred by the service provider in the course of providing taxable services, all such expenditure or costs shall be treated as consideration for taxable service provided. As per Rule 5 (2) of Valuation Rules, expenditure or cost that a service provider incurs, as pure agent of client shall be excluded from value, if service provider satisfies certain specified conditions. The term pure 50 Real Estate Sector In India

55 agent is defined in explanation 1 to rule 5(2) of Valuation Rules. Rule 6 of Valuation Rules provides for certain specific items for inclusion and exclusion in the value of taxable services Abatements For certain services, a specified percentage of abatement is allowed from the gross amount charged for providing the services. The said abatements and conditions thereto are provided under notification no. 26/2012-ST dated 20 June The gists of the same are given here below: Sr. No. Description of Taxable Service (i) for residential unit having carpet area up to 2000 square feet or where the amount charged is less than rupees one crore; (ii) for other than the (i) above. Conditions (i) No CENVAT credit on inputs to be availed. (ii) The value of land is included in the amount charged from the service receiver. (iii) The amount charged shall be the sum total of the amount charged for the service including the fair market value of all goods and services supplied by the recipient s in or in relation to the service, whether or not supplied under the same contract or any other contract, after deducting - (a) the amount charged for such goods or services supplied to the service provider, if any; and (b) the value added tax or sales tax, if any, levied thereon: Provided that the fair market value of goods and services so supplied may be determined in accordance with the generally accepted accounting principles. Abatement (%) Construction of a complex, building, civil structure or a p a r t t h e r e o f, intended for a sale to a buyer, wholly or partly except where entire consideration is received after i s s u a n c e o f c o m p l e t i o n certificate by the c o m p e t e n t authority,- Taxable (%) Real Estate Sector In India 51

56 5.8.3 Valuation in the case of Works Contract Service: In view of Rule 2A of Valuation Rules, the value of service portion in execution of works contract services is required to be ascertained as follows:- It shall be gross amount charged less value of property in goods. (the value of property in goods adopted for payment of VAT shall be taken as value of property in goods) In case the value has not been determined as above then the service portion in works contract to be calculated as given below: Execution of :- Nature of Works Contract % of Contract as Service Portion 40% 1. all new constructions 2. all types of additions and alterations to abandoned or damaged structures on land that are required to make them workable 3. erection, commissioning or installation of plant, machinery or equipment or structures, whether pre-fabricated or otherwise Maintenance or repair or reconditioning or restoration or servicing of any goods In case of other works contract not covered above including maintenance, repair, completion and finishing services such as glazing, plastering, floor and wall tiling, installation of electrical fittings of immovable property 70% 60% No CENVAT credit on inputs is eligible. However CENVAT credit on input services and capital goods can be availed. 52 Real Estate Sector In India

57 CHAPTER 6: VAT AND WORKS CONTRACT REGULATIONS 6.1 Position In The State Of Maharashtra Background The levy of VAT on Builders and Developers came in light with the decision of the Honourable Supreme Court in the case of K. Raheja Development Corporation Vs. State of Karnataka, [(2005) 141 STC 298 (S.C.)] Facts of the case Two separate contracts entered (i) sale of right in land and (ii) construction of buildings. There was an arrangement to sell an undivided fractional share, right, title and interest to the intended buyer. The developer, not being the owners of the land, had lien over the land and building until the intended buyers pay the full consideration with regard to both land as well as construction activity Ratio of the judgment The Honourable Supreme Court has held that, works contract has an inclusive definition which includes any agreement for carrying out building for construction activity for cash, deferred payment or other valuable consideration - hence appellants are owner to the extent that they have entered into agreements to carry out construction activity on behalf of somebody else for cash, deferred payment or other valuable consideration - they would be carrying out a works contract and would become liable to pay turnover tax on the transfer of property in the goods involved in such works contract. Real Estate Sector In India 53

58 The appellants are undertaking to build as developers for the prospective purchaser on payment of a price. Therefore it remains works contract as defined under the Act. If the agreement is entered into after completion of construction of flats, there would not be works contract. In case agreement is entered into before construction is completed, it would be works contract and liable to VAT. 6.2 Consequent Amendment In MVAT On the basis of decision of Honourable Supreme Court in the case of M/s K. Raheja Development Corporation (141 STC 298 (SC), Maharashtra Government amended definition of Sale with effect from 20 June According to amended definition, building construction contract was included in the definition of sale. Prior to 20 June 2006 Section 2(24) of the MVAT, defines the term sale to mean a sale of goods made within the State for cash or deferred payment or other valuable consideration, but does not include a mortgage, hypothecation, charge or pledge; and the words sell, buy and purchase, with all their grammatical variations and cognate expressions, shall be construed accordingly. With effect from 20 June 2006 New amended definition is as follows: Clause (b) (ii) of the explanation to Sec 2(24) was introduced. (ii) the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract including, an agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property; In pursuance to this definition the building and construction of an 54 Real Estate Sector In India

59 immovable property was brought within the ambit of MVAT though the indivisible contracts included charges towards land and labour which are out of the ambit of VAT Law. 6.3 Trade Circular Dated 7 February 2007 On the basis of judgment of K. Raheja, Trade circular is issued by Maharashtra Sales Tax Department on 7 February It clarifies that any transfer of property after 20 June 2006, irrespective of whether an agreement was signed prior to that date, would be governed by the amended definition of sale. Tri-partite agreements between land-owners, developers and prospective buyers would be covered by the amended definition of sale. If the agreement is entered into after the flat or unit is already constructed, then there would be no works contract, but so long as an agreement is entered into before the construction is complete, it would constitute a works contract. 6.4 Introduction Of Composition Scheme On 9 July 2010, the Government of Maharashtra provided for a composition scheme. It was made applicable to registered dealers who undertake construction of flats, dwellings, buildings or premises and transfer them in pursuance of an agreement along with land or interest underlying the land. Composition amount prescribed at 1% of the agreement amount or the value specified for the purpose of Stamp Duty under the Bombay Stamp Act, 1958, whichever is higher. For the contracts entered into a particular calendar year, the ready reckoner value as on 1 January of that year has to be taken in consideration. 6.5 Maharashtra Chamber Of Housing Industry And Ors Vs. State Of Maharashtra And Ors [2012-VIL-35-BOM] Real Estate Sector In India 55

60 The constitutional validity of the amended definition of sale, the Trade Circular dated 7 February and 1% Composition Scheme introduced with effect from 9 July 2010, was challenged in a spate of writ petitions. On the behalf of the petitioner, it was contended as under: The amendment was beyond the scope of the State s power to tax under Sl. No. 54 of List II of the Seventh Schedule to the condition. As per article 366(9A) (b), Contract would, inter-alia, involve a transfer of property in goods and immovable property does not constitute goods. Consequent to the 46th Amendment to the Constitution, only a transfer of property in goods involved in the execution of a works contract is taxable and a contract for the sale of immovable property is not a works contract. Thus, legal fiction created by Article 366(29A) would not apply. The purpose underlying the enactment of deeming fiction in Article 366(29A) was to override the imitated definition of the expression sale in the Sale of Goods Act, 1930 and to isolate the sale of goods element involved, inter alia, in a contract which is a works contract. The amended definition of sale falls within the compass of Article 366(29A). In an agreement which is governed by the MOFA, a conveyance of the interest in the flat or at any rate an interest therein is created at the stage of the execution of an agreement. The doctrine of accretion is always subject to a contract to the contrary. The provisions of the MOFA contain a statutory stipulation to the contrary where the accretion to the property ensures to the benefit of the flat purchaser; and the Trade Circular and the deduction schemes are only clarificatory in nature Ratio Of The Judgment Works contracts have numerous variations and it is not possible to accept the contention either as a matter of principle or as a matter of 56 Real Estate Sector In India

61 interpretation that a contract for work in the course of which title is transferred to the flat purchaser would cease to be a works contract. The effect of the amendment to Section 2(24) is to clarify the legislative intent that a transfer of property in goods involved in the execution of works contract including an agreement for building and construction of immovable property would fall within the description of a sale of goods within the meaning of the provision. The constitutional validity of the provisions of the MVAT Act, 2002, as amended, is not contingent upon any other statutory regulation of apartments under cognate legislation in the State of Maharashtra. Having regard to this statutory scheme, it is not possible to accept the submission that a contract involving an agreement to sell a flat within the purview of the MOFA is an agreement for sale of immovable property simplicitor. The Constitutional validity of the amended definition of sale, the Trade Circular dated February 2007 was upheld. Hence, it is liable for VAT. 6.6 Trade Circular No. 14t Of 2012 Dated 6 August 2012 It was issued in pursuance to the decision of the Honourable Bombay High Court in Maharashtra Chamber of Housing Industry case. Accordingly, it made developers liable to pay MVAT Act w.e.f. 20 June It provided facilities for obtaining registration, granted administrative relief for unregistered period and filing of returns from 20 June Options For Computing Works Contract Liability From the period 20 June 2006 onwards: Option 1: Deduction of actual expenses on labour Option 2: Standard deduction method Real Estate Sector In India 57

62 Option 3: Composition Scheme Option 1: Deduction of actual expenses on labour The deduction for labour and service charges is available on actual basis. Deduction for land is available. Set off is available (subject to Rule 53 and 54) in respect of materials transferred to customers. Option 2: Standard deduction method Standard deduction of 30% is available for labour from total contract value. Deduction for land is available. Set off is available (subject to Rule 53 and 54) in respect of materials transferred to customers. For Option 1 and Option 2, deduction towards cost of land shall not exceed 70% of the agreement value. Option 3: Composition scheme VAT payable on agreement value. Deduction for Land is not available. Input tax credit is available subject to reduction of 4% of purchase price. Option 4: Composition 1% From 1 April 2010 Introduction of one more option under Section 42(2A) read with Notification No. VAT 1510/CR-65/Taxation 1 dated 9 July Conditions: Agreements should be registered on or after 1 April Real Estate Sector In India

63 VAT is 1% of total agreement value. Deduction for Land is not available. Input tax credit is not available. (If input tax credit is already claimed in respect of these flats, the same has to be reversed.) A dealer (contractor) has an option to choose any of the above mentioned options. 6.8 Deduction For Sub-Contract For availing deduction of VAT liability discharged by subcontractor from total contract value, certain forms are required to be maintained by principal contractor and sub-contractor. 6.9 Refund Of Tax Paid By Developer In Case SC Judgement Comes In Favour Of Developer In the Interim order of the SC dated 28 August 2012 in case of SLP filed by Promoters and Builders Assn. and Ors. Vs. State of Maharashtra, (17709/2012), it is mentioned in para 3(iii) The payment of tax by the developers shall be subject to the final decision in the matter before this court. So, if it is ultimately held by Honourable SC that VAT is not payable on development agreements, the VAT paid by builders and developers will be refundable VAT Audit Under the MVAT Act, every dealer, registered or unregistered, liable to pay tax shall: If his turnover of sales or, as the case may be, of purchase exceeds Rs.1,00,00,000 in any year, or If he is a dealer or person who holds license in certain specified cases - get his accounts in respect of such year audited by an Real Estate Sector In India 59

64 accountant (i.e.practicing Chartered Accountant or Cost Accountant) within the prescribed period from the end of that year and furnish within that period the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars and certificates as may be prescribed. In case of failure to furnish the copy of such report within the time prescribed, the Commissioner may, after giving a reasonable opportunity of being heard, impose on him, in addition to any tax payable, a sum by way of penalty equal to 0.1 % of the total sales. It is pertinent to note that the terms sales and purchases under the VAT regime, include sale/purchase of capital goods, scrap, packing material, stationery, goods purchased and debited to Profit and Loss account, DEPB, Copyrights, etc. As per Rule 66 of the MVAT Rules the report of the audit under Section 61 shall be submitted within 9 ½ months from the end of the year to which the report relates Assotech Realty Pvt. Ltd. Vs. State Of UP [2007 (7) STR 129 ALL.] Facts of the case Developer issued allotment letter specifying that the terms and conditions of allotment are subject to sale deed to be signed by parties in future. As per the terms, allotee agreed that no right will accrue in his favour until the sale deed is executed. The petitioner shall remain the owner and the construction thereon and no rights shall devolve upon the allottee by way of allotment even though any / all payment(s) has / (have) been received by petitioner Ratio of the judgement Developers will continue to remain the owner of apartments including all constructions till execution of sale deeds of such apartment, hence no work for construction. 60 Real Estate Sector In India

65 The petitioner not carrying out construction activity for and on behalf of allottee as the right, title and the interest in construction remained with the petitioner at all times till execution of sale deed of apartment as a whole. Hence, it is not liable for VAT. In K. Raheja s case, the agreement provided that the developer will construct for and on behalf of the person who agreed to purchase the flat. In this case works contract was made taxable Larsen And Toubro Ltd And ANR. Vs. State Of Karnataka [2008 (SC2)-GJX 2195-(SC)] K. Raheja s case has been challenged in the case of Larsen and Toubro Ltd Vs. State of Karnataka decided on 19 August 2008 (2008) 17 VST 460 SC wherein the ratio of K. Raheja case was referred to the larger Bench for reconsideration. Where a builder purchases the land, develops it and sells fully constructed flats / premises to buyer, it is sale of immovable property. Hence, VAT will not be applicable on sale of immovable property. Building, residential / commercial premises, if sold by receiving booking amount and installments from buyer, that would not amount to agreement for construction of property for buyers. It would be sale of immovable property. VAT will not be applicable in such a case. If the ratio of K. Raheja s case is accepted, then there would be no difference between the works contract and a contract for sale of chattel as a chattel. The case of K. Raheja Development needs re-consideration. The matter is referred to larger bench Inter-State Works Contract The definition of sale in the CST Act was amended in 2002 so as to include within its purview the concept of deemed sales involved in the works contracts. Central Government has authority to levy CST on such deemed sale Real Estate Sector In India 61

66 involved in the works contract if such deemed sale is an inter state sale. Taxable event in works contracts: Taxable event in case of works contracts is deemed sale and such deemed sales are considered to have taken place, when the goods are incorporated in the works contract. In 2002, definition of Sale under CST Act was amended to include deemed sale in Works contract. The Punjab and Haryana High Court in Thomson Press (I) Ltd vs. State of Haryana (1996)100 STC 417(P and H) held that if the inter state movement of goods arises due to a pre existing contract then inputs and goods involved in the execution of works contract shall also be deemed to have moved and the State Government can not levy tax on deemed sale of such goods. The High Court made it clear that if a pre-existing works contract occasions the movement of goods, then such goods shall be deemed to have been incorporated in such inter state works contract. In such case, no tax can be levied by the State Government Summary Of VAT Provisions In the States of Andhra Pradesh, Gujarat, Karnataka, Tamilnadu, West Bengal and Delhi Sr. No. i State Andhra Pradesh Definition of Works Contract Works Contract includes any agreement for carrying out for cash or for deferred payment or for any other valuable consideration, the building Works Contract Option 1 Option 2 Option 3 Actual Standard Composition Expense Deduction Total Contract Value Less : Actual Charges for labor and Services Total Contract Value Less : Standard Compositio n 5 % Only 75% of Value of contract towards Land will be 62 Real Estate Sector In India

67 Sr. No. State Definition of Works Contract construction, manufacture, processing, fabrication, erection, installation, laying, fitting out, improvement, modification, repair or commissioning of any movable or immovable property Works Contract Option 1 Option 2 Option 3 Actual Standard Composition Expense Deduction etc. = Taxable Material Value VAT = Rate of Materials Input tax credit (ITC) available for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available allowed as deduction and on remaining 25% of portion Compositio n rate is 5%. ITC not available ii Gujarat Works Contract Total Contract Value Total Contract Value Compositio n tax 0.6% of Less : Less : Total Contract Standard Value means a contract for execution of works and includes such works contract as the State Government may, by notification in the Official Gazette, specify; Actual Charges for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available Provided all purchases are made from local registered dealer. Inter state purchase is not allowed. ITC not available Real Estate Sector In India 63

68 Sr. No. State Definition of Works Contract iii Karnataka 'Works Contract' Total Contract Value Total Contract Value Compositio n tax 5% of Total Less : Less : Contract Standard Value includes any agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property. Works Contract Option 1 Option 2 Option 3 Actual Standard Composition Expense Deduction Actual Charges for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available ITC not available iv Tamilnadu Works Contract Total Contract Value Total Contract Value Compositio n tax 2% of Total Less : Less : Contract Standard Value includes any agreement for carrying out for cash, deferred payment or other valuable consideration, building construction, manufacture, processing, fabrication, erection, installation, fitting Actual Charges for labor and Services etc. = Taxable Material Value for labor and Services etc. = Taxable ITC not available 64 Real Estate Sector In India

69 Sr. No. v State West Bengal Definition of Works Contract out, improvement, modification, repair or commissioning, of any movable or immovable property; Works Contract means any agreement for carrying out for cash, deferred payment or other valuable consideration- (a) the construction, fitting out, improvement or repair of any building, road, bridge or other immovable property, Works Contract Option 1 Option 2 Option 3 Actual Standard Composition Expense Deduction VAT = Rate of Materials ITC available Total Contract Value Less : Actual Charges for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available Material Value VAT = Rate of Materials ITC available Total Contract Value Less : Standard 25% for labor and Services etc. = Taxable Material Value VAT = Rate of Materials ITC available Compositio n tax 2% of Total Contract Value ITC not available vi Delhi Works Contract includes any agreement for Total Contract Value Total Contract Value Compositio n tax 2.5% of carrying out for cash Less : Less : Total or for deferred Standard Contract payment or for Actual Value if valuable Charges for Deduction purchases Real Estate Sector In India 65

70 Sr. No. State Definition of Works Contract consideration, the building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, repair or commissioning of any moveable or immovable property Works Contract Option 1 Option 2 Option 3 Actual Standard Composition Expense Deduction labor and Services etc. = Taxable Material Value VAT = Rate of 25% for labor and Services etc. = Taxable Material Value VAT = Rate of Materials and sale during the period for compositio n is opted within Delhi only 3% of the entire turnover on account of works contracts executed in Delhi if the dealer is engaged in procuring goods from any place outside Delhi or in supplying goods to any place outside Delhi. ITC not available 66 Real Estate Sector In India

71 CHAPTER 7: STAMP DUTY REGULATIONS 7.1 Background Stamp Duty in India is governed by the Indian Stamp Act, It applies in case of transfer of property whether moveable or immovable. Through this chapter, we aim to highlight certain pertinent aspects relating to Stamp Duty, its adjudication and various rates prevailing in different states of India. 7.2 Adjudication Levy of stamp duty is dependent upon many variable factors like area of the property, locality, circle rate, nature of interest, encumbrances, etc. Therefore, it is advisable to get the stamp duty adjudicated by the competent authority in case of uncertainty about the valuation. If an instrument is not duly stamped, the stamp authorities may levy a penalty, which is generally an ad valorem rate which varies from state to state, and maximum penalty could range from twice the deficient stamp duty to ten times the deficient stamp duty. Deliberate evasion of stamp duty could also attract imprisonment. 7.3 Other Related Aspects Stamp duty is a very important factor in structuring transactions. A document inadequately stamped is not admissible as evidence. Many states provide for levying differential stamp duty. Stamp duty implications must be examined when documents or their photocopies are being moved from one state to another. Many states provide that the shortfall in stamp duty must be paid within a specified period (most commonly 3 months) of the documents being brought into the state. The stamp laws of most states provide that when there are multiple Real Estate Sector In India 67

72 instruments for specified transactions, highest duty is to be paid on principal instrument and nominal stamp duty is payable on the rest of the documents. When a single instrument relates to distinct matters, stamp laws require that the instrument shall be chargeable with the aggregate amount of duties with which the separate instruments, each comprising of one of such distinct matters, would be chargeable. Finally, there may be situations where one stamps a document in anticipation of execution but the deal falls through and the document is not executed at all. If the stamp duty is high, then most states provide for claiming a refund within a specific time. Stamp duty depends upon many factors. Below is an indicative chart of approximate Stamp duty in case of transfer of immovable property in India: State Rate Andhra Pradesh 5% Bihar 9% Chhattisgarh 7.5% Goa 7% Gujarat 3.5% +Additional Duty 40% on Stamp Duty Haryana 5% Himachal Pradesh 8% Jharkhand 6% Kerala 8.5% Madhya Pradesh 7.5% Maharashtra 5% Orissa 14.7% Punjab 6% Rajasthan 10% Tamil Nadu 8% Uttaranchal 4% Uttar Pradesh 6% West Bengal 7% 68 Real Estate Sector In India

73 CHAPTER 8: FOREIGN INVESTMENT REGULATIONS 8.1 Background The Government of India frames broad guidelines on sector-specific FDI policy and issues press notes from time to time. As per the latest FDI policy, foreign direct investment and investments by NRIs are allowed under automatic route in almost all the sectors except in certain sectors/activities such as Trading in TDRs, real estate trading, etc., which are prohibited. Incidentally, the foreign investment is allowed in construction-development projects subject to fulfillment of certain specified conditions. The Foreign Exchange Management Act, 1999 empowers RBI to frame regulations in respect of cross border investments, foreign exchange transactions and transactions between residents and non-residents. Under this chapter, we aim to highlight few relevant provisions that govern foreign investment transactions in real estate sector. 8.2 Foreign Direct Investment In Real Estate Sector In India FDI is prohibited in real estate business or construction of farm houses, or trading in TDRs. However, the RBI has clarified in its Circular that Real Estate Business does not include construction of housing/commercial premises, educational institutions, recreational facilities, city and regional level infrastructure, townships. Further, the FDI policy of Government of India permits 100% foreign investment under automatic route in Construction Development activity i.e. Townships, Housing, Built-up infrastructure and construction development project (which would include, but not be restricted to housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional level infrastructure) subject to certain conditions given below: Minimum area to be developed* under each project would be as under: Real Estate Sector In India 69

74 In case of development of serviced housing plots, a minimum land area of 10 hectares; In case of construction-development projects, a minimum built-up area of 50,000 square meters; In case of a combination project, any one of the above two conditions would suffice. *Union Urban Development Ministry has suggested certain relaxations like minimum land area proposed to be reduced to 2 hectares from 10 hectares, minimum built-up area proposed to be reduced to 25,000 square meters from 50,000 square meters. However, the same is at the discussion stage at present and not finalized. Minimum capitalization of US$ 10million for WOS and US$ 5 million for JV with Indian partners. The funds would have to be brought in within 6 months of commencement of business of the Company. Original investment cannot be repatriated before a period of 3 years from completion of minimum capitalization. Original investment means the entire amount brought in as FDI. The lock-in period of 3 years will be applied from the date of receipt of each installment/tranche of FDI or from the date of completion of minimum capitalization, whichever is later. However, the investor may be permitted to exit earlier with prior approval of the Government through FIPB. At least 50% of each such project must be developed within a period of 5 years from the date of obtaining all statutory clearances. The investor/investee company would not be permitted to sell undeveloped plots. For the purpose of these guidelines, Undeveloped Plots will mean where roads, water supply, street lighting, drainage, sewerage, and other conveniences, as applicable under prescribed regulations, have not been made available. It will be necessary that the investor provides this infrastructure and obtains the completion certificate from the concerned local body/service agency before he would be allowed to dispose of serviced housing plots. 70 Real Estate Sector In India

75 The project shall conform to the norms and standards, including land use requirements and provision of community amenities and common facilities, as laid down in the applicable building control regulations, bye laws, rules and other regulations of the State Government/Municipal/Local Body concerned. The investor/investee company shall be responsible for obtaining all necessary approvals, including those of the building/layout plans, developing internal and peripheral areas and other infrastructure facilities, payment of development, external development and other charges and complying with all other requirements as prescribed under applicable rules/bye-laws/regulations of the State Government/Municipal/ Local Body concerned. The State Government / Municipal / Local Body concerned, which approves the building / development plans, would monitor compliance of the above conditions by the developer. Notes: The first four conditions given above would not apply to Hotels and Tourism, Hospitals, SEZs, Education Sector, Old age Homes and investment by NRIs. FDI is not allowed in real estate business (already discussed in para 8.2.1) Investment by NRIs are allowed in partnership firms or proprietary concerns on non-repatriation basis provided that such firms or concerns are not engaged in real estate business (i.e. dealing in land and immovable property with a view to earning profit or earning income therefrom). Real Estate Sector In India 71

76 8.2.3 Flow-chart for foreign investment regulations in real estate sector : FDI in Real Estate Sector Activity Real Estate Business* / Trading in TDRs Yes No FDI prohibited Townships, housing, built-up infrastructure and construction-development projects Yes FDI in Hotels and Tourism, Hospitals, SEZs, Education Sector, Old age Homes and investment by NRIs No Yes Condition w.r.t. area, capitalization, lock-in-period for repatriation, term of development need not be fulfilled Conditions w.r.t. area, capitalization, lock-in-period for repatriation, term of development need to be fulfilled Other conditions prevail and need to be complied *Real Estate Business means dealing in land and immovable property with a view to earning profit or earning income therefrom and does not include development of townships, construction of residential / commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships. 72 Real Estate Sector In India

77 8.2.4 Certain ongoing issues in relation to Foreign Investment Regulations in real estate sector, inter alia, include the followings: Once the project is completed, whether funds can be redeployed in another project without any restriction as mentioned above? From which date, the lock-in period of 3 years commence when amount is received in tranches/installment i.e. whether from the date of each installment or from the date of minimum capitalization? Whether foreign investor can acquire the property for the purpose of leasing? Whether the property constructed as per FDI guidelines can be leased out? Whether FII can subscribe to initial public offer of a company engaged in real estate business without FDI compliant project? 8.3 Liberalized Foreign Investment Policy For Retail Trading Sector - Impact On Real Estate Sector In the year 2006, FDI up to 51% under G overnment a p p rova l ro u te wa s a l l owed in retail segment under SBRT. This limit has been raised to 100% in the year The Government, vide Press note no.6 dated 22 August 2013, has allowed FDI up to 49%, in SBRT under the automatic route. In September 2012, the Government of India further liberalized FDI policy for MBRT, by allowing 51% under Government approval route with certain terms and conditions. One of the conditions of such FDI in MRBT is that at least 50% of total FDI should be invested in backend infrastructure within 3 years of the first tranche of FDI. This could enable significant growth in the Real Estate Sector in India. Real Estate Sector In India 73

78 8.4 Acquisitions And Transfers Of Immovable Property In India Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2000 regulate the transactions in immovable property by non-residents. The same are briefly discussed as under: A person resident outside India who has established in India, a branch, office or other place of business for carrying on in India any activity, excluding a liaison office, in accordance with the Foreign Exchange Management (Establishment in India of Branch or Office or Other Place of Business) Regulations, 2000,may acquire any immovable property in India, which is necessary for or incidental to carrying on such activity subject to complying with reporting requirements. Liaison office cannot acquire immovable property except by way of lease not exceeding 5 years. In addition to FDI permitted in real estate as discussed above, NRIs or PIO are permitted to acquire or transfer immovable property in India i.e. residential or commercial property. However, purchase of agricultural property, plantation or farm house is not permitted. NRIs/PIOs can also avail loan from an authorized dealer, a Housing Financial Institution or an Employer subject to certain conditions. Foreign nationals of non-indian origin, resident outside India are not permitted to acquire any immovable property in India unless such property is acquired by way of inheritance from a person who was resident in India. However, they can acquire or transfer immovable property in India, on lease, for a period not exceeding 5 years without prior permission of RBI. A person resident in India who is a citizen of Pakistan or Bangladesh or Sri Lanka or Afghanistan or China or Iran or Nepal or Bhutan would require RBI permission for acquisition or transfer of immovable property in India, other than lease, not exceeding 5 years. 8.5 External Commercial Borrowings ECBs refer to commercial loans in the form of bank loans, buyers credit, suppliers credit, securitized instruments availed from eligible non-resident lenders with a minimum average maturity of 3 years. 74 Real Estate Sector In India

79 The Indian Company or any other eligible entity as specified by RBI is allowed to raise ECBs from eligible lenders subject to specified conditions and end-use restrictions. The ECBs can be utilized for specified purposes only and shall not be utilized for any investment in real estate sector. In November 2012, RBI has permitted ECBs for low-cost affordable housing project ( Project ) under the approval route for certain eligible borrowers, subject to certain conditions which include the followings: A project in which at least 60% of the permissible FSI would be for the units having maximum carpet area up to 60 square meters, ECB proceeds should not be utilized for the purpose of acquiring land, The maximum fund that can be availed through ECB is US$ 1 billion, Developers / builders should have minimum 3 years experience in undertaking residential projects and should have good track record in terms of quality and delivery, Developers / builders should not have defaulted in any of their financial commitments to banks / financial institutions or any other agencies. Further, the project should not be a matter of litigation, The minimum NOF for the past 3 financial years should not be less than Rs. 300 crores, Borrowing through ECB should be within overall borrowing limit of 16 times of their NOF and the NNPA shall not exceed 2.5% of the net advances, The maximum loan amount sanctioned to individual buyer will be capped at Rs. 25,00,000 subject to the condition that the cost of the individual housing unit shall not exceed Rs.30, 00, Outbound Investments Under Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004, an Indian party can make investment in JV / WOS outside India subject to complying with certain conditions and procedural requirements. Real Estate Sector In India 75

80 However, Indian party is not allowed to make any investment in a foreign entity engaged in real estate business. Real Estate Business means buying and selling of real estate or trading in TDRs but does not include development of townships, constructions of residential / commercial premises, roads or bridges. As such, an Indian party can invest outside India in real estate business other than buying and selling of real estate or TDRs, subject to complying with net-worth criteria, certain conditions and procedural requirements. 8.7 Acquisition Of Immovable Property Outside India Under LRS Of RBI Under LRS scheme of RBI, the authorized dealers may freely allow remittances by resident individuals up to specified limits per financial year for any permitted current or capital account transactions or a combination of both. Till now, the resident individuals were permitted to acquire and hold immovable property outside India under LRS. However, recently, RBI has amended/clarified that LRS should no longer be used for acquisition of immovable property, directly or indirectly, outside India. Therefore, AD banks may henceforth not allow any remittances under the LRS scheme for acquisition of immovable property outside India. 76 Real Estate Sector In India

81 CHAPTER 9: FINANCIAL REPORTING STANDARDS 9.1 Background Accounting Standards (AS) are rules regarding recognition, measurement and disclosure aspects in financial statements and relate to the codification of generally accepted accounting principles. These are norms of accounting policies and practices, which direct how the items which make up the financial statements, should be dealt with in accounts and presented in the financial statements. There are various Accounting Standards followed worldwide (e.g. US GAAP, IFRS, Indian GAAP, etc.) In exercise of the powers conferred by clause (a) of sub-section (1) of section 642 of the Companies Act, 1956, read with section 211(3C) and section 210A(1) of the Companies Act, 1956, the Central Government, in consultation with National Advisory Committee on Accounting Standards, had made the Companies (Accounting Standards) Rules, Accounting Standards as specified under the Companies (Accounting Standards) Rules, 2006 are to be applied by the companies in the preparation of General Purpose Financial Statements for the accounting periods commencing on or after 7 December Accounting Under Indian GAAP The accounting standards that deal with the accounting treatment of revenue are (AS)-7 Construction Contracts and (AS)-9 Revenue Recognition. (AS)-7 is to be applied for accounting for construction contracts in the financial statements of contractor. As per (AS)-7, when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses Real Estate Sector In India 77

82 respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognized as an expense immediately in accordance with the standard. The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. (AS)-9 Revenue Recognition deals with the recognition of revenue arising in the course of the ordinary activities of the enterprise from: the sale of goods, the rendering of services, and the use by others of enterprise resources yielding interest, royalties and dividends. As per (AS)-9, revenue should be accounted when significant risk and rewards of ownership are transferred to the buyer and it is not unreasonable to expect ultimate collection. In 2006, the ICAI had also issued a Guidance Note on Recognition of Revenue by Real Estate Developers. As per the said guidance note, revenue would be recognized by applying the principles of percentage completion method as per principles provided in (AS)-7 if there is transfer of risk and rewards of ownership and no uncertainty exists as regard to collection of the amount. In most cases, Real Estate Developers would not fall under the definition of contractor. In such a situation, (AS)-7 cannot be applied to transactions entered by the real estate developers and principles laid down under (AS)-9 Revenue Recognition needs to be applied. However, due to the distinguished revenue model of this sector, it was observed that different practices were followed by the various real estate developers in recognising their revenue till recent past. To harmonize the diverse practices followed by different players in this sector into a single uniform practice, particularly, in the application of Percentage Completion 78 Real Estate Sector In India

83 Method of recognition of revenue, in 2012, the ICAI issued a Guidance Note on Accounting for Real Estate Transactions (Revised 2012) (AS) - 7 construction contracts Definitions A construction contract is a contract specifically negotiated for construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses. A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus percentage of these costs or a fixed fee. Contract revenue includes: the initial amount of revenue agreed in the contract; and variations in contract work, claims and incentive payments: to the extent that it is probable that they will result in revenue; and they are capable of being reliably measured. Contract revenue is measured at the consideration received or receivable. The measurement of contract revenue is affected by a variety of uncertainties that depend on the outcome of future events. Contract costs comprise of: costs that relate directly to the specific contract; costs that are attributable to contract activity in general and can be allocated to the contract; and Real Estate Sector In India 79

84 such other costs as are specifically chargeable to the customer under the terms of the contract. Costs that relate directly to a specific contract include: site labour costs, including site supervision; costs of materials used in construction; depreciation of plant and equipment used on the contract; costs of moving plant, equipment and materials to and from the contract site; costs of hiring plant and equipment; costs of design and technical assistance that is directly related to the contract; the estimated costs of rectification and guarantee work, including expected warranty costs; and claims from third parties. These costs may be reduced by any incidental income that is not included in contract revenue, for example income from the sale of surplus materials and the disposal of plant and equipment at the end of the contract. Costs that may be attributable to contract activity in general and can be allocated to specific contracts include: insurance; costs of design and technical assistance that is not directly related to a specific contract; and construction overheads. Recognition of contract revenue and expenses When the outcome of a construction contract can be estimated 80 Real Estate Sector In India

85 reliably, contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognized as an expense immediately. In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied: total contract revenue can be measured reliably; it is probable that the economic benefits associated with the contract will flow to the enterprise; both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably; and the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates. In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied: it is probable that the economic benefits associated with the contract will flow to the enterprise; and the contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably. Percentage completion method: Under this method, contract revenue is matched with the contract costs Real Estate Sector In India 81

86 incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. Under the percentage of completion method, contract revenue is recognized as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognized as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognized as an expense immediately. A contractor may have incurred contract costs that relate to future activity on the contract. Such contract costs are recognized as an asset provided it is probable that they will be recovered. When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognized in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable, is recognized as an expense rather than as an adjustment of the amount of contract revenue. The stage of completion of a contract may be determined in a variety of ways. The enterprise uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include: the proportion that contract costs incurred for work performed up to the reporting date bear to the estimated total contract costs; or surveys of work performed; or completion of a physical proportion of the contract work. Progress payments and advances received from customers may not necessarily reflect the work performed. 82 Real Estate Sector In India

87 Contract costs which are excluded are: contract costs that relate to future activity on the contract, such as costs of materials that have been delivered to a contract site or set aside for use in a contract but not yet installed, used or applied during contract performance, unless the materials have been made especially for the contract; and payments made to subcontractors in advance of work performed under the subcontract. When the outcome of a construction contract cannot be estimated reliably: revenue should be recognized only to the extent of contract costs incurred of which recovery is probable; and contract costs should be recognized as an expense in the period in which they are incurred. an expected loss on the construction contract should be recognized as an expense immediately. contract costs, recovery of which is not probable, are recognized as an expense immediately. Recognition of expected losses When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately. Change in estimates The effect of a change in the estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome of a contract, is accounted for as a change in accounting estimate. The changed estimates are used in determination of the amount of Real Estate Sector In India 83

88 revenue and expenses recognized in the statement of profit and loss in the period in which the change is made and in subsequent periods. 9.3 Guidance Note On Accounting For Real Estate Transaction (Revised 2012) Applicability This guidance note is applicable to all projects which are commenced on or after 1 April However, this guidance note does not apply to real estate transactions of the nature covered by AS-10, AS-12, AS-19 and AS-26. Illustrative list of transactions covered is as under: Definitions Sale of plots of land (including long-term sale type leases) without any development. Sale of plots of land (including long-term sale type leases) with development in the form of common facilities like laying of roads, drainage lines and water pipelines, electrical lines, sewage tanks, water storage tanks, sports facilities, gymnasium, club house, landscaping etc. Development and sale of residential and commercial units, row houses, independent houses, with or without an undivided share in land. Acquisition, utilisation and transfer of development rights. Redevelopment of existing buildings and structures. Joint development agreements for any of the above activities. Project Project is the smallest group of units/plots/saleable spaces, which are linked with a common set of amenities in such a manner that unless the common amenities are 84 Real Estate Sector In India

89 made available and functional, these units/plots/saleable spaces cannot be put to their intended effective use. Project Costs Project costs in relation to a project ordinarily comprise: Cost of land and cost of development rights - All costs related to the acquisition of land, development rights in the land or property including cost of land, cost of development rights, rehabilitation costs, registration charges, stamp duty, brokerage costs and incidental expenses. Borrowing Costs In accordance with (AS)-16, borrowing costs which are incurred directly in relation to a project or which are apportioned to a project. Construction and development costs These would include costs that relate directly to the specific project and costs that may be attributable to project activity in general and can be allocated to the project. Project revenues Project revenues include revenue on sale of plots, undivided share in land, sale of finished and semi-finished structures, consideration for construction, consideration for amenities and interiors, consideration for parking spaces and sale of development rights Accounting for real estate transactions Real estate activities and transactions take diverse forms. While some are for sale of land (developed or undeveloped), others are for construction, development or sale of units that are not complete at the time of entering into agreements for construction, development or sale. The typical features of most construction/development of commercial and residential units have all features of a construction contract land development, structural engineering, architectural design and construction are all present. The natures of these activities are such that often the date when the activity is commenced and the date when the activity is completed usually fall into different accounting periods. It is not unusual for such activities to spread over two or more accounting periods. Real Estate Sector In India 85

90 Real estate sales take place in a variety of ways and may be subject to different terms and conditions as specified in the agreement for sale. Accordingly, the point of time at which all significant risks and rewards of ownership can be considered as transferred, is required to be determined on the basis of the terms and conditions of the agreement for sale. Once the seller has transferred all the significant risks and rewards to the buyer, any acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor. Accordingly, revenue in such cases is recognized by applying the percentage of completion method on the basis of the methodology explained in (AS)-7 Construction Contracts. Where individual contracts are part of a single project, although risks and rewards may have been transferred on signing of a legally enforceable individual contract but significant performance in respect of remaining components of the project is pending, revenue in respect of such an individual contract should not be recognized until the performance on the remaining components is considered to be completed on the basis of the aforesaid principles Summary of principles to be followed for accounting of various types of real estate transactions Nature of Transaction Sale of plots of land without any development. Transactions of real estate which are in substance similar to delivery of goods Key Principles / Conditions Principles of (AS)-9 for recognizing revenue, costs and profits from the transactions need to be applied, provided: The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership; The seller has effectively handed over possession of the real estate unit to the 86 Real Estate Sector In India

91 Nature of Transaction Key Principles / Conditions buyer forming part of the transaction; No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and Sale of developed plots. Transactions and activities of real estate which have the same economic substance like a construction contract It is not unreasonable to expect ultimate collection of revenue from buyers. Where the development activity is significant, Percentage Completion Method to be applied, provided the outcome of a real estate project can be estimated reliably and when all the following conditions are satisfied: total project revenues can be estimated reliably; it is probable that the economic benefits associated with the project will flow to the enterprise; the project costs to complete the project and the stage of project completion at the reporting date can be measured reliably; and the project costs attributable to the project can be clearly identified and measured reliably so that actual project costs incurred can be compared with prior estimates. Revenue should be recognized under the percentage completion method only when the events in below cases are completed: Real Estate Sector In India 87

92 Nature of Transaction Key Principles / Conditions All critical approvals necessary for commencement of the project have been obtained. These include, wherever applicable: Environmental and other clearances. Approval of plans, designs, etc. Title to land or other rights to development/ construction. Change in land use. When the stage of completion of the project reaches a reasonable level of development. A reasonable level of development is not achieved if the expenditure incurred on construction and development costs is less than 25 % of the construction and development. At least 25% of the saleable project area is secured by contracts or agreements with buyers. At least 10% of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts. 88 Real Estate Sector In India

93 Thus the application of the methods described above requires a careful analysis of the elements of the transaction, agreement, understanding and conduct of the parties to the transaction to determine the economic substance of the transaction. The economic substance of the transaction is not influenced or affected by the structure and/or legal form of the transaction or agreement Additional consideration in application of percentage completion method For computation of revenue, the stage of completion is arrived at with reference to the entire project costs incurred including land costs, borrowing costs and construction and development costs. The method of determination of stage of completion with reference to project costs incurred is the preferred method. Other methods for determination of stage of completion include surveys of work done, technical estimation, etc. However, computation of revenue with reference to other methods of determination of stage of completion should not, in any case, exceed the revenue computed with reference to the 'project costs incurred' method. The project costs which are recognized in the statement of profit and loss by reference to the stage of completion of the project activity are matched with the revenues recognized resulting in the reporting of revenue, expenses and profit, which can be attributed to the proportion of work completed. Costs incurred that relate to future activity on the project and payments made to sub-contractors in advance of work performed under the subcontract are excluded and matched with revenues when the activity or work is performed. The recognition of project revenue by reference to the stage of completion of the project activity should not at any point exceed the estimated total revenues from 'eligible contracts /other legally enforceable agreements for sale. Real Estate Sector In India 89

94 When it is probable that total project costs will exceed total eligible project revenues, the expected loss should be recognized as an expense immediately. The amount of such a loss is determined irrespective of: commencement of project work; or the stage of completion of project activity. The percentage of completion method is applied on a cumulative basis in each reporting period to the current estimates of project revenues and project costs. Therefore, the effect of a change in the estimate of project costs, or the effect of a change in the estimate of the outcome of a project, is accounted for as a change in accounting estimate. Revenues attributable to cancelled contracts and cases where the property or part thereof is subsequently earmarked for own use or for rental purposes, previously recognized revenue on such contracts should be reversed and the costs in relation to property earmarked for own use shall be carried forward and accounted in accordance with AS 10, Accounting for Fixed Assets. Illustration on application of percentage completion method Total saleable area 20,000 Sq. ft. Estimated project costs Rs. 600 lakhs (This comprises land cost of Rs. 300 lakhs and construction costs of Rs. 300 lakhs) Cost incurred till end of reporting period Rs. 360 lakhs (This includes land cost of Rs 300 lakhs and construction cost of Rs 60 lakhs) Total area sold till the date of reporting period 5,000 Sq. ft. Total sale consideration as per agreements of Rs. 200 lakhs sale executed Amount realised till the end of the reporting Rs.50 lakhs period Percentage of completion of work 60% of total project cost including land cost or 20% of total construction cost 90 Real Estate Sector In India

95 At the end of the reporting period, the enterprise will not be able to recognize any revenue as reasonable level of construction, which is 25% of the total construction cost, has not been achieved, though 10% of the agreement amount has been realized. Continuing the illustration If the work completed till end of reporting period is (This includes land cost of Rs 300 lakhs and construction cost of Rs 90 lakhs) Percentage of completion of work would be Rs. 390 lakhs 65% of total project cost including land cost or 30% of construction cost The enterprise would be able to recognize revenues at the end of the accounting period. The revenue recognition and profits would be as under: Revenue recognized Rs. 130 lakhs (65% of Rs 200 lakhs as per agreement of sale) Proportionate cost Rs lakhs (5000 square feet / 20,000 square feet) x 390 Income from the project Rs lakhs Work in progress to be carried forward Rs lakhs Transferable development rights Transferable Development Rights (TDRs) are generally acquired in different ways as mentioned hereunder: Direct purchase - cost of acquisition would be the amount spent on for buying the said certificate. Development and construction of built-up area - cost of acquisition would be the cost of purchases or amount spent on development or construction of built-up area, respectively. Real Estate Sector In India 91

96 Giving up of rights over existing structures or open land - the development rights should be recorded either at fair market value or at the net book value of the portion of the asset given up whichever is less. For this purpose, fair market value may be determined by reference either to the asset or portion thereof given up or to the fair market value of the rights acquired, whichever is more clearly evident. When development rights are utilized in a real estate project by an enterprise, the cost of acquisition should be added to the project costs. When development rights are sold or transferred, revenue should be recognized when both the following conditions are fulfilled: title to the development rights is transferred to the buyer; and it is not unreasonable to expect ultimate realization of revenue Transactions with multiple elements An enterprise may contract with a buyer to deliver goods or services in addition to the construction/development of real estate [e.g. property management services, sale of decorative fittings (excluding fittings which are an integral part of the unit to be delivered), rental in lieu of unoccupied premises, etc.] In such cases, the contract consideration should be split into separately identifiable components including one for the construction and delivery of real estate units. The consideration received or receivable for the contract should be allocated to each component on the basis of the fair market value of each component. 9.4 Indian Accounting Standard (Ind AS) India is committed to implement IFRS. The ICAI and the MCA have expressed their view that India would converge to IFRS in a phased manned starting 1 April In February 2011, MCA has also 92 Real Estate Sector In India

97 notified 35 Indian Accounting Standards converged with IFRS (Ind AS,) but due to certain tax related issues, which needed to be resolved with the concerned department, the date of implementation is still not notified Key differences between (AS)-7 and Ind AS-11 (AS)-7 Applied in accounting for construction contracts in the financial statements of contractors. Is applicable to contracts specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. (AS)-7 does not deal with accounting for Service Concession Arrangements, i.e., the arrangement where private sector entity (an operator) constructs or upgrades the infrastructure to be used to provide the public service and operates and maintains that infrastructure for a specified period of time. Includes borrowing costs as per AS 16 - Borrowing Costs, in the costs that may be attributable to contract activity in general and can be allocated to specific contracts. Contract revenue is measured at the consideration received or receivable. Ind AS-11 Applied in accounting for construction contracts in the financial statements of contractors including the financial statements of real estate developers. It also includes agreements of real estate development to provide services together with construction material in order to perform contractual obligation to deliver the real estate to the buyer. Appendix A of Ind AS 11 deals with accounting aspects involved in such arrangements. Does not specifically make reference to Ind AS 23. Contract revenue is measured at the fair value of the consideration received or receivable. Real Estate Sector In India 93

98 CHAPTER 10: CERTAIN PROPERTY RELATED LAWS 10.1 Restriction On Transfer Of Land Holding Right to property is a Constitutional right. This is a transferable right. However, the Government for various social, political and economic reasons restricts the transferability of land. There are many laws which impose restriction on transfer of immovable property. These laws are meant to protect the interest of specific class of people. Every State has separate laws which protect its residents in one way or other. Before entering into any transaction regarding immovable property, one must be sure that no such law is attracted to that particular transaction. The laws which restrict a person s rights of transfer of the land in the State of Maharashtra are as follows: Maharashtra Land Revenue Code, 1966 As per the Maharashtra Land Revenue Code, no land used for agriculture shall be used for any non-agricultural purpose, and no land assessed for one nonagricultural purpose shall be used for any other non-agricultural purpose or for the same non-agricultural purpose but in relaxation of any of the conditions imposed at the time of the grant or permission for non-agricultural purpose, except with the permission of the Collector Bombay Tenancy and Agricultural Lands Act, 1948 As per section 43 of this Act, no land purchased by a tenant under sections 32, 32F, 32I, 32O, 33C and 43ID or sold to any person under section 32P or 64 shall be transferred by sale, gift, exchange, mortgage, lease or assignment without the previous sanction of the Collector. Any transfer of land in contravention of aforesaid provision shall be invalid The Bombay Prevention of Fragmentation and Consolidation of Holdings Act, 1947 This Act prohibits transfer of any fragment in respect of which a notice has been given under the Act, except to the owner of a contiguous survey number 94 Real Estate Sector In India

99 (contiguous holder) or recognized sub-division of a survey number. Further, this Act also prohibits subdivision of the land. Section 8 of the Act provides that no land in any local area shall be transferred or partitioned so as to create a fragment The Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961 This Act restricts the size of holdings which a person or family can own. Acquisition of land in excess of the ceiling is prohibited. Land rendered surplus to the ceiling is taken over by the state and distributed among the weaker sections of the society. Any person or family cannot hold land in excess of ceiling area fixed on 26 September A person or family cannot transfer surplus land until the land in excess of the ceiling area is determined under the act (Section 8). A person possessing land in excess of ceiling area cannot acquire land by transfer (Section 9). The land held by individual or the family of the Maharashtra State or the part of India is to be taken into consideration while calculating the ceiling area Wakf Act, 1995 Wakf is a permanent dedication of movable or immovable properties for religious, pious or charitable purposes as recognized by Muslim Law. Board constituted under the Act has the power to sanction any transfer of immovable property of a wakf by way of sale, gift, mortgage, exchange or lease, in accordance with the provisions of Act, provided that no such sanction shall be given unless at least two thirds of the members of the Board vote in favour of such transaction Bombay Public Trust Act, 1950 Section 36 of this Act provides that notwithstanding anything contained in the instrument of trust no sale, exchange or gift of any immovable property, and no lease for a period exceeding 10 years in the case of agricultural land or for a period exceeding 3 years in the case of non-agricultural land or a building belonging to a public trust, shall be valid without the previous sanction of the Charity Commissioner. If the Charity Commissioner is satisfied that in the interest of any public trust any immovable property thereof should be disposed of, he may, on application, authorise any trustee to dispose of such property subject to such conditions as he Real Estate Sector In India 95

100 may think fit to impose, regard being had to the interest or benefit or protection of the trust The Maharashtra Restoration of Lands to Schedule Tribes Act, 1974 Section 3 and 4 of this Act provide for restoration of land held by non-tribal transferee to tribal transferor by the collector either suo motto at any time or on application of tribal transferor made within 30 years from 6 July Land Acquisition Act, 1894 No company for which any land is acquired under part 7, which deals with Acquisition of Land for Companies, shall be entitled to transfer the said land or any part thereof by sale, mortgage, gift, and lease or otherwise except with the previous sanction of the appropriate Government Transfer Of Property Act, 1882 Definitions Contract for sale Sale A contract for the sale of immovable property is a contract that a sale of such property shall take place on terms settled between the parties. It does not, of itself, create any interest in or charge on such property. Sale is a transfer of ownership in exchange for a price paid or promised or part-paid and part-promised. Transfer of property Transfer of property has been defined in Section 5 of the Transfer of Property Act meaning 'an act by which a living person conveys property, in present or in future to one or more other living persons and to transfer property is to perform such act'. 'Living person' has been defined to include a company or association or body of individuals whether incorporated or not. 96 Real Estate Sector In India

101 Immovable property The definition of Immovable Property given in Transfer of Property Act, 1882 is not exhaustive. It simply says: 'Immovable Property' does not include standing timber, growing crops or grass. The definition of 'Immovable Property' in the General Clauses Act is also not exhaustive. Some of the things such as piece of land or superstructure constructed thereon in all circumstances are considered as immovable property. Interests in property Sale how made As ownership consists of a bundle of rights, the various rights and interests may be vested in different persons. Absolute ownership is an aggregate of component rights such as the right of possession, the right of enjoying the usufruct of the land, and as on. These subordinate rights, the aggregate of which make up absolute ownership, are called in this Act Interests in Property. A transfer of property is either a transfer of absolute ownership or a transfer of one or more of these subordinate rights. Transfer, in the case of tangible immovable property of the value of Rs. 100 and upwards, or in the case of a reversion or other intangible thing, can be made only by a registered instrument. In the case of tangible immovable property of a value less than Rs. 100, such transfer may be made either by a registered instrument or by delivery of the property. Delivery of tangible immovable property takes place when the seller places the buyer or such person as he directs, in possession of the property. Part performance Where any person contracts to transfer for consideration any immoveable property by writing signed by him (from which the terms necessary to Real Estate Sector In India 97

102 constitute the transfer can be ascertained), and the transferee has, in part performance of the contract, taken possession of the property and has performed or is willing to perform his part of the contract, then in such circumstances, the transferor is debarred from enforcing against the transferee any right in respect of the property of which the transferee has taken possession. Registration The following documents shall be registered: Instruments of gift of immovable property; Other non-testamentary instruments which purport or operate to create, declare, assign, limit or extinguish, whether in present or in future, any right, title or interest, whether vested or contingent, of the value of Rs.100, and upwards, to or in immovable property; Non-testamentary instruments which acknowledge the receipt or payment of any consideration on account of the creation, declaration, assignment, limitation or extinction of any such right, title or interest; and Leases of immovable property from year to year, or for any term exceeding 1 year, or reserving a yearly rent. Time for presenting documents for registration No document affecting transfer of immovable property executed in India is accepted for registration unless presented for that purpose to the proper officer within 4 months from the date of its execution. However if, owing to urgent necessity or unavoidable accident, any document executed is not presented for registration till after the expiration of 4 months, the Registrar, in cases where the delay in presentation does not exceed 4 months, may direct that, on payment of a fine not exceeding 10 times the amount of the proper registrationfee, such document shall be accepted for registration. Effect of non-registration of documents If the document purporting to transfer immovable property is not 98 Real Estate Sector In India

103 registered in accordance with the provision of Registration Act, 1908 then it will not affect any immovable property comprised therein or confer any right to adopt, or be received as evidence of any transaction affecting such property Other Significant Laws Building and Other Construction Worker Act, 1996 provides for constant and adequate supervision o f a n y b u i l d i n g o r o t h e r c o n s t r u c t i o n w o r k i n h i s establishment as to ensure compliance with the provisions of this Act relating to safety and for taking all practical steps to prevent accidents. Further, this Act provides for responsibility of employer to provide proper facilities as follows: effective arrangements to provide drinking water sufficient latrine and urinal accommodation temporary living accommodation to all building workers employed by him in every place wherein, more than 50 female building workers are ordinarily employed, there shall be provided and maintained a suitable room or rooms for the use of children under the age of 6 years of such female workers. provide first-aid facilities The Environment (Protection) Act, 1986 provides for the necessary safeguards which need to be adhered to in handling any hazardous substance in case of employer undertaking construction or development activity The Indian Electricity Act, 2003 provides for various safeguards which should be adhered to while installing electricity line in a particular area Bombay Lift Act, 1939 provides for the duty of person intending to install lift in a building to comply with the prescribed requirements. Real Estate Sector In India 99

104 The Public Liability Insurance Act, 1991 provides for the liability of the employer, in case of death or injury to any person (other than a workman) or damage to any property has resulted from an accident, liability as specified in the act The Child Labour (Prohibition and R e g u l a t i o n ) A c t, p r o h i b i t s employment of children below the age of 14 years in any specified occupation as mentioned in Schedule to the above act The Indian Fatal Accidents Act, 1855 provides for obligation of the employer to pay compensation to the families of the deceased employee caused by actionable wrong Payment of Bonus Act, 1965 provides for the payment of bonus to persons employed in certain establishments on the basis of profits or on basis of production or productivity and for matters connected therewith The Payment of Gratuity Act, 1972 provides for payment of gratuity to every employee who has rendered continuous service of not less than 5 years on his superannuation or resignation or death. The employer shall be under an obligation to obtain insurance for his liability for payment towards the gratuity under the act The Contract Labour (Regulation and Abolition) Act, 1970 provides for the duty of the employers as under: To make an application in the prescribed manner for registration for twenty or more employees are employed. To nominate a representative to be present at the time of and to certify the disbursements of wages paid by the contractor The Employees Provident Funds and Miscellaneous Provisions Act, 1952 provides for duty of employer (to whom the above Act applies) to contribute 12% of the basic and dearness allowance to the provident fund within 15 days of the last day of calendar month in which the contributions fall due The Maharashtra Shops and Establishments Act, 1948 provides for registration of commercial establishment which carries on any business, trade or profession with respect to state of Maharashtra and regulation of conditions of work and 100 Real Estate Sector In India