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Real Estate Tax and Regulatory regime

Contents
1. Introduction

2. Overview of Relevant regulations 3. FDI in Real estate 5. 7. Conditions Issues for consideration Funding options

4. Affordable housing sector Listing of properties outside India Indirect tax aspects 6. Income tax aspects 8. Accounting issues
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Real estate in India Key drivers

Economic growth and prosperity to drive demand for real estate

Economic growth & prosperity is driving demand for real estate in India along with a large and growing urban & youth population

India's GDP* Growth

3,000 2,500 USD BN 2,000 1,500 1,000 500 2007 2011 2015 1,153 1,843 2,738

Per capita income

1,600 1,344 USD per annum 1,200 882 800 400 FY06 FY07 FY08 FY09 FY10 FY11 669 769 1,146 1,001

Source: Datamonitor, US Census Bureau, Office of the Registrar General & Census Commissioner (India), IMF World Economic Outlook

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Real estate in India : Demand is expected to be strong across residential, commercial office and retail space
Residential Space
India Residential
5 4 MN units 3 2 1 2011 2015 2.6

Commercial Office Space

Commercial Office Space Demand

Commercial Retail Space

Commercial Retail Space Demand
60 57

CAGR - 11%

3.9

200 160 Mn sq. ft. 120 80 40 2010 127

CAGR - 6%

160 dd

50 40 30 20 10 16

CAGR - 37%

2014

2011 2015

Growth drivers Population growth, rapid urbanization, decreasing household size, increase in working age population and increase in income levels

Widening demand supply gap Urban housing shortage expected to increase from 20.5 Mn in 2010 to 21.7 MN units in 2014 Localized, fragmented market presents opportunities for consolidation

Growth drivers Global and Indian economic growth, domestic demand, export growth and increase in working population skill sets IT/ITeS and BFSI would continue to account for 60-70% of the office demand Labour force estimated at ~490 MN (2011); expected to grow at a CAGR ~2.3% to reach ~550 MN by FY16

Growth drivers Economic growth, population expansion, increasing income levels and the rapid growth in organized retail Indias retail market size is expected to grow at a CAGR of 1520% over the next 4 years to reach over USD 850 BN Indias Organised Retail Penetration is expected to increase from 6.5% to 9.2% by 2015
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Source: CRISIL, Cushman & Wakefield, PwC research & analysis

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Overview of Indian Regulatory & Tax Regime

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Key Relevant Legislations

Foreign Investment & Exchange Control
Foreign Direct Investment Policy

Corporate Laws

Fiscal Laws Direct Taxes

Fiscal Laws Indirect Taxes

Other key legislations

Companies Act

Income-tax Act

Customs Act

Indian Stamp Act

Foreign Exchange Management Act

Related Rules, Regulations and procedures

Wealth Tax Act

Central Excise Act

Intellectual property right laws

Related Rules, Regulations and procedures

Service Tax legislation

Labour laws

Value Added Tax (VAT) legislation

Environmental laws

Central Sales Tax Act

Industrial Licensing Policy

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FDI in Development & Construction Activity

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Background

Historically highly regulated FDI permitted in limited sectors Recent policy measures opened up the sector for FDI March 2005 FDI guidelines allowing 100% in few real estate segments Currently, FDI in real estate is allowed 100% through automatic route subject to conditions to be satisfied

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Real Estate Sector

Industrial Park and infrastructure facilities for the park

Conditions to be satisfied

Hotels, resorts, Hospitals

Educational institutions and old age homes

Residential townships, housing

Development of SEZ

Real estate sector

100% FDI permitted

Commercial premises, Recreational facilities

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Construction development Conditions for FDI

Minimum Hectare requirement Minimum Capitalization requirement Realisation

Serviced housing plots min 10 hectares; Construction-Development projects 50,000 sq.mts Combination project any one of the above USD 10M for WOS USD 5M for JV Funds should be brought in within 6 months from the date of commencement of business 3 yrs from minimum capitalisation 3 yrs applied from date of receipt of each tranche of FDI and completion of min cap Which ever higher 50% should be completed within 5 years Bye-laws, rules and regulations of State Government/Municipal/Local bodies Responsible for obtaining all necessary approvals
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Lock-in-period Completion percentage Compliance to norms/standards

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Industrial Park Conditions for FDI

Industrial Park Meaning Plots of developed land+built up space or combination with common facilities developed and allotted for industrial activity

Industrial activity

Means manufacturing, electricity, gas and water supply, post and telecommunications, software publishing, consultancy and supply, data processing, database activities, and distribution of electronic content, other computer related activities, basic and applied R&D on bio-technology, pharmaceutical sciences/life sciences, natural sciences, and engineering, business and management consultancy activities, and architectural, engineering and other technical activities Plots of developed land net area excluding common facilities Built up space floor area and built up space for common facilities Combination site area and floor area available for allocation excluding site area and built up space for common facilities Minimum of 10 units No single unit shall occupy more than 50% of allocable area

Allocable Area Meaning

Minimum units requirement

Allocation for Industrial Activity

Minimum 66% of allocable area to be allocated for Industrial activity

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Issues for consideration

Minimum area Built up area definition Super built up or carpet area? Minimum Capitalizations with funds to be brought within 6 months - Clarity on definition, start, end of 6 months Restriction on repatriation of original Investment restriction on investment or investor Timeline for development of the project consequence and remedy? Commercial complexes Vs. Industrial Parks FDI in company with Mixed projects Lock-in-period Investor or Investment? Exit to another non-resident

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Funding options
Instrument Equity Compulsorily Convertible Preference Shares(CCPS) Compulsorily convertible debentures (CCD) External Commercial Borrowing(ECB) Non Convertible Debentures(NCD) Permitted only for Industrial Park For FIIs only Must be listed Feasibility Extensively used Profit repatriation Dividend No cap Dividend Subject to cap Capital repatriation Restrictive Buyback/Capital reduction

Interest Subject to cap Interest- Subject to cap High flexibility

Interest subject High flexibility to cap

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Affordable housing sector key aspects

Key focus by the Government in India Regulatory initiatives through Finance Act, 2012 ECB opened up for this sector Capital/funding Credit guarantee Trust Fund continuation of interest subvention scheme for another year Tax incentives through Finance Act, 2012 Enhancing Investment linked deduction of capital expenditure 10 150% Service tax exemption specified construction services and low cost mass housing Interest payments on ECB - Lowering tax rate to 5%

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Listing of Commercial properties outside India

Debt Instruments
Management & Performance Fee Mgmt Co. Investors Listed on SGX

Listing options

REITs / Business Trusts (for certain types of assets)

Business Trust

IHC

Private Offering (Funds / GDR) Offering to institutions & high net worth individuals

Singapore India

Project SPV1

Project SPV 2

Public offering of shares (shares / SDR) Offering to institutions, high net worth & retail investors

Sponsor SEZ Projects

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Taxation of Real Estate Sector

Direct Tax Indirect Tax Stamp duty

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Direct Tax

Tax incentives under Income Tax Act:

1. SEZ Developers 2. Housing projects 3. Industrial Park

Tax issues faced by industry:

1. 14A disallowances 2. Income Characterization Business Income Vs. House Property Business Income Vs. Capital Gains 3. Joint Development Agreements Issues and planning avenues 4. AOP taxation

New issues in light of Finance Act, 2012:

1. Domestic TP 2. GAAR

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Tax incentives for real estate sector

Conditions Profits and gains from the business of developing a SEZ notified on/after 1st April 2005 Tax incentives - Deduction of 100% of the profits and gains for 10 consecutive yrs out of 15 yrs

Sec 80-IAB SEZ developer

Sec 80-IB Developing and building housing project Tax incentives:

Conditions : Approved by a local authority before 31st March 2008 Min area 1 acre of land ; Residential unit min built up 1000 1500 sq ft Built up area of shops and commercial eshtablishment not more than 3% of aggregate built up or 5000 sq ft which ever higher Conditions on allotment of residential houses

100% of profits from such housing project

Sec 80-IA Industrial Park

Conditions: Develops,operates,maintains and industrial park After 1st April 1997 and before 31st March 2011 Tax incentives: 100% of profits for 10 consecutive years

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Tax issues faced by Real Estate Industry

Disallowances u/s 14A Characterization of Income Joint Development Agreements AOP Taxation

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Disallowances under section 14A

The Past

Assessees claimed expenses relating to exempt income

Contentious issue subject matter of substantial litigation

Hon'ble SC* held that if exempt & taxable income earned from indivisible business then expenditure not to be apportioned

Section 14A inserted in 2001, with retrospective effect from AY 1962-63

No deduction to be allowed for expenditure relating to exempt income (14A disallowance)

Disallowance to be computed as per prescribed formula^ (Rule 8D)#

The Present

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Sec 14A contd. Rule 8D

Notification dated 24.03.2008 amended the Income-tax Rules by insertion of Rule 8D Interest cost (as per the formula prescribed)^

Expenditure having direct nexus with exempt income

0.5 % of avg. of investments*

Aggregate Disallowance

^ Prescribed formula to determine interest cost

Interest expense of the current year

Avg. value of investments *

Avg. Total Assets appearing in the Balance Sheet

* Only those investments, income from which does not / shall not form a part of the total income

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Sec 14A contd Concern for Real estate business run through SPVs
Expenditure disallowed even if no income earned?!

Blanket minimum disallowance of 0.5% of investments

Results in disallowances and higher tax outflow

May be a concern when business is necessarily run through SPVs

No flexibility to exclude investments out of owned funds

Balance Sheet Approach

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Income Characterization:
Real estate developer

Residential complex

Commercial complex

Held as Capital asset Held as stock-in-trade View 1 : Developer in the business of leasing out View 2 : Rent from building / land to be taxed under House Property Profits taxed as House Property
Only 1/3rd standard deduction

Profits taxed as Business Income

Profits taxed as Business Income

All costs & depreciation allowed

Taxability of units leased out > 12 years?

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Joint Development Agreements

Taxation in the hands of Land Owner

Taxation on entering JDA

Taxation on sale of completed residential apartments

Drafting of JDA Granting of License to Developer

Sec 53A of Transfer of Properties Act

Transfer taxed as Capital Gains in the hands of Developer on date of JDA Taxed as Business Income if Land owner is in business of developing

Taxed in the year in which sale takes place

Normally taxed as Capital gains

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Joint Development Agreements

Taxation in the hands of Developer

Taxation on sale of completed units

Taxed in the year in which revenue is recognized

Taxed as Business Income

Taxation of SPVs for commercial complexes

Income taxed as Capital gains

Lease rentals may be taxed as House Property income depends on dry lease/wet lease

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AOP Taxation issues

Fundamental tests for determination of AOP
existence of two or more persons coming together for a common purpose common action on part of the constituent members Joint and several liability common object of producing income by the common action

Tax issues of AOP: Developer/SPV is Company MAT would be applicable Results in double taxation ???

Risk of AOP between Landowner and Developer triggered

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Finance Act, 2012 - Tax issues for Real Estate

Domestic Transfer Pricing

General AntiAvoidance Rules (GAAR)

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Domestic Transfer Pricing

Transactions between related parties As referred in section 40A(2b), transfer of goods/services as per 80A, 80-IA(8),80-IA(10),10AA Where aggregate of such transactions exceeds 5 crores Computation of Arms length price As specified u/s 92C Real estate sector SPV model impacts inter company transactions More documentation and procedural formalities

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GAAR - Overview
No

Is there an Arrangement to obtain tax benefit?

Yes

GAAR not applicable

No

Was the main purpose or one of the main purpose to obtain tax benefit?
Yes

Not at arms length Misuse or abuse of the Act Lacks commercial substance

No

Does the arrangement contain any of 4 tainted elements

Yes

Not for bona fide purposes

Arrangement is Impermissible Avoidance Arrangement

Yes

Consequences thereof includes:

Reallocate income/ expenses accrual/ receipt

Disregard/ recharacterise

Lift corporate veil

Treaty override

Change place of residence or situs

Recharacterise equity-debt, income-expense

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GAAR Issues for real estate sector

JDA Structuring

Characterization of Income

Availing Tax incentives

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Treaty provisions relating to sale of immovable property

Definition of Immovable Property
Meaning as per Domestic Law Plus : Certain inclusions Minus: Certain exclusions Direct Use, letting, use in any other form IP used for the performance of Independent personal services

Income derived from Immovable property

Taxability of Income

May be taxed in the state in which the Immovable property is situated

Taxability of Capital gain

Income derived from alienation of shares assets of which consist wholly/principally of Immovable property taxed in the state in which Immovable property is situated
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Clause 4 of Article 13 of Treaties

Real estate Indirect Tax Issues

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Real Estate Indirect Tax Issues Value Added Tax (VAT)

Three options for determining the sale price of the goods and computation of VAT payable:
OPTION I : DEDUCTION METHOD OPTION II : IF THE VALUE OF LABOUR CANNOT BE IDENTIFIED OPTION III : COMPOSITION SCHEME

Construction Contracts could be classified as a works contract Works contract essentially means a composite contract involving both the supply of service as well as the supply of goods - VAT is generally discharged on the sale price of the goods. In the case of a works contract, the sale price or taxable turnover is arrived at by deducting certain labour and other element from the bill amount - There are basically three options for determining the sale price of the goods and computation of VAT payable

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Real Estate Indirect Tax Issues Service Tax

In the Union Budget 201213, it is proposed to exempt service tax on services of erection, construction or maintenance of pipeline, conduit or plant for
drinking water supply water treatment Sewerage treatment or disposal

Service tax is levied on specified services rendered or received in India. In case of construcation contracts, the designing and drawing, civil works, installation and commissioning, site testing, training services, operation & maintenance would be taxable under service tax The tax rate at present is 10.30% and will be 12.36% from 1-04-2012 In Union Budget 2012 13 ,it is proposed to levy service tax on all activities except specified services in the negative list. This would impact the tax consideration for the construction projects

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Accounting issues guidance notes

ICAI has recently issued guidance note on Accounting for Real Estate Transactions Revenue recognition as per percentage of completion method AS 7 on satisfying following conditions: Significant risk and rewards transferred Handed over possession No significant uncertainty on amount of consideration Not unreasonable to expect ultimate collection Additional conditions to be satisfied for revenue recognition: All critical approvals and clearances are obtained Expenditure incurred on construction and Development is more than 25% of total cost At least 25% of saleable project area is secured by contracts or agreements with buyers At least 10% of the total revenue are realized at the reporting date reasonable to expect that the parties will comply with payment terms
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QUESTIONS & ANSWERS

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Thank You

2012 PricewaterhouseCoopers Private Ltd. All rights reserved. PwC, a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PwC International Limited, each of which is a separate and independent legal entity.

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