pwc

PricewaterhouseCoopers

Real Estate IndustryJune 2010

Ashutosh ChaturvediAnnu Gupta


Real Estate Industry Trends

Bro

ad C

onte

nts

Real Estate – Typical Models Tax Issues

Direct Tax benefits

Direct Tax Code


Real Estate Industry Trends


Development and Key Drivers Estimated economic value : accounting for 5% of

GDP. (Services : 57%, Agriculture : 17%)

India leads the top real estate investment markets in Asia for 2010.

Top investment destinations : Mumbai & Delhi

Increase in share of real estate in overall FDI pier from 10.2% in FY 2008-09 to 11% in FY 2009-10 (Services Sector comprising financial and non financial services sector -21% of total FDI inflows)

Affordable Housing is expected to drive the future growth in the real estate sector.

Real Estate growth to be driven by infrastructure growth in the commercial and residential space.

Allocation for urban development were increased by more than 75% from US $ 660.3 million to US$ 1.17 billion in 2011.

Key Drivers of Indian Real Estate Sector

• Robust & sustained macro economic growth

• Upsurge in industrial & business activities

• Significant rise in consumerism• Rapid Urbanization• Creation of demand for

housing/commercial real estate• Favourable demographics• Political stability• Mature and progressive domestic

market• Developing financial markets

Slide 4


Economic Outlook

General

Fundamental of Real Estate Industry improving due to better liquidity condition and higher demand in the residential segment

Demand in commercial segment remains weak impacted by oversupply and scale back of expansion plans.

Gross Revenue of Real estate companies to increase in FY 11

Key Risks

Competitive environment coupled with fluctuations in material prices amongst the key issues to be faced in FY 11.

Ability of leveraged players to service their interest costs and fulfill their immediate term debt obligations continue to remain the concern

Slide 5


Key Legislations/Regulations involved

• SEBI• Tax Laws• Exchange Control• Foreign Direct Investment

• Stamp Duty Laws

• Accounting Implications

• Companies Act

• Competition Act

Multiple law affect Real Estate Industry

Slide 6


Real Estate – Typical Models


Typical Real Estate Models

Purchase Of Land

Residential Model : Purchase/Sale Model

\Advance Money

Received for Purchase of flat

Construction of Property

Possession / RegistrationOf Property

Timing of taxability in the hands of Seller-

On signing of Agreement to Sell or

Possession or

Registration of the Sale Deed

Is advance received pursuance to letter of allotment taxable as income?

Recognition of Revenue & Expense - Whether on basis of percentage completion or completed contract method?

Applicability of Guidance note for recognition of Revenue for Real estate Sales

Slide 8

What is the Timing of taxability: Whether on signing of Agreement to sell or Registration of sale deed?

TPA - Where an agreement to sell executed to transfer property with reasonable certainty, and transferee has taken possession thereof - even if the sale deed is not registered, transferor right on such property against the transferee is barred.

* Taxability on execution of agreement to Sell- Madathil Brothers v DCIT (HC Chennai) (2007) 301 ITR 345 - CIT v Podar Cement Pvt.Ltd (SC) (1997) 226 ITR 625- CIT v Ved Parkash & Sons (HUF) (HC P&H) (1994) 207 ITR 148

** Taxability on execution of registered Sale deed- ACIT v Karnataka Minerals and Manufacturing Co.Ltd. (ITAT Bangalore) 2009-TIOL-159- CIT v F.X. Periera and Sons (Travancore) Pvt. Ltd. (HC Kerala) (1989) 184 ITR 461- Hall and Anderson (Private) Ltd. v CIT Calcutta (HC Calcutta) (1962) 47 ITR 790


Construction Contracts

Types of Construction Contract

Fixed Price Contract- the contractor agrees to a fixed

contract price or fixed rate per unit of output, which

- in some cases is subject to cost escalation.

Cost plus Contract- the contractor is reimbursed for

allowable or otherwise defined costs, plus percentage of these costs or a fixed rate

Slide 10

Contract Revenue and Costs should be recognized as revenue and expenses by reference to the stage of completion of the contract activity at the reporting date.

Expected Loss to be recognized immediately.

Stage of completion of a contract may be determined by following methods:Proportion of costs to the estimated total costSurveys of work performedPhysical proportion of contract work


YEAR I

YEAR

II

Initial amount of revenue agreed in contract (A) 9000 9000

Variation (C) 200

Total Contract Revenue 9000 9200

Contract Costs incurred upto the reporting date 2093 6168

Contract costs to complete 5957 2032

Total Estimated costs (B) 8050 8200

Estimated Profit (A+C-B) 950 1000

Stage of Completion 26% 74%

Illustration on AS-7

Recognized in year I (26%) (X)

To be Recognized in year II (48%) (Y)

Total Recognition (74%) (X+Y)

Revenue (P) 2340 4468 6808

Expenses (Q) 2093 3975 6068

Profit (P-Q) 247 493 740

Slide 11


Guidance Note on Recognition of Revenue on Real Estate Sales

Recognition of revenue incase of real estate sales

Seller has transferred to the buyer all significant risks and rewards of ownership and retains no effective control to a degree usually associated with ownership

No significant uncertainty exists regarding the amount of consideration that will be derived from real estate sales

It is not unreasonable to expect ultimate collection

Where the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognized on proportionate basis by applying AS-7

Example:

A building on which construction is not yet completed though all significant risks and rewards of ownership are transferred.

Slide 12



Residential Model : Joint Development Agreement

Development Agreement


Sale of developed Of Property

Allocation of developed Property/ sale proceeds

between landowner & Developer

When transfer of development rights is chargeable to tax?

Is there any AOP exposure?

Computation of income of owner?

Whether amount receivable chargeable as business income or capital gains?

Slide 13


When is Transfer of Development Rights chargeable to Tax?

Agreement has all elements of transfer at the stage of entering into the agreement and therefore, there was inescapable conclusion that there was transfer of property by the owner to the developer . Also, as stipulated by the agreement, the owner had decided to hand over his share of built up area to the builder for sale (CIT v Askok Kapur) 213 CTR 241Delhi HC (2007)

The assessee had entered into a Joint Development agreement with a builder. The plot was handed over in 1995. Date of transfer was held as date on entering into a development agreement. Any capital gains that will arise will be in the year of transfer (Vemanna Reddy (HUF) v ITO 114 TTJ 246 (ITAT Bangalore)

Transfer of capital asset and capital gains payable in the year of execution of the GPA. (Jasbir Singh Sarkaria 294 ITR 196) (AAR)(2007)

Capital gain is to be levied on giving physical possession of the property even though the final sale deed is not registered. (Gripwell Industries Ltd. V ITO) 284 ITR 188 ITAT Mumbai (2005)

Capital Gains had accrued to the assessee when he had executed a general power of attorney in favour of the builder or developer of land and handed over the possession to the builder for construction of flats (Dnyaneshwar N. Mulik v ACIT) 98 TTJ 179 ITAT Mumbai 2007

Capital Gain chargeable on handing over possession of the property (Maya Shenoy v CIT) 124 TTJ 692 ITAT Hyderabad 2008

Slide 14


AOP exposure in a Joint Development Agreement

Slide 15

Implications Taxable as AOP

Liability of Members Liability of Members of the AOP is Unlimited.

Taxability of JV Taxed at Maximum Marginal Rate (‘MMR’)

Taxability of Members Exempt in the hands of members of AOP. MAT implications may arise where the member is paying tax under MAT provisions.

Carry forward of losses

Losses would be carried forward by AOP.

Fundamental tests laid down by judicial pronouncements* for determination of AOP:− existence of two or more parties− coming together for a common purpose− common action on part of the constituent members− joint and several liability, and

Is it beneficial to be taxed as AOP??


Computation of Income of owner

Facts :

Landowner to contribute land for development of property

Landowner to get 40% of constructed portion of flats

Developer to keep 60% of constructed portion of flats

Calculation of Taxability of Landowner

Capital Gain = (FMV of 40% flats – land cost of 40% flats)

On sale of Land (-) 60% CoA of Land

XXXX

Capital Gain* = Sale Consideration to end user

On sale of 1 Flat (-) 1/40 of (FMV of 60% of land)

XXXX

Slide 16

* Would it be Capital Gain Or Business Income ?


Whether income of land owner is taxable as Business income or Capital Gain on sale of property?

Whether purchase and sale was allied to his usual trade or business/was incidental to it or was an occasional independent activity?

Whether scale of activity is substantial, continuous and regular?

Whether purchases are made out of own funds or borrowings?

Objects in the MOA and AOA

The time devoted to the activity and the extent to which it is the means of livelihood.

The characterization of property in the books of account.

Capital Gain: Raja Bahadur Kamakhya Narian Singh v. CIT

(1970) 77 ITR 253 (SC)

CIT v. Sugar Dealers (1975) 100 ITR 424 (HC Allahabad) 1973

CIT v. H.Holck Larsen (1986) 160 ITR 67 (SC)

Janak S. Rangwalla v ACIT (11 SOT 627) ITAT Mumbai

CIT v. H.Holck Larsen (1986) 160 ITR 67 (SC)

Fidelity Northstar Funds v DIT (198 Taxation 75) (AAR)

Business Income : G. Venkataswami Naidu & Co v CIT 35 ITR 594

(SC) 1958

CIT v . Associated Industrial Development Co. (P) Ltd 82 ITR 586 (SC) 1971

Raja Bahadur Visheshwara Singh v. CIT (1961) 41 ITR 685 (SC) 1960

Dalhousie Investment Trust Co. Ltd v. CIT 68 ITR 486 (SC) 1967

Slide 17



Purchase Of Land

Commercial – Lease Model


Lease of Commercial Property

Recognition of Revenue & Expense - Applicability of Guidance note for recognition of Revenue for Real estate developers – Fixed Asset

Income from lease of land/property - Chargeable as ‘Business income’ or ‘House Property Income’?

Slide 18


Composite Letting: Business Income

CIT v. National Storage Pvt Ltd (56 ITR 596) Manohar Singh v. CIT (58 ITR 592) (Punjab

HC) Associated Building Co Ltd (137 ITR 339) (Bom

HC) Bharat Hotels Ltd (53 ITD 450) (Delhi ITAT) PFH Mall and Retail Management Ltd v ITO

(110 ITD 337) (Cal) CIT v Kongarar Spinners Pvt. Ltd. (208 ITR

645) (Mad) Karnani Properties Ltd. v. CIT (82 ITR 547)

(SC)

Whether on Letting – Income chargeable as Business Income or House property Income?

Principles for determination of the nature of income:

If the main Intention is to exploit the immovable property, it is Income from House Property vz. If it ancillary or supporting the commercial activity - it would be Business Income

If a person is just holding leasehold rights, it would be business income, while if he is the owner of the property, it will be Income from House Property

Composite letting – (eg. Business convention centre) – Business Income

Even if a company was formed with the objective of developing and setting up markets rental income will be income from house property.

In case of asset being let out temporarily and assessee intends to restart its business, it shall be business income

Where the rental and the service arrangement are separable, then the rental income should be characterized as HP income and the service income should be regarded as Business Income

Pure Letting: Income from House Property Shambhu Investment Pvt Ltd v. CIT (263 ITR

143) (SC) East India Housing and Land Development

Trust Ltd v. CIT (42 ITR 49) (SC) Ballygunge Bank Ltd. v. CIT [1946] 14 ITR 409

(Cal) CIT v. Chennai Properties and Investment Ltd

(266 ITR 685) (Madras HC) National Storage Pvt. Ltd. (48 ITR 577) HC CIT v New India Industries Ltd. (HC Bombay) Indian City Properties Limited (55 ITR 262)

Calcutta

Slide 19


Other Direct Tax Benefits

PricewaterhouseCoopers Slide 21

Tax Holidays

SEZ Development :

100% income tax holiday for 10 consecutive years out of 15 years (from year of SEZ notification) on profits derived from SEZ development.

Exemption from payment of DDT Exemption from MAT Tax holiday on lease of land

Issue: • Whether Income of developer Income from Business or House Property also

eligible for exemption?

Benefits for Developers/ Co-developers

PricewaterhouseCoopers Slide 22

Tax Holidays

100% income tax holiday for projects where a housing project has been approved on or after April 1 ,2005

Construction to be completed within five years from the financial year in which a housing project is approved

Maximum built up area of 1,000/ 1,500 sq ft for residential unit [based on city of location], project land area minimum 1 acre;

Commercial space to be higher of 3% of aggregate built up area/ 5,000 sq ft.

Hotels/Convention Centers: ( Section 80-ID) 100% income-tax holiday – for 5 Years Companies engaged in hotel business or in business of building, owning and operating

convention centre Hotel and convention centre located in NCR (Delhi and specified adjoining areas) Construction completed or started functioning before 31st July, 2010`

Issues for Consideration: Long Gestation Period before hotels start making profits Deduction only for 5 years Is the Section actually giving any benefit to Hotel industry?

Housing Projects Section 80IB(10):


FDI in Real Estate

General:

100% FDI under Automatic Route (ONLY Construction Development)

Minimum Investment - USD 10mn for WoS- USD 5mn for J/V

Funds to be brought within six months of commencement of business

Minimum Area - development of serviced housing plots : 10 hectares- other construction development : 50,000 sq meters

50% of project to be completed within 5 yrs from obtaining statutory clearances.

Lock in period : 3 years

Sale of undeveloped plots not permitted

Construction Development

includes:• Townships• Housing• Built-up infrastructure• Commercial premises• Resorts• Educational institutions• Recreational facilities• City and regional level

infrastructure

Not applicable to SEZs, Hotels and

Hospitals

Slide 23


Agriculture Income – Case Study

Assessee had shown certain income from film shooting in his gardens where he used to grow agriculture produce.

Held that shooting of films has no nexus with agriculture operations and nexus claimed by assessee was non existent. Income held as business income.

B Nagi Reddi v CIT (2002) 125 Taxman 20

Slide 24


Budget 2010 - Wish list

Slide 25

Direct Tax

Infrastructure status was expected to be granted to integrated townships and group housing development for facilitating tax holiday : not granted

Relief to home loan borrowers by way of standalone deduction of Rs. 1 lakh on repayment of principal as well as hike in interest deduction from Rs.150,000 to Rs. 300,000 : not granted

Tax holiday for housing projects was expected to be reintroduced and time limit for completion of existing projects was to be extended : granted

Clarification was expected on pending issues related to Real Estate Mutual Funds and Real Estate Investment Trust like valuations, taxes etc. Clarification not yet issued


Direct Tax Code


Concept of DTC for presumptive rent @ 6% of the rateable value or cost of construction / acquisition – rolled back

Calculation of Gross rent:

– For let out house property - amount of rent received or receivable

– For house property not let out - Nil

Deduction for taxes, interest, etc. not available in case of house property not let out

Interest on borrowings for construction / acquisition allowed only for one self-occupied house property

– Subject to maximum ceiling of Rs. 1.5 lakh

Overall limit of deduction for savings to be calibrated accordingly – details not provided

Standard deduction reduced from 30% to 20 %

Direct Tax Code : Income from House Property

Slide 27

PricewaterhouseCoopersThank you

pwc

Documents

proportion of costs

contract activity

fixed contract price

costs b80508200estimated

defined costs

v cit calcutta hc calcutta

significant risks

real estate salesit