FOREWORD
Government of India has recently allowed 100% FDI for development of townships, including housing, commercial premises, hotels, resorts city and regional level infrastructure facilities such as roads and bridges, mass rapid transit systems and manufacture of building materials.
POTENTIAL FOR GROWTH
Real Estate sector is also considered as a great employment generator and could be instrumental in growth of cement, steel and other connected industries. A study reveals that for every one crore (10 million) rupees of investment in housing, nearly 290 industries in the building material sector get activated besides the core manufacturing sector constituting cement, steel and bricks. Therefore, investment in housing is capable of achieving a three-in-one solution of employment generation, economic development and human development.
INVESTMENT OPPORTUNITIES
Money invested in real estate offers both a regular return on investment as well as a possibility of capital appreciation. With the tax reform measures taken in the last few years, the real estate is considered to be the most lucrative investment over the coming years.
Opening up of Foreign Direct Investment (FDI) in the real estate sector, setting up real estate mutual funds coupled with other fiscal reforms like rationalization of stamp duty, property taxes etc. initiated by the Government are steps taken to continue to make the real estate a promising investment option.
The first FDI project for Rs. 100 crore (1 billion) residential township in Gurgaon, North India has already been approved by the Government. It is estimated that urban housing sector would require investments of USD 25 billion over the next five year period. Urban population is expected to grow from 290 million to 600 million by 2021, while the requirement for housing units will grow to 68 million by 2021. At present, India has only about 19 million housing units. As per a study conducted by the United Nations, by the year 2015, 10 of the world’s largest cities will be in Asia (excluding Japan) and three of these will be in India. The projection suggests that the demographic growth will be high and the country is poised for rapid urbanisation, which will lead to major developments in real estate and infrastructure projects.
LEGISLATIVE FRAMEWORK
The matters pertaining to the housing and urban development have been assigned by the Constitution of India to the State Governments. The 74th amendment to the Constitution has further delegated many of these functions to the urban local bodies. Thus, the constitutional and legal authority of the Government of India is limited only to Delhi and other Union Territories and to the subject which State Legislatures authorise the Union Parliament to legislate.
The national policy issues are decided by the Government of India which also allocates resources to the State Governments through various centrally sponsored schemes, provides finances through national financial institutions and supports various external assistance programmes for housing and urban development in the country as a whole. Policies and programme contents are decided at the time of formulation of Five Year Plans. Further, the fiscal, economic and industrial location decisions of the Government of India have an indirect effect on the pattern of urbanisation and real estate investment in the country.
The Ministry of Urban Development & Poverty Alleviation is the apex authority of Government of India at the national level to formulate policies, sponsor and support programmes, coordinate the activities of various Central Ministries, State Governments and other nodal authorities and monitor the programmes concerning all the issues of urban development and housing in the country
FOREIGN DIRECT INVESTMENT (FDI)
Presently, FDI up to 100% has been permitted with prior approval of the Government for development of integrated townships, including housing, commercial premises, hotels, resorts, city and regional level urban infrastructure facilities such as roads and bridges, mass rapid transit systems; and manufacture of building materials. Development of land and providing allied infrastructure will form an integral part of township’s development, for which necessary guidelines/norms relating to minimum capitalization, minimum land area, etc., are notified separately by the Government. The FDI is subject to the following conditions:
- The foreign company will be permitted to take up land assembly—the minimum area of the proposed township to be 100 acres.
- The minimum capitalization shall be $10 million for a wholly owned subsidiary and $5 million for joint ventures with Indian partners, with funds being brought upfront.
- A minimum lock-in period of three years from completion of the project. Minimum capitalization shall apply before repatriation of original investment is permitted.
- A minimum of 50 per cent of the integrated project must be completed within a period of five years from the date of possession of the first piece of land. However, if the investor intends to exit earlier due to reasons beyond his control, it shall be decided by the FIPB (Foreign Investment Promotion Board) on a case-to-case basis.
- Integrated development to be in accordance with local byelaws, town planning norms, standards and master plans.
- Land for peripheral services such as police stations and milk booths should be developed and handed over free of cost to the concerned departments.
- Land for social and community facilities should be developed and made operational before the houses are occupied.
- Parks and playgrounds should be handed over free of cost to the urban local body.
These conditions have been put to discourage fly by night operators from entering this sector. Theses conditions are the guiding factors for according approvals however in deserving cases, the FIPB may consider relaxation of some conditions.
Further, Non Resident Indians (NRIs) / Overseas Corporate Bodies (OCBs) are allowed to invest in the following activities under the Automatic Route of FDI:
- Development of services plots and construction of built up residential premises
- Investment in real estate covering construction of residential and commercial premises including business centers and offices
- Development of townships
- City and regional level urban infrastructure level facilities, including both roads and bridges
- Investment in manufacture of building materials, which is also open to FDI
- Investment in participatory ventures in (i) to (v) above
- Investment in housing finance institutions.
REPATRIATION
The repatriation of principal investment of foreign exchange is permitted. The repatriation of dividend on equity, interest on shares/convertible debentures subject to payment of applicable taxes without any lock-in-period is also permitted.
CONSTRUCTION IN EXPORT PROCESSING ZONES (EPZS) / SPECIAL ECONOMIC ZONES (SEZS) BY PRIVATE/JOINT/STATE SECTOR
With a view to augment the infrastructure facilities for export production, private/joint/state sector investments may be utilized to develop additional infrastructure facilities including construction of Standard Design Factory Buildings in the existing EPZs / SEZs. For this purpose, land already available in the EPZs / SEZs may be leased or sub-leased to developers on the terms and conditions contained in the guidelines issued for this purpose. RBI guidelines for real estate ownership/development by NRI and Foreign/Indian companies also apply to the construction of SDF Buildings in EPZs/SEZs by private/joint/state sector.
REAL ESTATE MUTUAL FUNDS (REMF)
In a bid to attract public funds into the sector, the Government has permitted the mutual funds to launch specialized funds that will invest in real estate.
A REMF invests directly in property or indirectly in the equity of real estate investment trusts (REITs). A REIT is a company that owns and, in most cases, operates income-producing real estate, such as apartments, shopping centres, offices, hotels and warehouses. Introduction of REMFs would enable the routing of the investments of the small investors into the construction sector and in particular result in the growth of the housing sector.
Currently, mutual funds are not allowed to have direct exposure in real estate, but can make equity or debt investments in real estate companies. However, mutual funds were recently allowed to invest in mortgage-backed securities issued by housing finance companies. These securities are issued by housing finance companies against their loan receivables and the underlying fixed assets (residential property). This gives mutual funds a chance to indirectly invest in real estate.
The fact that real-estate prices do not move in tandem with the stock market provides a sufficient hedge against fluctuations in the equity market. Moreover, returns from real estate in the form of rentals and capital appreciation are generally higher. Therefore, a portfolio consisting of investments in real estate is expected to generate higher returns than a plain portfolio of equity and bonds.
TAX STRUCTURE
The tax liability upon the income of a company is based on the nature of its income as well as its residential status and is governed by the provisions of Income Tax Act, 1961.
A foreign company carrying on operations in India through its branch or project office or simply as exporter of goods/services to India is generally treated as a non-resident and are taxed in India on the following incomes:
- Income received or deemed to be received in India,
- Income accrued, arises or deemed to accrue or arise in India.
The following types of income are deemed to accrue or arise in India:
- income arising from any business connection in India. The term business connection generally implies a close connection between the activities performed in India and the business carried on outside India;
- interest, royalties and fees for technical services paid by an Indian resident to a non-resident, or paid by one non-resident to another for the purpose of business of the payer in India.
Further, the taxation of a non-resident is also governed by the relevant Double Taxation Avoidance Agreement with the country in which it is resident, where such an agreement exists. Generally these treaties provide for a lower rate of tax on dividend, interest, royalty and technical service fee, or may even exempt such items from taxation in India.
A WOS or a JV Company incorporated in India are classified as resident and are taxed on their global income in India.
Tax Liabilities and Rate of Tax under Income Tax Act, 1961
- Foreign Company:
The rate of income tax applicable to foreign companies is 40% plus a 2.5% surcharge. No additional tax is levied on remittance made by branch office. A deduction of up to 5% of gross taxable income (calculated in specified manner) towards head office expenditure is also available to foreign companies.
- Indian/Domestic Company (WOS or JV Company):
Income tax would be applicable on:
The parent company, on the dividends/other fees & royalties received from the domestic company in case the domestic company is a WOS of a foreign company.
|
S. No.
|
Taxable Entity |
Taxable Income |
Rate of Tax (Assessment Year 2004-05) |
|
1.
|
Domestic company |
Income, when it commences its commercial operations |
35% Surcharge: 5%
|
|
2.
|
Parent/ Foreign company |
i. Dividend received from the domestic company. ii. Royalty or fees for technical know how or service iii. Interest on foreign currency loan advanced by a foreign company to an Indian concern. |
20% Surcharge: 5% 20% Surcharge: 5%
20% Surcharge: 5% |
Minimum Alternate Tax (MAT):
MAT is applicable to a Foreign as well as Indian company if the tax payable by it on its taxable income is lower than 7.5% of its book profits calculated in the specified manner. In such cases, tax rate is deemed to be 7.5% of the book profit and the surcharge applicable.
PROFESSIONAL SERVICES
Income derived by a resident of a Contracting State in respect of professional services or other independent activities of a similar character shall be subjected to tax only in the Contracting State where such services or activities are performed, except in the following circumstances:
(a) if he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities ; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other Contracting State ; or
(b) if his stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 183 days in the relevant "fiscal year" ; in that case, only so much of the income as is derived from his activities performed in that other Contracting State may be taxed in that other Contracting State.
The term "professional services" includes independent scientific, literary, artistic, educational or teaching activities, as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants.
In the case of Government employees, the salary is taxable in the home State, irrespective of the place where the services are rendered. In other cases with a few exceptions, the salary for services as an employee is taxable by the country where the service is rendered. Similarly, income arising from independent professional services will be taxable in the country where the services are rendered.
RECENT CONCESSIONS AND INCENTIVES
For maintaining the present momentum of growth in this sector, the Union Budget 2003-2004 had announced the following major incentives for the real estate and housing sector:
- Earlier, a deduction of 100% of the profits and gains of an undertaking engaged in the business of developing and building housing projects was allowed provided the housing project is approved by the local authority at any time before March 31, 2003. To promote the housing sector, the time limit for obtaining approval from the local authority has been extended to March 31, 2005. Further, the time limit for the completion of the project has been removed.
- Interest deductible under income tax up to Rs. 150,000 for construction or purchase of self-acquired house property shall continue.
- Permission has been granted to non-residents to repatriate earnings in India. Person responsible for deducting tax under sections 193 and 194-I of Income Tax Act, 1961 from interest on securities and rent shall be required to do so in the case of payments to residents only and not to non-residents.
- Customs duty has been lowered on a number of refractory raw materials by 10%, which include natural graphite powder, silicon metal, sintered aluminum, fused zirconium and boron carbide. This will have the effect of bringing down the cost of steel, cement and clinker thereby facilitating larger construction activities as well as reducing construction costs.
- Mandatory appropriate authority clearance of Chapter XX-C of the Income Tax Act (1961) has been abolished. It is likely to boost liquidity in the real estate market by boosting transaction volumes. This can also be seen as a cut in the red tape and would also cut timeframes for transaction closure.
- There has been a deduction of 50% of the profits for convention center and multiplex projects for the next five years. This would give a boost to the entertainment industry in general, and integrated entertainment projects, particularly, in the non-metropolitan cities, where multiplex projects have been given the concession.
- A series of initiatives to incentives reforms in the urban sector have been proposed, which include setting up an Urban Reform Incentive Fund (URIF), a City Challenge Fund (CCF) and a Pooled Finance Development Scheme.
- The National Housing Bank will launch a Mortgage Credit Guarantee Scheme, which would be provided to all housing loans thereby fully protecting lenders against default. This will make housing credit more affordable thereby also increasing access to housing credit in rural areas.
- The additional equity expansion of HUDCO (Housing and Urban Development Corporation) will be done enabling it to take up large-scale housing and urban development activities throughout the country.
CONCLUSION
With wide spectrum of changes taking place in the real estate sector in the country coupled with proposed reforms such as computerization of land records, removal of tenancy laws, correction in taxation structure etc., India has emerged as a preferred and lucrative destination for real estate developers/investors.
Disclaimer
Actual resolution of legal issues depends upon many factors, including variations of fact and laws of the land. Though the firm has taken utmost care in the preparation of this article, the information contained herein is not intended to constitute any legal advice and the firm cannot accept any responsibility towards those who rely solely on the contents of this article without taking further specialist advice. The reader should always consult with legal counsel before taking action on matters covered by this article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
