Excerpts from an exclusive conversation with Sachin Sandhir, Global Managing Director – Emerging Business, RICS
There are several reasons why black money exists within real estate, and some of these are natural consequences of legacy structural issues. The most complex issue is that of tax. Taxation in real estate is considerably regressive. The corrupting areas in real estate – land transactions, for the most part, followed by permissions, followed by use of “creative accounting” practices by developers to conceal income – all of this is fuelled by a common urge to treat tax overheads as a liability. In terms of tax base, real estate has been consistently treated as a direct tax cash cow – with current tax overheads being in the range of 22 to 25 percent.
How black money gets accumulated in real estate
Eradication of ‘black money’ has a different impact on real estate as opposed to eradication of cash, which has an entirely different set of impacts. Imagine for a moment that there is a marginal farmer, who has something like 2 acres of land which is being used for agriculture. Now, one fine day, this is notified as “nazul land”, i.e. land that is declared as suitable for development for purposes other than agriculture, such as urban and/or industrial purposes.
The new Land Acquisition, Rehabilitation & Relief Act, 2013 specifies compensation (in case of forced acquisition) by way of multiples of ‘market value’. However, developers have their way of being able to convince farmers to sell their land for less – also considering that market values in many States have now actually become higher than prevailing rates! Now, for the farmer – the proceeds from sale of this land is ‘capital gains’ and also cannot be classified as ‘income from agriculture’ – making such proceeds from sale taxable both in terms of income as well as capital gains, effectively reducing the amount of liquidity the farmer has in his hand. One way a farmer can avoid this is to take up part (or even whole) of the amount in unaccounted cash, thereby reducing tax liabilities and making surplus amounts available for investment in other forms of wealth, as in land and/or gold.
The same issue arises for a person who may have purchased some property at a low price at some point of time, but now when s/he wishes to dispose it of, is faced with the prospect of a significant tax overhead on the value that such property will carry. Besides, there is no dearth of landlords who will accept rents for their premises only in cash, as they do not wish to disclose that amount for the fear of taxation.
The other problem is fuelled by the fact that a lot of sales that are generated within emerging real estate markets is made towards ‘investors’, people who invest in real estate assets without any intent of ever using them, but holding the same for future capital gains. Unutilised land or property is barely penalised or taxed in India – making it profitable to hold on to such assets as long term wealth. The way our mind-sets work, we are always ‘seeking rent’, i.e. if we know that we sell an item for Rs 10/- to a person who can potentially make Rs 50/- from it, we will seek to capitalise on that future value, often in terms of monies that will not be accounted. So, in addition to the Rs 10/-, we will seek another Rs 2/- for the gain our purchaser may make at a later time. Again, to minimise tax liabilities on both buyer and seller, this ‘surplus rent’ will be never be accounted – effectively making it ‘black’. This is one of the other facts that drives the incentive for a seller to seek a component of the sale price in unaccounted money.
The same issue is seen when seeking development permissions, where every permission comes for a price – with a legitimate as well as an illegitimate component. No, ‘single window’ doesn’t work to solve the problem. The way government business is arranged (“Rules of Business Allocation”), there are distinct responsibilities which can be performed only by one department and not the other, so – a single window, by itself – cannot legally take responsibility for securing the approvals which the owner of the ‘window’ cannot provide in the first place. The only place where this can be done is in a planned environment, where a parcel of land is pre-provisioned all the necessary approvals for a certain range of development. But then – the way spatial planning works in India – very, very few places can offer that kind of predictability. Even in a city like Bengaluru, there is a statutory requirement that any development with 20 or more apartments must have its own wastewater handling system – which is odd for the fact that the city is well positioned to provision for trunk infrastructure in wastewater management that can handle a lot more than 20 apartments!
These apart, we have a situation where a person who earns 20 lakh per annum and a person who earns 1 crore per annum have the same tax incidence rate of 30 percent! As long as these kinds of disincentives remain for people to pay tax, the impetus for generating black money is unlikely to subside. GST could alleviate the impact of tax overheads to an extent, but there has to be careful re-categorisation of both real estate products as well as inputs that can generate tax credits in a way that reduces effective tax liability. The problem in doing this is that as of this time, the GST Council is more involved in ensuring that States do not end up facing losses in revenue from the legacy pre-GST mechanism.
Accordingly the tax regime needs to be re-organised so that tax avoidance is no longer worth the effort. This requires a very general change in Government attitude – an understanding that real estate, by itself is not the ‘cash cow’ it is made out to be – but an enabler to several businesses, trades which contribute to the economy!