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GST: A Burden for Commercial Lessors

The new tax regime does nothing for commercial real estate developers who bypass a sale and instead opt to lease out their property

The introduction of the ‘Goods and Service Tax’ in July of 2017 was hailed as a defining moment of the government’s tenure, dreamed as a miraculous antidote to the surplus of taxes which were ailing business operations up till then. Its aim was simple: the consolidation of all these divergent charges under the common header of the GST, streamlining tax collection and reducing business overheads.

This short read is aimed at illuminating the differences between the ways GST addresses the taxation of the sale of commercial property compared to leasing it out in terms of the tax credits which are granted on the construction or purchase of the property. This may not appear significant but it has to be considered when evaluating the merits of the new system within the real estate market.

Before we formulate any conclusions though, we need to understand what the peculiarities are.

Differences in Taxation between Sale and Leasing

Sale of commercial property in the post-GST era attracts a single tax rate standing at 12% of the market value. This 12% was unaffected by the reformation of residential property rates that came into effect on April 1 st , 2019.

Of particular importance are the tax credits which are granted to realty developers for the GST payments they've already realized during the development or purchase of their property. These can be deducted from the tax incurred on the final sale of the commercial property to recover the amount of tax you've already incurred in expenses on product and service inputs. This, in essence, prevents double-counting as you're not paying tax twice on the same asset(s).

Compare this now to the leasing market which attracts an 18% rate on rental income above 2,000,000 INR/annum (20 lakh/annum). However, no tax credits are granted for GST paid on construction and improvement inputs to property developers who choose to lease out their completed property. This results in boosted rents which have to be borne by lessees.

In case you’re wondering why that’s a big deal, let’s answer that question for you.

Why is this so important?

Purchasing office spaces for your company is becoming a thing of the past in the growing Indian economy. Innovative strategies such as co-working spaces are being called the ‘offices of the future’ on account of their inexpensiveness and state-of-the-art amenities. Not only are startups opting for leased office spaces but traditional companies are recognizing the benefits attributable to letting-out as well.

In an economy where establishing a stable and performing business is already a chore, flexibility, up-gradation and advancements that leasing entails is attracting a rising number of players in the market. This trend is only likely to accelerate.

Keeping this in mind, putting upward pressure on the prices in rental markets with the absence of provisions for adequate tax credits is unlikely to be conducive to the growth of businesses.

In summary

India’s growing economy requires a taxation system supportive of businesses, an element of which is recognizing that firms are switching to leasing office spaces rather than purchasing commercial property. So, an amendment for the GST Act should incorporate a provision for tax credits for construction expenses even on rental income. It’s not even unprecedented; examples like the UK’s VAT coverage exist which GST can be modelled after.

Else, this new tax system would just be replacing older shortcomings with new ones.

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Akhilesh Sharma, Managing Partner

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