PwC

1. Real Estate Industry June 2010 Ashutosh Chaturvedi Annu Gupta PwC

2. Real Estate Industry Trends Real Estate – Typical Models Tax Issues Broad Contents Direct Tax benefits Direct Tax Code

3. Real Estate Industry Trends

4. 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. Development and Key Drivers • 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

5. 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 Economic Outlook

6. 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

7. Real Estate – Typical Models

8. Typical Real Estate Models Residential Model : Purchase/Sale Model Purchase Of Land \ Advance Money Received for Purchase of flat Construction of Property Possession / Registration Of Property • Timing of taxability in the hands of Seller- • On signing of Agreement to Sell or • Possession or • Registration of the Sale Deed • 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 • Is advance received pursuance to letter of allotment taxable as income?

9. 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 Slide 9

10. Construction Contracts Types of Construction Contract • Cost plus Contract • the contractor is reimbursed for allowable or otherwise defined costs, plus percentage of these costs or a fixed rate • 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. • 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 cost • Surveys of work performed • Physical proportion of contract work

11. Illustration on AS-7

12. 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. Guidance Note on Recognition of Revenue on Real Estate Sales

13. Typical Real Estate Models Residential Model : Joint Development Agreement Allocation of developed Property/ sale proceeds between landowner & Developer Development Agreement Construction of Property Sale of developed Of Property • 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?

14. 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

15. AOP exposure in a Joint Development Agreement • 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??

16. 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 * Would it be Capital Gain Or Business Income ?

17. 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

18. Typical Real Estate Models Commercial – Lease Model Lease of Commercial Property Purchase Of Land Construction of 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’?

19. Whether on Letting – Income chargeable as Business Income or House property 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 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 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)

20. Other Direct Tax Benefits

21. 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 Tax Holidays Benefits for Developers/ Co-developers • Issue: • Whether Income of developer Income from Business or House Property also eligible for exemption? Slide 21

22. 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` Tax Holidays • Housing Projects Section 80IB(10): • 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? Slide 22

23. 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 FDI in Real Estate • 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

24. 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

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 Budget 2010 - Wish list

26. Direct Tax Code

27. Direct Tax Code : Income from House Property • 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 %

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