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Has the real estate sector been delivered a knock-out punch?

There seems to be no end to the woes of real estate players. The government seems to be carpet bombing the sector with a series of policy measures that are hitting it where it hurts the most.

As if demonetisation were not bad enough, the introduction of a real estate regulator, followed by the recent ordinance in bankruptcy laws, have all been body blows to the sector, rightly identified as being one of the main sources of black money in the country.

Read more: Inventory tax on unsold property refers to an old amendment

As demand fell in recent months and prices stayed subdued, real estate developers held on to their inventory rather than sell it at lower prices. They were allowed to sit on the unfinished or semi-finished property until prices bounced back.

But the government seems to have seen through the game plan. A newspaper report says that in a bid to curb hoarding of unsold inventories by real estate developers, the Income Tax Department is set to tax unsold flats that have been lying with developers for more than one year.

This is no new tax, however. Tax experts say that an amendment to Sections 22 and 23 of the Income Tax Act was introduced in the Union Budget 2017.

(Budget 2017 had proposed that if any house property is held as ‘stock in trade’ and such property is not let during the whole or part of the year, the deemed annual value would be nil for the period up to one year from the end of the financial year in which the certificate of completion of construction of property obtained from the competent authority. This is now being activated, say tax experts.)

The tax would be levied on the property that is held under “stock in trade” by developers. The tax rate could be anywhere between 8 and 10 percent of the total value of the property. The Central Board of Direct Taxes has already sent the internal guidelines to I-T officials across the country in this regard.

Tax officials are of the view that real estate developers artificially keep prices high by holding on to their ‘inventories’ until they are able to get the price they demand.

For a manufacturing sector a ‘stock in trade’ is shown in the books of accounts as lower of the cost of producing it or the realizable value. The builder shows this property at the cost which is lower than the price which he could realize by selling it. Thus, any fluctuation in the price of the property is not reflected in the books of the builders.

The news report says that income tax officials are likely to use the provision of Section 22 of the Income Tax Act. This means that the annual value of property shall be chargeable to income-tax under the head “Income from house property”. The annual value of the unsold portion will be considered for the purpose of income calculation under the head ‘Income from house property.’

This is a big blow to the builders as they will either have to either get rid of the unsold inventory or pay taxes on it. Coupled with the cost of leverage of holding the inventory added taxes will impact the builders’ profitability.

Reports say that builders are sitting on nearly 1,000,000 units in the top eight cities, which is equivalent to 44 months of sales. The only way to entice buyers would be by reducing prices.

Reports say that smaller builders have, under pressure of demonetisation and to avoid coming under the regulator’s glare, had got rid of some of their inventory by selling it at 25-30 percent discount. But this law, if implemented, will penalise even those builders who have been shying away from registering themselves with the regulator.

The developers will have the bank officials, recently empowered with the bankruptcy laws, knocking at their front door. If they try to escape behind delays in delivery the real estate regulator and the income tax officials will be guarding the backdoor and the windows.

In a nutshell, the consumer will benefit from falling prices going forward, while the developers have just been given a black eye.