Property prices are likely to rise in India after the Supreme Court said last week that a value-added tax may be levied on real estate transactions in addition to stamp duty.

The apex court upheld a judgement of the Bombay high court that directed builders to pay a 5% VAT to Maharashtra government on under-construction houses sold during 2006-10.

More state governments can now choose to levy VAT in addition to stamp duty, further affecting the real estate industry that’s already battling a slowdown, say analysts.
“Lot of uncertainties have emerged post this judgement, specifically on how state governments will interpret this,” said Pratik Jain, partner at consulting firm KPMG India. “At present, not many state governments levy VAT on real estate transactions. But now more state governments may seek to levy VAT on flats that are sold before the completion of construction.”

Selling residential and commercial units at the time of the launch of a project is a common industry practice. It helps developers generating cash for construction.
“Some states which are already levying stamp duty are likely to go ahead and levy VAT as well because of their current (revenue) deficit. It will also create more uncertainty and increase litigations between developers and consumers as in some purchase agreements it may not be specified on who will pay the VAT,” said an official of Confederation of Real Estate Developers’ Associations of India, a trade lobby group. He declined to be identified.

A larger bench of the Supreme Court, affirming the judgement in the K Raheja Development case of 2005, said that an agreement entered into by a builder with a buyer before a project is completed is in effect a work contract and, hence, a VAT can be levied.

Work contract refers to any contract where one of the parties is liable to provide construction work. VAT will not be payable if a fully constructed flat is sold to a buyer.
In 2005, the Supreme Court upheld the decision of the Karnataka High Court, in a case filed by Raheja builders, which allowed the Karnataka state government to levy VAT on builders.

“The Supreme Court upholding the right of state governments to levy VAT does not mean that the other states need to follow this, but if they intend to do so now, it would be prospective,” said Shobhit Agarwal, managing director, capital markets, Jones Lang LaSalle India, a property consultant.

KPMG’s Jain concurred. “The industry would expect that the tax is applied prospectively, as in most states there was no mechanism prescribed for payment of VAT. Further, it would be extremely difficult for the developers to recover the amount from the customers where the flats have already been handed over.”

Mumbai, the national capital region, Bangalore, Kolkata, Chennai, Hyderabad, Pune, Chandigarh, Kochi and Ahmedabad are expected to have 1.4 billion sq. ft. of supply for residences, with the first two accounting for about 55% of this, and 167 million sq. ft. of office space supply, between 2013 and 2015, according to a report by Crisil Research.

“Many state governments are looking at areas to increase revenues in a way which will cause them minimum damage,” said Anshuman Magazine, chairman and managing director, CBRE South Asia Pvt. Ltd, a real estate consultant.

“If new states decide to levy VAT, it will be an additional burden for real estate industry, which is already dealing with tight liquidity, low sales and high cost of money,” Magazine said. “Depending on the location and the sales, developers may increase property prices and eventually the burden will be passed on to consumers.”