Every person has the desire to own a house. He either purchases a built house/ apartment or constructs one. In this article, an attempt is made to understand the effect of taxation on such a purchase or construction. By taxation, we refer to Value Added Tax (VAT), (earlier known as Sales Tax), Service Tax (ST) and Income Tax (IT).
VAT is a tax on purchase and sale of goods. It also takes into its ambit Works Contract when a contractor executes the work with material. ST is a tax on services. A contractor executing the works contract in a residential complex of more than twelve residential units, typically an apartment or a villa in gated community, attracts the levy of ST. Being indirect taxes, both VAT and ST are passed on to, or recovered from the owners.
When a ready house is acquired, it does not attract either VAT or ST. Purchase of immovable property does not attract VAT. Purchase of property not being a service, does not attract ST. The transfer of ownership gets completed only on completion of registration of the sale deed.
It is different when the purchase is of a flat or villa in a gated community. Two types of agreements are in vogue.
One is a single agreement, wherein the sale of both, the ownership of land and the residential unit, is transferred simultaneously.The other is a dual agreement, wherein the ownership of the land is sold while the residential unit is constructed on behalf of the purchaser. The twin agreement concept is perceived to reduce stamp duty on transfer. A single agreement does not attract either VAT or ST. The dual agreement does attract VAT at 4% or 12.5% and ST at 4.12% or 12.36% of the construction amount. The taxes are the liability of the developer, but are finally passed on to the purchasers.
When the construction of a house is undertaken, such construction can be of three types:
The owner himself purchases all materials, employs the labour and completes the construction. Since no contractor is involved, this type of construction does not attract either VAT or ST, except what is paid on purchase of materials and services.
The owner buys all materials required, but employs a labour contractor to carry out the labour jobs. There is no VAT effect. However, the labour contractor would pass on the ST he is required to pay on his bill, which will work out to 4.12% or 12.36% of the total labour bill.
A contractor is entrusted with the work of construction. He purchases the materials, employs labour and completes the construction. There could be more than one contractor, like civil, sanitary, electrical. These contractors are performing a works contract. He is required to pay VAT of either 12.5% or 4% on the total contract value. This tax is passed on to the owner getting the construction done, as an additional cost.
IT is a tax on the income. The investment made in a house, should be made out of taxed income or explainable source of funds like bank loans, advances, etc. The sources of investment have to be explained and that part which cannot be satisfactorily explained, is treated as income and taxed.
In many a case, the actual area constructed is in variance to the sanctioned plan. The tax department is concerned with the actual area constructed and not the sanctioned area.
In almost all cases, housing loans are taken for the investment. IT prohibits loans taken otherwise than through banking channels it shall be taken only by an Account Payee Cheque. The borrower, i.e., investor, is prohibited either to accept or repay in cash. Failing this, such borrowed or repaid amount attracts an equivalent amount as penalty. This prohibition also applies to deposits (exceeding Rs 20,000) like rental and mortgage deposits.
Loans taken, should be confirmed by the lenders to the satisfaction of the tax department. Else, the amounts borrowed are considered as the income of the investor and taxed. Written confirmation has to be obtained from the lenders, containing name, address, PAN, mode of lending and repayment, and source for such lending. It is advisable to borrow from reputed and sound sources. In case of relatives and friends, make sure that they are of sound financial background and assessed to income tax.
The tax department needs to be satisfied about the extent of investment, especially, in case of construction. It has a separate engineering division which can be pressed into action for valuing the cost of investment.
Valuation is an estimate based on some accepted base assumption. It cannot be actual. Thus, it normally varies from actual expenses. Variance upto 15% is normally an acceptable range. Beyond this, the difference is treated as income of the investor. To avoid such issues it is advisable that:
Do all financial transactions through bank;
Keep proper and correct records and documents of the cost, like material bills/ vouchers, labour vouchers, contractors agreement, bills & receipts, etc.;
To the extent possible, issue cheque for all payments. Wherever cash is paid, draw from the bank and record the link of withdrawal to that payment;
When you maintain these records, normally, the cost or investment is accepted.