The direct tax code is a major evolutionary step in direct tax history of the country, and is set to change the financial landscape of India. As it spells major change, it will require fairly in-depth study before all its implications can be understood and assimilated.
On the face of it, DTC may have added cheer to the lives of Indian tax payers due to some of its moves, but it looks like a dampener for the realty industry. Moreover, it is likely to undergo many changes and corrections before it is finally enacted. Hence commenting on the DTC is a minefield. With these qualifications, let us see analyse some aspects that will impact the property market.
There is a significant change in the way income from house property is calculated under the DTC, most of which are adverse from the point of view of residential property investments: l Current tax provisions provide for paying tax in respect of every property (except one self-occupied property) whether let out or not, based on'contractual rent' and where that is not available, then based on what I call 'reasonable rent'. There is also a provision for a vacancy allowance in case of property that has previously been let out at any time. Under the DTC Bill, tax is payable on all properties (except one non let-out property) on the basis of higher of contractual or presumptive rent.
The provision for vacancy allowance has been deleted. The real killer here is 'presumptive rent' which is assumed at 6% of the 'rateable value' fixed by the local authorities. In most cases now, the local authorities have moved to a market value-based rateable value. It is a very rare residential property that gets anywhere close to 6% of the market value as rent nowadays (normally, they get around 4%). Possibly, the presumptive rate has been kept at a middle value of 6% considering that commercial properties can be rented out at around 8% of market value. Of course, this simplicity works against residential property ownership.
Since the income is higher of contractual rent or presumptive rent, the end result will be taking completely non-existent income as 'income'. Thus, whether or not a tenant is available for the premises, it forces the owner to pay tax on income that he may never get as when he is unable to find tenants.
Without the protection of the vacancy allowance that is available under the current tax laws, this single change will drive investors out of the market. Some may argue that not having 'investors' (as distinct from buyers who buy for their own use) may not necessarily be a bad, thing but I am not one of them.
l The wordings for not applying this income clause to one non let-out property (equivalent to self-occupied property under the current provisions) are a little unclear and if left unchanged, can jeopardise even this small relief
l For let-out properties, the standard deduction has been reduced from 30% to 20% of gross rent
l Deduction is available on all properties for local taxes and service tax to the extent paid
l There is no deduction for interest on non let-out property (broadly self-occupied under current provisions) where the income is taken as 'nil' unlike the current provision where this is available up to Rs 1.5 lakh
l There is no provision for deduction on principal payment of the loan taken to buy a home
l As far as commercial property is concerned, it is now clear that renting it out in whatever guise will now be taxable as 'income from house property' and not business income or 'income from other sources'. The impact is that no deduction for any other expenses will be allowed, except local taxes, service tax and interest on loan (and off course the standard deduction of 20%)
l The good thing is that calculations for jointly-owned properties have been made absolutely clear, as also treatment of interest payable for loans taken to re-pay the original home loan (transfer of loan from one lender to another) All in all, the real killer here is the presumptive rent. This is a stiff annual wealth tax on owning residential property, in the guise of creating an objective benchmark for the rental potential of a house. With the changes in capital gains tax as well as current rental laws and the stiff service tax on rentals, owning residential property except one for self-occupation will be fairly taxing thing.
Clearly, the government is not in favour of you owning more than one property and if you do, you will have to pay tax through your nose. These provisions, if enacted, are likely to have a very large impact on the residential property market.
Firstly, residential properties purchased for investment purposes or ownership of second properties is likely to go down significantly. Secondly, tax-driven decisions to purchase an own residence are likely to significantly reduce.
Still, these are early days so let us see what actually gets enacted as law.