Foreign Direct Investment (FDI) policy for the Real Estate sector

CA Maneet Pal
09810774806
http://www.capasricha.com/

The term real estate means a piece of land, including the air above it and the ground below it and any buildings and structures on it. Real estate can include business and/or residential properties and are generally sold either by realtor or directly by the individual who owns the property.

In law the word “real” means relating to a thing as distinguished from a person. Thus the law broadly distinguishes from “real” property and “personal” property (like furniture, clothes etc). IMMOVABLE property was the distinguished feature here, the transfer of title along with the land and, movable property which a person would retain to.

The Boom

India’s Real Estate sector can be recognized as the fastest growing industry. India’s emergence as a leader in global economy over the couple of years has encouraged foreign direct investment. This development has led to more companies from other parts of the world to work with India. The strengthening of the economic relationship of India and other countries has increased the number of joint ventures between the two.

According to an estimate in the eleventh five year plan that is 2007 to 2012 there would be an unsatisfied demand of over 20million houses which are of course a brilliant opportunity to invest in real estate. Since 2005 when government permitted FDI in various sectors of the Indian economy there has been rapid growth in the economy. Back in 2005 when the government broadened the view of FDI and changed the norms back then to 100% involvement in the construction industry, a step had been taken to meet the demands of residential and commercial real estate sectors.

Developments in the Foreign Direct Investment

Due to the amendments made by the government it has persuaded financial firms as well as private equity funds to launch exclusive funds in this particular sector resulting growth in the Private Equity segment (PE). Some of the sectors with 100% Foreign Direct Investment are Mass rapid transport system, Roads and Highways, Toll roads, Ports and Harbors, Hotel and Tourism etc.

Advantages of Foreign Direct Investment

• Affordable housing sector will play a vital role in this rapidly growing and expanding area of business operation.
• Development of SEZ that is the Special Economic Zones as government introduced 100% FDI.
• Housing loans eligible for 1 per cent subsidy.
• The real estate sector of India will become more organized.
• CREDAI chairman said “affordable housing will be a key factor in driving the sector and we have already started working on progressive solutions in this area for effective and customized implementation of such projects.
• US$ 20.3million allocated towards Urban Infrastructure Development.
• It will enable a strong and spirited competition among domestic as well as alien investors.

Permissible areas of FDI in Real Estate

·  townships

·  housing

·  commercial premises

·  hotels

·  resorts

• hospitals
• industrial parks
• resorts
• hospitals
• educational institutions
• recreational facilities
• SEZ’s, etc

Finance available for Real Estate Projects

1. External Commercial Borrowings

External commercial borrowings also known as ECB are nothing but commercial loans raised by financial organizations in India from lenders which are Non Resident Indians that is NRIs to facilitate finance in different projects. These borrowing may be in the form of bank loans, credit from either suppliers or buyers, from instruments like fixed rate bonds, and floating rate notes and investments from Foreign Institutional Investors or FIIs. The Government of India permits these loans as an additional funding to the corporate of India.  The Ministry of Finance regulates the funding in accordance with the guidelines from the Reserve Bank of India (RBI) under the Foreign Exchange Management Act, 1999. The sole purpose of these ECBs is to provide additional funding to the corporate that the usual domestic sector is not able to provide for. The average maturity of external commercial borrowings is pegged at three years at the very minimum. The SEZs or Special Economic Zones can also raise ECBs but their requirement will altogether be different. Even though ECBs are allowed by the government as an additional source of funding but there are also restrictions to the use of such funds. 

a.       All corporate borrowers are eligible to raise ECBs up to a maximum of US$ 500 million under automatic route

b.      ECB can be raised only for investment in real sector - industrial sector including small and medium enterprises and infrastructure sector in India, including industrial/ technology parks and for working capital requirement

c.       ECB not permitted for real estate activities other than development of integrated townships as defined by Press Note 3 (2002 series) (ie the 100 area criteria)

2. Foreign Collaboration models

a.       PRIVATE EQUITY CAPITAL –

As we have discussed above there has been a massive inflow of FDIs in growing India in the past decade or so. And different financial funding have crop up thanks to the encouraging Government policies, among the very widely used financing techniques one is something called as Private Equity. Private Equity consists of institutional investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Private Equity largely consist of sums lend by investors for long time periods. PE consists of equity securities in operating companies that are NOT publicly traded on a stock exchange. Private Equity investments in India are on a positive approach, more deals are coming up as Indian Entrepreneurs are relaxing and submitting to this type of financial assistance.

b.      Joint Equity

Joint venture companies are the most favored for of business entities in India today. Even companies incorporated in India with 100% foreign equity are treated as Joint Venture.

A Joint Venture is when:

(a)          Two individuals or two companies incorporate a company in India. Business of one party is transferred to the company and as consideration for such transfer; shares are issued by the company and subscribed by that party. The other party subscribes for the shares in cash.

(b)          Above parties subscribe to shares of the joint venture company in agreed proportion, in cash and start a business.

(c)           Promoter shareholder of an existing Indian company and a third party, who/which may be individual/company, one of them non-resident or both residents, collaborate to jointly carry on the business of that company and its shares are taken by the said third party through payment in cash.

International Joint Ventures are becoming more and more popular as they aid companies to form a strategic alliance that is form a relationship between companies to undertake a set of goals while remaining separate business entities.

JOINT VENTURE COMPANY –

Foreign investor to contribute capital and engineering capabilities. Indian developer to contribute land and local resources.  Both partners have joint ownership of project specific SPV. 

JOINT DEVELOPMENT AGREEMENT –

Foreign investor sets up Indian presence and undertakes development activity.  Indian partner contributes land and receives deferred consideration in terms of share of development or share of revenues. 

Tax Effect on Real Estate

1. Industrial parks:

a.       10 year tax holiday (in a block of 15 years) on profits derived from developing, developing & operating, maintaining & operating industrial parks in India, developed before March 31, 2006;

b.      Tax holiday available subject to obtaining Government approval under Industrial Park Scheme, 2002 & subsequent notification by Central Board of Direct Taxes.

2. Special Economic Zones

a.       10 year tax holiday (in a block of 15 years) on profits derived from developing; SEZ’s in India, notified on or after April 1, 2005 (as per SEZ Bill 2005);

b.      Tax holiday available subject to obtaining Letter of Permission from Board of Approvals in the Ministry of Commerce and notification by Central Government.

3. Housing projects

a.       Income tax holiday available to housing projects approved by local authority before      March 31, 2007;

b.      Construction of project to be completed within 4 years from end of financial year in which approval is obtained;

c.       Residential unit should have maximum built up area of 1,000/ 1,500 sq ft (based on city of location);

d.      Project should be on a plot of land which has minimum area of 1 acre;

e.      Built up area of shops & other commercial establishments included in housing project not to exceed 5% of aggregate built up area of housing project or 2,000 sq ft, whichever is less.

4. Section 10(23G)

a.       Income from dividends, interest and long term capital gains by companies/ trusts from investments in shares/ long term finance (more than 5 years), of specified infrastructure development companies (eg engaged in industrial parks, hotels, housing projects, etc) is tax exempt;

b.      However, MAT may apply on such income of investors;

c.       In order to claim above exemption, the project company should be notified by CBDT.

5. Section 115O

a.       Domestic companies declaring dividend liable to pay dividend distribution tax (‘DDT’);

b.      DDT is in addition to regular corporate tax payable by companies.

Sec 80C - Be smart and Save smart

CA Maneet Pal

09810774806

http://www.capasricha.com/

Income Tax Act 1961 Section 80C

Income tax is being made obligatory by the Government of India on taxable incomes of individuals, Hindu Undivided Families (HUFs), companies, firms, Co-operatives societies and trusts. The Income Tax department of India has the authority to charge such taxes on various each of the above. It is governed by the Central Board of Direct Taxes (CBDT) and is a part of Department of revenue under the Ministry of Finance, Government of India.

About Section 80C

The Section 80C came into existence from 1^st April, 2006. This section allows certain incomes and expenditure to avail tax benefit as they can be exempt from the taxable income. It is a merger of section 88 and section 80CCC.

What are the benefits of Section 80C?

The government of India encourages people to invest in various schemes and policies that can enable an individual to receive tax advantage by getting a deduction on it. And getting a deduction basically means that’ll you have to pay less of charge your taxable income.

How can you take advantage of this section?

Paying lesser amount of tax basically means, say your Gross Total Income turns out to be Rs800000, this section allows you invest up to Rs100000 of your income and claim a deduction up to Rs100000. say that you invested your income up to Rs100000 and as above we know that your GTI is Rs800000, now as per this deduction you’ll have to pay tax only on Rs700000 and you get to save the Rs100000 by utilizing the amount and making smart investments and policies for your benefit. It’s like you saved tax on Rs100000 and also made some good investments for yourself!

Also how much you save depends on what bracket of tax liability does your annual income come under. The following slab of the current year will help you deduce the amount:

Income                                                                                Tax Rate

Up to 160000                                                                           0%

Up to 190000 (for women)               

Up to 240000 (senior citizen older than 65years)     

160000-500000                                                                        10%

500000-800000                                                                        20%

Above 800000                                                                          30%

The following few sources will help you save tax and also will serve as valuable saving and investment:

Life Insurance Premiums:

The amount that you pay towards life insurance premiums can be availed as a deduction under section 80C. Any amount you pay as LIC premiums for yourself, spouse or your children can be included here.

Provident Fund and Voluntary Provident Fund:

Provident fund is routinely deducted from your salary; your employers as well as you contribute to it. You can contribute a maximum amount of Rs70000 towards it. The employer’s contribution is exempt from tax and the employee’s contribution is deductible from gross total income.

National Savings Certificate

Compounded half-yearly giving an 8% interest, these are six year saving instruments. The interest accrued here is eligible for deduction under sec 80C.

Education fee of kids

Since education these days means a lot of expenditure, parents spent a lot of money on their kids’ education. You can avail this deduction on the tuition fee only and to the maximum of two children.

Housing Loan

When go for a housing loan there will be two components to it that is the principal and the interest which together is known as the Equated Monthly Installment also known as EMI. The principal amount qualifies for the tax deduction.

Unit linked Insurance Plan

Unit linked insurance plans comes with benefits of life insurance and benefits of equity investments. These have become popular among the people because they provide tax saving benefits and also give excellent return in investments.

These are few investments that’ll reap you immense tax saving benefits. Although it depends on individual to individual what type of investment they’d prefer but some are chosen by almost everybody like PF is compulsorily deducted from a salaried employees pay and LIC plans are adopted by a major population as well.

“80GG - Rent deduction for Self Employed”

By CA Maneet Pal
09810774806
http://www.capasricha.com/

80GG of Income Tax Act, 1961, is the most ignored section of Income tax Act, 1961 by the consultants and the taxpayers. This section is important as it provide leverage to self employed/ professional/ businessman/ or person who’s salary does not include the House Rent Allowance (HRA), to still claim the deduction under section 80GG.

To understand deduction u/s 80GG and its difference with HRA we would also need to understand the difference between “Exception and Deduction”. Both “exemption” and “deduction” actually deals with two different components eg: When we calculate the HRA exemption while deducing the taxable salary we exempt a portion of amount from the HRA and the exempted amount is NOT taxable also that taxable amount is subject to some specified conditions under the income tax act. And when calculate the rent deduction allowable under section 80GG of the act; we calculate the deduction which is deducted after we calculate the gross total Income.  The difference between exemption and deduction can be further taken up while understanding the concept of HRA u/s 10(13A) and Rent Deduction for self employed u/s 80GG.

What is HRA and how do you claim HRA? (Exemption)

HRA or House Rent Allowance is among the many benefits that an employer gives to his employees for rendering certain services to him. HRA is given by the employer to the employee to meet the expenses in connection with the rent accommodation which the employee might have to take. HRA is except u/s 10 (13A) subjects to the minimum amount of the following three conditions:

                     ·         Actual HRA received by the employee in respect of the relevant period.

                     ·         Excess of rent paid for the accommodation occupied by him over 10% of the salary for the ‘relevant period’.

                     ·         50% of the salary where the residential accommodation is situated at Mumbai, Chennai, Kolkata or Delhi and 40% of the salary where the house is situated at any other place for the relevant period.

Are you Self-Employed? You can avail this deduction! (Deduction)

If you’re a self employed professional/ businessman/ your salary does not include the House Rent Allowance (HRA) you can still claim the deduction under section 80GG. Now here comes the part where we talk about the deduction. In case of deduction the amount is first included in your Gross Total Income (GTI) and the later the deduction is allowed. Self employed citizens are entitled to tax deduction under section 80GG of the Income Tax act, 1961.

Now as we can see the core difference between the two, there are numerous people who have no idea about the deduction. There are certain conditions which are needed to be met to claim this deduction:

·         Quantum of Deduction

The deduction shall be the minimum of the following amounts:

(i)                  Excess of rent paid over 10% of the “Adjusted Total Income”;

(ii)                25% of the “Adjusted Total Income”;

(iii)               Rs.2000 per month.

·         Other Conditions

(i)                  taxpayer under no condition should be enjoying the benefit of HRA; and

(ii)                the taxpayer, his spouse or his minor child should not have any house in the same city where they reside to claim this deduction.

                                                                                                                                                                                                                                              

Few further more interesting things:

If you happen to reside with your parents in their house, you can pay them the rent. If the parent pays a lower tax or has no source of income then your tax liability can be considerably lower down.  Since Rs 2000 pm is the highest you can claim a month, you can’t go above that. But this 2000 pm can bring down your tax liability to good extent. To claim this 80GG deduction you need to submit a declaration on form 10-BA that you pay rent and are not receiving any HRA benefits.

Amount of deduction – something is better than nothing?

The maximum deduction under section 80GG that is provided by the Income Tax act, 1961 is actually very less to the current value of money. With the rising trends and the ever increasing standard of living the mere amount of Rs 2000 per month as a deduction is primarily close to nothing. There are people who pay house rent that ranges from 10000 pm to 50000 pm, here the deduction provided to the general public does not even suffice a months benefit. Therefore the government should make the necessary amendments for the same as the amount does not anywhere matches the current consumption and saving trends.

Thin Capitalization Rules – "Debt to Equity to Tax can no longer be tossed"

                                                                               By CA Maneet Pal

                                                                                           9810774806

                                                       http://www.capasricha.com/

Any and every business needs some kind of finance to invest in business opportunities and get rewards out of it in form of profits. Many Foreign Companies eye India as great business opportunity for expanding its operations and increase the kitty of its ultimate Foreign/ Holding Company.  

With the decision of entering in Indian markets, Companies have to take decision on their capital structure. Companies prefer to invest/ bring money into India by way of lending loan to its Indian Counterpart, there keeping high Debt-Equity Ratio. Companies borrowing large amount of loans enjoys tax deduction on the interest paid thereby on such loans. But companies may no longer be able to enjoy this huge deduction on their taxable profit as the government is planning to implement the “Thin Capitalization Rule” to avoid such tax evasion.

Before we proceed towards the Rules, let’s just have a look at what does the term “Thin Capitalization” means. The definition hereby goes as, “when a company’s capital is made up of a much greater proportion of debt than equity, that is, its leverage or gearing is too high, it is said to be thinly capitalized”

For a company to function, it needs to first take the decision of best available financing options.

There are largely two sources of finance:

·         Issue of shares in equity; and  

·         Other is by borrowing.

The source by which the company raises its finance affects the Finances and taxation of corporate income. However, generally in practice we see companies raising finance partly by equity and partly by loans that is “debt”. Interesting part, in case of raising money is that many companies prefer to raise money through loan or debt as it is deductible from the company’s taxable profit.

Now let’s analyze the equity points, if a company’s finance has large portion of equity then the shareholders or the owners have to be rewarded from the profits of the company which is essentially NOT deductible from tax! Therefore some companies sought to raise higher proportion of their funds through loans which means rather than paying a large a sum of money to their owners and not receive any tax benefit they raise large proportion of their capital through debt (preferably from their Holding company) in which they receive tax benefit as the “interest on loan” is deductible from the taxable profits of the company.

THE FINANCE EFFECT

Suppose ABC ltd raises it capital by issue of shares and debt, the equity capital consists of Rs 10,00,000 and Rs. 16, 00,000 in the form of borrowing. The bank lends the loan at 10.5% pa. Suppose the company makes the profits of 1,00,000/- during the year, out of which it has to pay, the dividend amounting to Rs 90,000. We know that at the end of the year the company has to bears a 10.5% interest on its debt which comes out to be Rs 168,000. This favours the equity shareholders since a highly geared firm will have more surpluses to distribute amongst less number of equity shareholders. Therefore the returns will be higher as compared to a less leveraged firm since debt is a cheaper source of finance than equity.

If shareholders have a nominal proportion of capital in comparison to the total finance, then the company has lower financial reserves and lenders bear the risk of solvency of company as it’s the company which has to eventually pay off large amounts of its capital (debt) with interest. There are large risks involved of failure of company to pay off the interest and debt that may lead it to declare insolvency. This will adversely impact the economy growth and reputation of company in markets.

THE TAXATION EFFECT

Taking the same illustration into consideration as mentioned above we can now deduce the tax effect as well. The real benefit of the company can be seen while analyzing the tax effect, since the company has raised more of its capital through debt the interest on raising such debt can be availed as a deduction from the company’s taxable profit. Whereas if the company had raised capital through equity the dividend paid couldn’t have been used as an expenditure that’ll give the benefit of deduction from tax.

Generally the companies, who prefer to maintain high Debt to Equity ratio, borrow funds from their foreign holding company, so as to dilute the overall negative effect of financial imbalance and gain the benefits of taxation convention.

Now where is the problem in all of this for tax and economic regularities?

There are two major problems, when a company’s capital is made up of higher proportion of debt than equity:

·         Credit Risk

·         Taxability

Credit Risk

Now in all of the above discussed work wherein companies raising a greater part of its capital through “debt” and claiming deduction on “interest on loan” All this would mean that the company has low financial reserves to meet its needs. Since most part of the finance of the company comes through debt it means that the company would have to repay it unlike equity.

Taxability

Many companies would use this higher debt as a tax saving mechanism since dividend is not deductible from the taxable profit and on the contrary interest on borrowed capital is, therefore this phenomenon may be used in saving tax.

Many foreign countries like USA, Netherlands, China, Poland, Russia have introduced this rule to put a grip on the gearing ratio. In India also, the government is planning to introduce “Thin Capitalization Rules” to dodge such tax evasions and believe to have introduced the rules in Direct Tax Code (DTC).

It would be exciting to see how and what measures does government bring in to evaluate and identify high leveraged firms. Some of the ways in which High leveraged firm can be identified are:

·         Debt to Equity Ratio

·         Subjective approach

·         Hidden profit distributions

Debt to equity ratio

Debt equity ratio = total liabilities/shareholders equity

In this approach if the company’s portion of debt exceeds by a fixed amount specified the interest on loan on the excess of the loan will be disallowed from the deduction of taxable profit.

Subjective approach

The basis on which the principle which works here is to analyze the terms and nature of the contribution of debt and the circumstances under which the financing has been made and decide whether the real nature of funds is debt or equity.

Hidden Profit Distributions

The very basic idea here is to if the loan amount exceeds an arm’s length situation that is “that the both parties in the deal are acting in their own self interest and not subject to any pressure from other party” the lender here must be considered to have an interest in the profitability of the enterprise and the loan, or any amount in excess of the arm’s-length amount, must be seen as being designed to procure share in the profits.

In conclusion we could say that it will be a big change in India if Thin Capitalization Rule gets implemented. The companies will now need to vitally review their debt to equity as the time for implementation comes closer. However the big hurdle still needs to be solved as to what ratio of debt to equity would be agreeable and what amount precisely would be feasible for tax deduction.