Tax Leader: 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

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)

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

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.

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.

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.

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.