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Goods and services tax rate cut a conundrum?for realty?developers
February, 26th 2019

A careful analysis of the reduction in goods and services tax (GST) rate for under-construction real estate projects unveils new challenges for developers.

True, the reduction in rates from 8% to 1% in the affordable housing category, and from 12% to 5% for other categories narrows the gap between completed and under-construction projects. This should fuel demand, as most of the inventory overhang in housing is in the under-construction segment. A Motilal Oswal Securities Ltd report, citing industry people, pointed out that 88%, 83% and 87% of the unsold inventory in Mumbai, Bengaluru and Delhi-NCR, respectively, were projects under construction. Indeed, this is a win-win scenario for developers and buyers, if lower GST can fuel sales.

But the worry lies in the caveats. First, lower GST rates comes with a bitter pill, which is the withdrawal of input tax credit. Withdrawing credit on inputs implies a pressure on developer margins, unless they pass on the cost (to the extent of the input tax credit withdrawn) to the buyer.

The only option with developers will be to increase the selling price, which may not be possible given the beleaguered state of the sector. A report from SBICap Securities Ltd says: “This is likely to raise the developer’s construction cost (ex-land), by ~18-20%."

The impact of lower GST in the absence of input tax credit, therefore, will vary based on the region and the project. For instance, projects in Mumbai and Delhi or Gurugram, where land cost is high, may have less pressure on margins, as they can build in the increase in cost into the price. But those in south India, such as Bengaluru, and non-metros such as Pune, where cost of land is relatively lower, and the share of developmental cost is higher, will feel the heat on margins. Based on this, analysts are concerned about the negative impact on profit margins of firms such as Sobha Ltd and Prestige Estates Projects Ltd, which are developing projects at places where land cost is relatively lower.

Two, the big disappointment is that the notification has fixed a cap of ?45 lakh in value for a unit classified as affordable, in spite of increasing the carpet area. This excludes a host of projects, especially in the listed realty firms, which may otherwise have gained from the 1% GST on affordable housing projects.

No doubt, the motive to withdraw the input tax credit stems from lack of clarity in calculating the same, given the myriad services and goods that go into a realty project. Adhidev Chattopadhyay, analyst at ICICI Securities Ltd, said: “There have been fence sitters who were waiting for the GST cut on under-construction projects." The drop in the Nifty Realty index on Monday showed investors preferred to remain fence sitters.

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