Finance Policies - Impact Of Kelkar Report On Real Estate

The Kelkar committee, which is the task force on direct taxes, submitted its recommendations to the Finance Minister on the 2nd of November 2002. Dr. Vijay Kelkar, advisor to the finance minister, has recommended sweeping changes on all income tax exemptions (including the standard deduction for salaried employees), significant reduction in tax rates and complete liberalisation of procedures. These tax reforms are different from all previous reforms in that it aims at removing the differential treatment given to various industries over the years, as opposed to lowering tax rates, bringing greater compliance and widening of the tax net. The Finance Minister is not bound to follow the recommendations, but this should have some impact on the 2003 Budget, since his Finance department itself has made this report. The government must have the political will to follow all and not some of the recommendations, keeping the big picture in mind. This complete reworking of the Direct Tax System makes it simple and transparent, reducing compliance costs. Let us examine the impact of the Kelkar report on Real Estate.

• Withdrawal of wealth tax: At present vacant urban vacant land and certain categories of house property are liable to wealth tax. Therefore the proposed abolition of wealth tax will be beneficial to the building industry.
  


• Interest on housing loans: The Task Force has proposed the phasing out of the deduction of interest on home loans for the construction or purchase of self-occupied property. Presently the interest paid on borrowings for the construction or purchase of a self-occupied house is entitled to a deduction of up to Rs. 1,5 lakh, if the construction or acquisition of the property is completed within 3 years from the end of the financial year in which the capital is borrowed. This provision is effective from 1/4/2003, viz. assessment year 2003-04 onwards. The deduction is to be reduced to Rs. 1 lakh for the year 2004-05, Rs. 50,000 for 2005-06 and Nil for 2006-07 onwards. This withdrawal of the interest deduction will have an adverse effect on the purchase/construction of owner-occupied property and will slow down the housing industry as well as the housing finance industry.
  


• Capital gains tax: It is proposed that long term capital gains should be taxable at the normal rate, as any other income of the tax-payer. This would mean that the long-term capital gains would be taxable at 30% in place of the present rate of 20%, except in cases where total income of the tax payer is below Rs. 4 lakh. Besides, the exemption for roll over of capital gains is to be abolished for all schemes other than investment in house or the bonds of National Highways Authority of India. This proposal will discourage investors from entering the housing industry for rental income and capital appreciation returns. Hence this abolition of capital gains tax will have an overall negative impact on real estate, though it will also tend to keep the gains within the housing industry to reduce the tax liabilities.
  


• Removal of section 88 of Income Tax Act: Under section 88, rebate in income tax is allowed for sums paid for purchase or construction of residential property up to Rs. 20,000/- for repayment in any financing scheme. This will further discourage purchase or construction of residential property.
  


• Withdrawal of section 80P of IT Act: Presently a housing society providing loan for house building to its members is entitled to deduction of the income earned from this business of providing credit facilities to its members. Removing this section will have a negative impact on the cooperative housing society business and hence the housing industry.
  


• Abolition of profits and gains from multiplex theatres and convention centers: Section 80-IB provided for a deduction of 50% of profits and gains from the business of building, owning and operating a multiplex theatre or convention center for 5 consecutive years from the initial assessment year 2003-04 onwards. Removal of this deduction will affect the building industry adversely.
  

Low interest rates and tax benefits on the principal repayments on a housing loan have in large measure been fuelling the demand on home loans and growing the realty sector. The Kelkar report to the Finance Minister for tax reforms has put an overall damper to the housing and the housing finance industries. Of course, the Finance Minister does not have to follow the recommendations, but use it as a guideline to plot the future income tax strategy of the nation. The question really is whether the government will aggressively implement the Kelkar package in toto, or do it in a piece meal fashion. The latter is likely to occur. So there is still some hope that the 2003 budget will continue the housing loan tax sops for the real estate industry.