This article is written by Ms. Shivani Agarwal, from Institute of Law, Nirma University. This is a comprehensive article that discusses the black money formation in the real estate industry and the corrective measures and policies adopted by the government regarding such situations.
Table of Contents
Whenever we hear the term ‘real estate’, the first meaning or image attached to the word is property. But if we look upon the literal sense of the term ‘real estate’, there is much more to it than property. Real estate is a category of real property that includes land and anything permanently attached to it, whether natural or human-made. In simple words, real estate means real property, including any land or modifications attached to it. An apartment, a multi-family home, villa are all examples of real estate. The Indian real estate sector is one of the largest sectors for a significant contribution to the GDP of the Indian economy.
Black money is a phrase that we often see in the news, whether political-related or big business scams. There is no classic definition of black money, but black money can generally be defined as all the funds collected through illegal activities. These are the funds that cannot be recorded for tax purposes.
Structure of real estate markets
The real estate market/sector can be classified into four categories:
1) Land- Land is the basic standard for all types of real property. Land can be defined as the area of ground on which real estate can be located.
2) Residential real estate- Any kind of property that can be used for or is used for residential purposes. Various examples of residential real estate can be residential flats, cooperative societies, family homes, etc.
3) Commercial real estate- These are the properties that are used for business or commercial purposes like shopping complexes, business showrooms, etc.
4) Industrial real estate- This type of real estate can be understood as the real estate that is used for industrial activities. Factories, warehouses are very good examples of industrial real estate.
Another category that can be added is real estate for special purposes. These are the properties that are made accessible to the public like government buildings, public gardens, libraries, etc.
The real estate sector in India has four further sub-categories:
(a) Housing- This is similar to residential real estate.
(b) Retail- This contains the buildings or land that has been developed for shopping and other entertainment purposes.
(c) Hospitality- The estate or property that is associated with a service hotel or resort that can be either full service or limited service.
(d) Commercial- This type of real estate is similar to commercial real estate i.e. estates or properties that are used for business purposes.
There are many complications associated with the real estate sector while we understand this market. Different fields of profession are related to the real estate sector like accountants, insurance companies, lawyers, etc. This sector can also be understood as producing, buying, and selling real estate.
Tax burden on real estate transactions
The real estate sector being a crucial factor in the Indian economy, would also be liable for taxability. Various direct and indirect taxes apply to different real estate transactions. This taxation concept on capital gains from real estate transactions is governed under the Income Tax Act, 1961. There are some regular charges as well, such as stamp duty and registration fees. Various new amendments have been made to the Act.
To understand the tax structure on real estate transactions, one must understand some of the following terms:
(a) Long-term and Short-term Capital Asset– Section 2(14) of the Income Tax Act, 1961 defines a capital asset as any kind of property that an assessee holds. It is not necessary to have a connection with the business or profession of the property.
Any capital asset that an assessee holds for less than 36 months immediately before the transfer is a short-term capital asset. Taxes are deducted from short- term capital asset transactions. The short-term real estate transactions should be taxed as any other income, i.e., according to slab rates.
That capital asset that an assessee holds for more than 36 months before the transfer is a long-term capital asset. A concession is provided in the long-term capital asset transaction. The long-term real estate transactions shall be taxed at a flat and special rate of 20%.
(b) Cost of Acquisition- This is the cost that is incurred by the asset holder while acquiring the asset. Those expenses are capital in nature i.e., money spent on buying or maintaining the fixed asset by a person. Under Section 55 of the Act, it is provided that it is at the option of the assessee to either consider the actual cost of acquisition or fair market value of a particular asset.
Real estate transactions have 4 different categories:
- Sale of land
- Sale of building
- Sale of Gifted/Inherited property
- Compulsory acquisition of property by the government
Sections of Income Tax Act that are associated with the taxation of real estate transactions:
- Section 50C: Under this section, it is mentioned that if the sale consideration of an immovable property being sold is less than the SDV (stamp duty value), then the SDV has to be considered as a sales consideration to compute capital gains. This section does not apply to that immovable property that the assessee holds as stock in trade.
- Section 43CA: Since the above-discussed section does not apply to the immovable property being held as stock in trade, this section was inserted by the Finance Act, 2013, and it states that where the assessee sells such property at a value less than SDV, then the SDV shall be considered as sale consideration.
- Section 56(2)(vii): The above two sections apply to the seller, and this section talks explicitly about buyers who buy a capital asset. This section provides that where a person receives an immovable property at a value less than SDV but more than ₹50,000, the difference shall be taxable under income from other sources.
Economic reform, legal bottlenecks and black money
The real estate sector in India is often seen as unorganized. There have been many economic reforms in India that helped the real estate sector, such as demonetization, GST, FDI rules and regulations, etc. In recent times the real estate sector has emerged in the Indian economy.
A major economic reform that aided the real estate sector was demonetization. Though after the demonetization, there was a wave of confusions in the Indian economy but in the Union Budget 2017-2018 the Central government also talked about ‘Housing for all by 2022’ by providing infrastructure status to the affordable housing sector. This act by the government had many benefits with it, mainly for the developers, like access to funds with quicker approval to encourage the development of affordable housing projects. The FDI rules and regulations were improved which made it easier for NRIs and investors from abroad to purchase the property in India.
The developers and buyers also appreciated the introduction of RERA in 2017. The Act focused on various aspects and issues in the sector like more transparency, faster redressal of disputes, and proper authority to ensure multiple transactions and investments.
The GST policy that was introduced in July 2017 also proved to be beneficial to the real estate sector. Since it was about ‘one nation, one tax”, real estate had many tax rates before it, and removing those extra tax rates was an advantage for the developers and buyers.
There are various difficulties and issues in the real estate sector. It is widespread to see fraudulent transactions and misrepresentations in the real estate market. A typical example is that the buyer is promised about specific features of a property that he wishes to buy, like its possession, furnishings, etc., and at the time when a sale happens, the buyer is left with complications like another party claiming that the property belongs to them. Buying and selling transactions in the real estate sector mostly happen involving brokers, lawyers, agents, etc. that creates another kind of trouble for buyers.
Some of the legal constraints in this sector are:
- Breach of contract- This can occur from either of the parties. If any of the parties feels that some transaction issue might not perform their part of the contract, and this breach attracts legal action. A violation of contract is often associated with fraud, misrepresentation, and breach of duty.
- Incompetent agents- Parties in most of the transactions do not know each other, and hence a broker or agent is involved in the transaction. This is one of the significant drawbacks in this sector because if the agent involved is incompetent in any manner, then it might severely affect the transaction. An incompetent agent might create difficulties like some kind of problems in procedure, etc.
- Not disclosing accurate information- This phrase is often associated with the term ‘misrepresentation.’ This happens a lot when a buyer is promised a property with some unique features like friendly location, well-constructed property, etc. and when the transaction has taken place, the buyer observes that the stuff he bought was nothing as promised.
We earlier discussed black money. The real estate sector is considerable ground for black money and its various other operations. This is because the value of real estate properties is often undecided, which attracts many other activities related to the generation of black money. Various activities constitute black money in the real estate sector like incorrect valuation of property, brokerage cost, or the fees that agents charge are not mentioned anywhere.
Link between real estate market and black money
There have been various studies and research showing that there exists some kind of link between the real estate market and black money. Two main or primary reasons that generate black money in the real estate markets are: (a) Low chances of getting caught in the act of tax evasion and if caught, the penalty rate is also quite low and (b) There is a good return on investment in properties.
We all know that tax evasion is a significant player in creating black money, and in the real estate market, tax evasion becomes much easier because of the uncertain value of the properties involved. There are so many procedures and technicalities to ascertain the correct and fair value of a property. The brokerage or the cost charged by the agent also cannot be determined since the value of the property is uncertain, and because of this, many buyers and brokers earn vast amounts of money, and these often go unaccounted for.
Some of the other ways by which sellers create black money in the real estate market are overestimation of the cost of production that consequently helps them to record lower profits and thus, ultimately saving money from paying huge taxes, the seller often takes advantage of the Rent Control Act to undervalue the property, etc.
Estimation of black money in real estate
The existence of black money in the real estate sector has been a kind of trouble for India’s policymakers. The Indian policymakers have tried many times to eradicate the issue of black money. The primary concern of the policymakers has been tax evasion in the real estate market. To get a fair estimate about the black money in the real estate sector, one must understand the concept of ‘black income,’ this phrase in the context of the real estate market means an income that is generated in situations when the value of immovable properties is stated below the real and fair deal.
The estimation of black money is quite a tedious and challenging procedure to locate. There are several reasons for this: both the buyer and seller prefer to undervalue the property, different types of charges such as registration fees, capital gains tax, stamp duties, etc., are reduced because of some unacceptable strategies.
A study of 1987 estimated black money in the real estate sector somewhere between ₹4500 – 10,550 crores. So, one can imagine with development in this sector how much black money is created in this sector.
There are various concepts that are associated with the estimation of black money in real estate sector such as:
(a) Properties that are acquired by the Income Tax Department;
(b) The registered value of the immovable property that is transferred;
(c) A rough estimation of black money involved in a transaction and many other factors.
Though one can discuss the different factors that help estimate black money in the real estate sector but reality, it is challenging to estimate black money in this sector mainly because the actual value of a property is unknown. Sometimes brokers and buyers also hide their actual earning from actual transactions, and even if the unaccounted income is disclosed, the unaccounted income does not need to be the right income.
Sources of black money generation
The Union Government’s ‘White Paper on Black Money’ also stated that real estate is a source of the production of black money. Real estate accounts for a whopping 11 percent of the GDP of the nation, according to the study, and it is the largest contributor to the country’s total black capital. Real estate contributes more than $200 billion to the GDP of the country. Basically, for three key reasons, black money is produced in the market.
Firstly, because of obsolete government guideline values; secondly, because accurate data on the actual market price of the traded property is not available; and thirdly, because of the market mechanism that paves the way for parties to meet and negotiate privately on market value and other terms of sale. The real market value of the transactions is, hence, not publicly disclosed.
Existing administration machinery to tackle black money
The Indian legislation system has provided for different regulatory and authoritative bodies to tackle the problem of black money. Some of these agencies are:
- Benami Transactions (Prohibition) Act– A Benami purchase can be defined as a transaction or purchase in which a purchase takes place in the name of another person who is not paying consideration but is merely lending his name into the transaction.
These activities were a huge source of black money and thus it was necessary to monitor these kinds of activities and hence this Act came into force. This Act states that a person entering Benami transactions will be an offence.
- ED (Directorate of Enforcement)– It is a law enforcement agency that enforces some of various legal policies like prevention of money-laundering, Foreign Exchange Management Act, etc.
- Income Tax Act, 1961– There are various provisions in this Act that deals with unaccounted income and also mentions the punishment of different crimes as per the Act.
- Central Board of Direct Taxes (CBDT)– This body deals with all kinds of direct taxes and also governs the administration of applicability of direct taxes.
- Prevention of Money Laundering Act (PMLA), 2002– Offences under this act criminal in nature. This Act has specified 156 offences and 28 different statutes related to money laundering.
- Narcotic Drugs and Psychotropic Substances (NDPS) laws– We all might have seen or heard in the news about illegal drugs being seized by the government officials in huge quantities. The drugs business is a huge market that generates illegal income that is not recorded in the economy. Laws such as the NDPS Act provide for the offence and punishments related to illegal drugs.
Corrective action to be taken by the state government
State governments should take few corrective steps to reduce underreporting of transaction value, tax, and stamp-duty evasion in order to minimise the black money menace.
- Automating the method of paperwork to decrease corruption.
- By mandating such education and qualification requirements to market mediators such as brokers, mediators, etc. in real estate, to increase the professional standards of the real estate industry.
- Registration fees, stamp duty, and other property transfer taxes need to be rationalised to curb tax evasion.
- In order to track suspicious transactions, the formation of an online database of all property transactions.
Since the demonetization happened in 2016 there have been many ups and downs in the India real estate sector. The Indian policymakers have tried to bring many transformations in the real estate sector that would help in improvising the conditions such as:
- Real Estate (Regulation and Development) Act [RERA]- This was a major influence for the real estate sector industry. This Act basically protected the interests of the people who bought homes from developers and builders. This Act brought a positive reform in the real estate sector by getting the confidence of buyers.
- Real Estate Investment Trust (REITs)– This pre-approved platform by the SEBI provided a common stage to all the investors from across the country to pool their money and invest in the real estate’s sector along with safer investments with a proper authority.
- Smart cities mission- This campaign encouraged the renovation of urban cities and it was the goal of the Centre to be able to make 100 such cities along with help of state governments.
- Amendment to Benami Transactions (Prohibition) Act– This Act was focussed on prevention and regulation of the unaccounted money into the economy. This was also applauded by the buyers and investors as this reform brought transparency in the real estate sector.
- Foreign Direct Investment in Real Estate- This was quite a major change that was brought by the government. With the introduction of this change, it became quite simple and efficient for foreign investors to invest in the real estate sector in India.
- Extension in project registration amid COVID-19– The pandemic created a lot of uncertainties and losses to many sectors. Various state governments provided extension in the real estate sector for around 6-9 months. This step kind of provided a relief to the developers who were in the middle of a crisis during the lockdown period.
Black money also has various adverse effects on individuals, the economy, culture, infrastructure, etc., leading to India’s corruption and the development of a parallel economy. It also affects the planning and resource mobilization of the economy, inconsistencies with other policies, deflation in the impact of the income distribution, unemployment, inflation, forcing adjustments in the fiscal policy system, budget deficits and debt traps resulting in transaction costs, leading, amid low wages, to a high-cost economy and increasing the supply of cash.
It also causes micro-economic consequences, such as political failures, the low left at the mercy of the market, the criminalization of society, the impact on national security, the impact on work ethics, the impact on export efficiency, the reduction of public trust in the state.
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