The Western media often refers to India is as the ‘noisy’ democracy. As always, the noise has reached its peak during the electoral phase, but we can look forward to the dust settling in mid-May 2014. A stable regime at the centre will ensure that India regains its growth trajectory.
There are several areas where reforms and interventions are required to propel this growth. Out of these, two policies which have been delayed for a long time can dramatically change the macro economic scenario – GST and REIT.
Goods and Service Tax (GST)
One of the biggest taxation reforms in India, Goods and Service Tax (GST) will integrate State economies and boost overall growth by creating a single, unified Indian market. While presenting his Budget in July 2006, Finance Minister Pranab Mukherjee had indicated that GST would come into effect from April 2010. However, up to the last budget no decision has been taken.
The implementation of GST will phase out other taxes such as octroi, Central Sales Tax, State-level sales tax, entry tax, stamp duty, telecom licence fees, turnover tax, tax on consumption or sale of electricity, taxes on transportation of goods and services, et cetera. It is the only way out of the multiple layers of taxation that currently exist in India.
What is GST?
Goods and Services Tax is a comprehensive tax levy on the manufacture, sale and consumption of goods and services at a national level. It employs a tax a credit mechanism to collect tax on value-added goods and services at each stage of sale or purchase in the supply chain.
The system allows the set-off of GST paid on the procurement of goods and services against the GST which is payable on the supply of goods or services. However, the end consumer bears this tax as he is the last person in the supply chain. GST is likely to improve tax collections and boost India’s economic development by breaking tax barriers between States and integrating the country through a uniform tax rate.
What are the Benefits of GST?
Under GST, the taxation burden will be divided equitably between manufacturing and services through a lower tax rate by increasing the tax base and minimizing exemptions. Such a system is a major step towards transparent and corruption-free tax administration. GST will be is levied only at the destination and not at various points (from manufacturing to retail outlets). Currently, a manufacturer needs to pay tax when a finished product moves out of a factory, after which it is again taxed at the retail outlet when sold.
Benefits to Centre and States
It is estimated that India will gain $15 billion a year by implementing the Goods and Services Tax, as it would promote exports, raise employment and boost growth. It will divide the tax burden equitably between manufacturing and services.
Benefits to Individuals and Companies
In the GST system, both Central and State taxes will be collected at the point of sale. Both components (viz. the Central and State GST) will be charged on the manufacturing cost. This will benefit individuals, as prices are likely to come down. Lower prices will lead to more consumption, thereby helping companies.
If implemented the GST regime will revolutionize the logistics sector. It will also help create small and medium size enterprises and thereby create more employment. Various hinterland cities like Nagpur, Indore etc. will emerge as hotspots with robust demand for real estate.
Challenges for Implementation of GST
The biggest impediment on the way of implementing GST is getting all the state government on the board. Various State finance ministers have expressed their apprehension that it will reduce financial autonomy of the States and make them more dependent on the Centre.
The success of the policy will depend on the derivation of right kind of revenue-sharing mechanism between the Centre and the States. We hope that a stable and decisive Central Government will be able to crack the deadlock.
Real Estate Investment Trusts (REITs)
A real estate investment trust (REIT) is a company that owns, and in most cases operates income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping malls, hotels and even timberlands. Some REITs also engage in financing real estate.
The REIT system was designed to provide a real estate investment structure similar to the kind that mutual funds provide for investment in stocks. REITs can be publicly or privately held, but only public REITs may be listed on public stock exchanges. REITs can be classified as equity, mortgage or a hybrid.
REITs were created in the United States when President Dwight D. Eisenhower signed into law the REIT Act. REITs were created by the US Congress in to give all investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate in the same way they typically invest in other asset classes – through the purchase and sale of liquid securities.
Since then, more than 20 countries around the world have established REIT regimes, with more countries actively considering them. The spread of the REIT approach to real estate investment around the world has also increased awareness and acceptance of investing in global real estate securities.
The Government of India is still in the process of formulating legislations for REITs in the Indian real estate market. SEBI published its draft regulation in the last quarter of 2012. Once implemented, Indian REITs will help individual investors reap the benefits of owning interest in the securitised real estate market.
The greatest benefit will be that of fast and easy liquidation of investments in the real estate market, in marked contrast to the traditional manner of disposing of real estate. The government and Securities and Exchange Board of India, through various notifications, is in the process of making it easier to invest in real estate in India directly and indirectly through foreign direct investment, via listed real estate companies and mutual funds.
Benefits For Indian Real Estate
REITs will enable retail investors to participate in the real estate space with small investment sizes. This will unlock a new source of project financing for real estate. As of now there is very little holding power available with the developers. Therefore, there is little interest with them to create high-grade commercial, retail or any other income generating assets.
Even large developers strata sell commercial or retail projects to multiple HNI investors. Such a situation creates complexity in maintaining and promoting these spaces, apart from creating title issues and many other complications. Once a REIT takes charge of a commercial property, the scenario improves significantly.
Smaller developers will also be encouraged to create lease-hold assets, because REITs will provide them with exits and an incentive to develop high-grade buildings. This would have a very positive impact on the overall real estate industry, since developers who are currently doing only residential projects would be able to diversify their portfolios and achieve a more balanced growth.
There would definitely be more momentum on the market, and various new asset classes hitherto considered non-viable by many developers would emerge in strength – for instance, student housing, senior living projects and rental housing schemes.
Challenges For REITs
There are several challenges to overcome before the successful implementation of REITs in India. To begin with, title certification in India is an ambiguous and cumbersome process, and this complexity discourages many potential foreign and domestic investors from buying into income-yielding properties.
Another issue is the valuation mechanism. Real estate valuation in India is largely unregulated and lacks a standard code of practice or ethics. In order to implement REITs, the government will have to address these issues via making and amending multiple legislatures.
It is to be hoped that the new government will seriously look into the urban development and focus on the creation of right kind of built infrastructure that is the key for sustainable growth. REITs and the associated changes in the legislature need to find a place on a priority list that aims for larger developments and subsequent employment creation.
About the author
Subhankar Mitra, Head – Strategic Consulting (West), JLL India