The Service Tax Conundrum on Property Developers

March 12, 2010 - PRLog -- This year's budget has left aspiring homebuyers in a tizzy. A chartered accountant, can't decide if he should wait and watch or buy his dream home. He fears he will lose out thanks to the price rise that the new service tax on real estate developers is likely to bring about. A number of people are seeking clarity on changes in price and demand that are likely to result from the 10.3 per cent spike in costs that developers will now incur.

Experts are unanimous in their views on the new tax impact. The impact of the service tax will be passed directly onto the buyer, resulting in an increase in real estate prices. So, for projects under construction, we will see a marginal price increase. Tax experts anticipate the increase to be about 3.4 per cent of sale value.

In case developers are dissuaded from accepting presale advances because of the additional service tax liability, they may have to look for funding from banks to complete their projects. This could, in some instances, escalate the cost of projects.

The benefits implied by the tax savings and interest rate subvention will, to some extent, be negated by the service tax levied on properties in preferred locations and construction costs of yet-to-be-completed buildings. Builders are likely to pass on this additional burden to customers by increasing property prices proportionately.

Whether (increased costs) are actually passed on to the buyer will depend on the level of demand. Increasing home loan rates will surely impact the demand adversely, which may not be offset by the increased disposal income accruing to individuals as a result of the raised tax slab. The equation might have been different had there been incentives that would drive demand stimulation, such as an increase in the existing Rs 1.50 lakh deduction for interest paid on housing loans.

Overall, given the already high property prices and slowing demand for property, it is possible that some developers may choose not to pass on the whole burden of the service tax on to consumers. The effect will be felt across India -- on the projects under construction and those on sale. However, "The affect may be relative to the category of homebuyers. While the affordable housing segment and developments in Tier-II and Tier-III cities are some what susceptible to the cost increase, given that the net impact is only 3.5 per cent.

Typically, properties are costlier when purchased after completion of construction. Thus, the buyer is likely to choose between comparatively lower prices of under-construction properties and constructed property with a higher price tag, though without the service tax component.

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