Annexure 1

Taxation on letting out and sale of Commercial Real Estate

The main taxation implications under the prevailing Indian Income-tax Act, 1961, (the Act) on letting out and sale of commercial real estate property are summarised in brief for the general understanding and reference. The tax material is not exhaustive and not intended to be advice on any particular matter. The clients should verify all the facts, law and contents with the text of the prevailing statutes and seek appropriate professional advice before acting on the basis of any information contained herein as the taxation implications may vary depending upon the facts in each case and the tax laws are subject to change from time to time.

The taxation write-up does not consider the taxation implications in the hands of the NRI in his home country. As the income in the hands of the NRI will be governed by the local tax laws in the country of his residence, the same needs to be examined separately by the client.

The prevailing tax laws relevant to Assessment Year 2005-06 (Financial Year 2004-05) are summarised below:

A. Income from letting out of commercial real estate property

The income from letting out of property will be assessed under the head 'Income from house property' of the Act. The computation of the said income will be as under: "Annual Value as reduced by deductions for (i) 30% of annual value under section 24(a) (ii) interest payable on borrowed capital for purposes of acquisition, construction, repair, renewal or reconstruction of house property under section 24(b).

Notes:

1. Annual value of a house property is higher of the following:

    a. Fair rent of the property i.e. rent fetched by similar property in the same or similar
locality on similar terms, (Municipal rateable value determined by the Municipal
authorities is adopted as one of the tests for determining fair rent), or,

    b. Rent actually received or receivable.

2. If the customer lets out a business center wherein the purpose is to provide a
composite service of providing fully furnished infrastructure for commercial use, the
income will be taxed as business income under the head "Profits and Gains of Business
or Profession". In that case, the business income will not be computed in the manner
discussed above with respect to the head 'Income from house property' but in
accordance with the provisions of Act applicable for calculation of business income.

3. The interest on borrowed money eligible for deduction under section 24(b) for the
pre-acquisition or pre-construction period would be deductible in five equal annual
installments commencing from the year in which the house has been acquired or
constructed.

4. The interest on borrowed capital towards renovation or refurbishment in the nature of
interior decoration & beautification would not be eligible for deduction.

The tax liability of the NRI will be subject to tax rates ranging from 10% to 30% depending upon the taxable income in India.

The person paying the consideration to the NRI customer for letting out of property or business center will be liable to deduct tax at source (TDS) under the prevailing provisions of section 195 of the Act. Under the prevailing Indian income-tax laws, TDS is applicable @30% (plus applicable surcharge). The NRI customer can, however, obtain a certificate under section 195 / 197 of the Act from his Assessing Officer in India for nil / low deduction of tax at source in accordance with the tax laws.

The Double Taxation Avoidance Agreements (the treaty), entered into between the country of residence of the NRI and India, do not generally provide for any tax concession and the income is subject to tax as per the Indian income-tax rates. However, the treaty implications need to be verified on a case-to-case basis. The TDS rates as specified under Indian Income-tax laws will be applicable irrespective of the tax liability of the NRI.

B. Income from sale / transfer of commercial real estate property

The profit / loss on sale / transfer of the property held as capital asset by the NRI is brought to tax under the head 'Capital Gains', in accordance with the provisions of the Act, if the property is held as investment. The tax implications will be different if the property is held as stock-in-trade by the NRI. If the property held as investment is held for equal to or less than 36 months it will be taxed as "short term capital gains" (STCG). If it is held for more than 36 months, it would be taxed as "long term capital gains" (LTCG). In terms of section 50C of the Act, sale consideration for the purposes of capital gains computation is adopted at the value adopted or assessed by the stamp duty valuation or actual sale price, whichever is higher. Capital gains would be computed as the difference between sale price under section 50C as reduced by cost price (as inflated by the cost of indexation notified under the Act in case of property held for more than 36 months) and expenses on transfer (brokerage, stamp duty, etc).

The provisions of the Act provide for various tax saving avenues to save incidence of long term capital gains tax.

The incidence of LTCG can be saved by way of setoff against long / short-term losses in accordance with the provisions of the Act. The incidence of STCG can be saved only by way of setoff against short-term losses in accordance with the provisions of the Act.
The other avenues available for saving the incidence of LTCG on sale of commercial real estate are summarised below:

1. If the LTCG are invested within a period of six months after the date of the transfer in any specified long-term asset, being specified bonds issued by NABARD, NHAI, REC, NHB and SIDBI under Section 54EC, then it enjoys tax exemption. If only a portion of capital gains is so invested, then the exemption is available proportionately. In case such specified bonds are transferred or converted into money within a period of 3 years from the date of acquisition, the exemption will stand withdrawn and taxed in the year of transfer or conversion as short term capital gains.

2. Subject to the provisions of Section 54F, LTCG will be exempt from tax, provided the net consideration is utilised in the purchase of a residential house within a period of one year before or two years after the date of transfer, or in the construction of a residential house within a period of three years after the date of transfer of the long-term capital asset. If only a portion of the net consideration is so invested, then the exemption is available proportionately. In case the new house property is transferred within a period of 3 years from the date of purchase /construction, the exemption will stand withdrawn and taxed in the year of transfer as short term capital gains. Also, a house property in addition to this new house cannot be purchased/constructed within 2/3 years from the date of transfer of the original asset whose capital gains were invested in the residential house property to save tax incidence.

    Pending deployment of funds, under section 54F, by the end of financial year, the capital gains are required to be deposited in Capital Gains Account Scheme offered by nationalised banks in India in the intervening period. The account will have to be opened by the due date for filing return of income by the NRI.

The tax liability of the NRI will be subject to tax rates ranging from 10% to 30% depending upon the taxable income. The person paying the consideration to the NRI customer on sale / transfer of property or business center, will be liable to deduct TDS under the prevailing provisions of section 195 of the Act. Under the prevailing Income-tax laws, TDS is applicable under section 195 @ 30% (plus applicable surcharge) on STCG and @20% (plus applicable surcharge) on LTCG. The NRI customer can, however, obtain a certificate under section 195 / 197 of the Act from his Assessing Officer in India for nil / low deduction of tax at source in accordance with the tax laws..

The Double Taxation Avoidance Agreements (the treaty), entered into between the country of residence of the NRI and India, do not generally provide for any tax concession and the income is subject to tax as per the Indian income-tax rates. However, the treaty implications need to be verified on a case-to-case basis. The TDS rates as specified under Indian Income-tax laws will be applicable irrespective of the tax liability of the NRI.