In response to COVID-19, businesses around the world are looking at options to raise capital and manage their short-term cash flows. In the Indian context, navigating through complexities of taxes and regulations, adds a layer of challenge, as businesses explore all options and have to deal with business issue brought about by the endemic.
Businesses and real estate investors will compare feasibility of holding such valuable assets such as against ability to free up capital. Many business owners have traditionally owned real estate be it the form of factories, corporate offices etc and have also leveraged such assets as collateral with the financial institutions. The real estate assets could also become non core for certain businesses. In the current environment where capital raise could be tight companies could look at unlocking real estate as capital for companies which could be through a sale and leaseback of assets and other could be simpliciter sale of non core real estate.
Sale and leaseback entails sale of the real estate at fair market value to a financial institution along with a long term lease back from the financial institution to the seller. The lease could be in the nature of a financial or operating lease depending on the transaction. From a stamp duty perspective, sale of immoveable property through conveyance will incur a stamp duty ranging between 6 and 10 percent depending on location and the long term lease could also entail a similar stamp duty thereby entailing a high stamp duty cost. From an income tax perspective, the lessee can claim an expense deduction only with regard to the finance charge. The lessor is able to claim depreciation based on the cost of the asset to the previous owner which is a significant dis-incentive to undertaking such transactions. From a goods and services tax perspective the lease will be liable to a GST of 18 percent which should be available as an input credit. Some other methods could be to sale the asset to wholly owned subsidiary or to Real Estate Investment Trust and lease it back. However, in order to make this option viable there is a need to amend the Indian income tax laws to permit the lessor to claim depreciation on the acquisition price as it relates to “depreciable assets rather than cost to original owner. Stamp duty needs to also be rationalised and state could look at providing a concessional rate for the leasing rates.
Another issue which is being witnessed and could be an issue in these times is around tenants are demanding concessions, which will have a significant bearing on the ability of real estate owners and investors to service their own capital. These concessions could be through a number of ways such as complete or partial waiver of dues for affected period, deferral of dues for affected period – to be recovered over rest of the FY ending March 2021 in equal instalments, deferral of dues for affected period to be adjusted in next escalation as per lease agreement, complete or partial forfeiture of security deposit etc. Income-tax implications will differ, depending on whether income is offered to tax as “Business income” or “Income from House Property”. In case of business income, taxability of income, will be governed by principles of accrual; and ‘Reasonable certainty’ test under ICDS.
Where income is offered to income tax as “Income from House Property there is a need to assess whether un-realised rent deduction or vacancy allowance will be available, depending on commercial agreement with tenants and whether tax will still need to be paid on notional income. If yes, need to explore if overall rents have got re-benchmarked. Where a complete/ partial forfeiture of security deposit is contemplated, one needs to consider the tax implications that could arise, depending on whether it is pursuant to enforcement of contract or a mutually agreed forfeiture. Depending on the nature of waivers/ deferrals or re-negotiation, the corresponding GST impact could be significant. An assessment of the consequences will be critical for each of the options. From a stamp duty perspective one would need evaluate who would bear the stamp duty and registration costs for where the renegotiation is required to be documented and registered.
In summary, unlocking real estate as capital will in the new normal to help deleverage balance sheet make them asset light and provide true value to the real estate inside companies. In the short run the new normal requires commercial asset owners to deal with tenant concessions which could result in strain on their capital and short term tax issues.
