Friday, November 17, 2006: In recent years, India has been witnessing unprecedented growth in the real estate sector fueled by the increased business activity. Real estate development in India is estimated at USD 12 billion and growing at 30% every year. Though all segments of real estate business such as corporate, retail and residential have been driving this growth, investment in residential property itself constitutes 80% of this sector.

Non-resident Indians (NRIs) are one of the key contributors to the growth of the real estate industry and considering the immense potential in India, they are likely to step-up the investment in future. In this article, senior tax professionals with Ernst & Young - Gaurav Taneja and Rajesh S provide an overview of the key exchange control and tax implications that should be considered by NRIs while investing in house property in India.

Exchange control regulations -

The Indian Government has considerably eased the restrictions relating to investments by NRIs in house property. There is virtually no restriction or approval required for an NRI to invest in properties in India from funds received in India through normal banking channels or held in Non-resident External (NRE) account/ Foreign Currency Non-resident (FCNR) account (B)/ Non-resident Ordinary (NRO) rupee account. However, investment in agricultural land/ plantation property/ farm house is currently prohibited. The recurring rental income earned on letting out of property is also freely repatriable.

Sale/ Repatriation -

An NRI can freely sell or gift his/ her property to another Indian resident or NRI or person of Indian origin. However, there are certain restrictions imposed on repatriation of sale proceeds. In case of investments made from inward remittances or out of NRE account or FCNR account (B), the repatriation of sale proceeds is permitted only upto the amount of initial investment.

In case the repatriation is made out of balances held in NRO rupee account (balances include sale proceeds of house property), then an amount of USD one million per calendar year can be repatriated.

One of the significant restrictions that is placed on repatriation is that the NRI can repatriate the sale proceeds only upto two residential properties. This could dampen the interest of NRIs in residential property, as investors would like to have free flow of capital while making such investments.

Income tax -

The income tax implications on house property income in India would be dependent on whether the property is kept vacant or let out. In case an NRI has only one property in India and if it is kept vacant, then it would be possible to say that there should not be any rental value for such property as the NRI was not able to occupy the same owing to his employment, business or professional carried out at any other place. However, if he owns two properties and both of them are kept vacant, then he is required to pay income tax on one of the properties as if the property had been let out. The tax laws do not provide clear guidance on how the rental value is to be determined for such property. It simply states that the annual rent should be the sum which the property might reasonably be expected to let from year to year. Though there are judicial precedents that are available which suggest adoption of municipal value/ fair rent, there could be some practical difficulties in ascertaining such value in the ever increasing rental market.

In case of let out properties, the actual rental income (after reducing the municipal taxes) would be subject to tax. The tax law allows a general deduction of 30% on the rental income and also allows for deduction towards interest subject to certain conditions.

Tax payments -

Under Indian tax law, the payer is required to withhold tax on rental income paid to a non-resident @ 30.6% where the income of the non-resident does not exceed Rs 10,00,000, otherwise at 33.66%. In case an NRI wishes to have a lower rate, then he has to apply to the tax authorities in a specified format for obtaining a certificate for deduction of tax at lower rate. The NRI would be required to file a return of income at the end of the year if the taxable income exceeds Rs 100,000.

In case the NRI is taxed in the home country on the rental income derived from India, then he could consider claiming exemption or tax credit in the home country based on the double tax treaty agreement entered into India with such country, if any.

Other aspects -

It is common practice to have joint ownership of properties by a husband and wife. However in case an individual intends to split the income between himself and his wife for tax purposes, then it is important to establish that both of them contributed for the investment in property and the share of ownership is clearly outlined. In case the entire investment is made by one person, then in all likelihood, the entire income would be taxable in that individual’s hands on account of the clubbing provisions that exist in India though the property may be jointly held.

Wealth tax -

Tax implications are not restricted only to income tax and NRIs have to keep in mind the wealth tax implications as well. Wealth tax is levied on the value of specified assets in excess of Rs 15,00,000. Specified assets include house property. However, the Wealth Tax Act provides an exemption in respect of one house property. In case of more than one property, the NRI would have to pay wealth tax @ 1% on the value (value determined based on the prescribed valuation rules) in excess of Rs 15,00,000 and file the required return.

There is a specific exemption available for returning Indians in respect of investment made in house property out of money brought from outside India or from balances held in NRE accounts as on date of return to India. The value of such house properties would be exempt from wealth tax for a period of seven consecutive years starting from the year when he/ she returned to India. This exemption is available only if the NRI has come to India with the intention of ‘permanently residing in India’.

As may be discerned from the above, the liberalized exchange control regulations provide unrestricted access to NRIs to invest in house property in India, thereby helping them to capture the great potential available on such investment. There are however, some restrictions imposed on the repatriation of sale proceeds. NRIs also need to understand the tax implications in India on their proposed investment both from an income tax and wealth tax perspective, to ensure full compliance with the statutory requirements.

Source - http://www.moneycontrol.com