The retail sector is likely to take a hit as service tax on commercial property rentals squeezes margins

It is taking from the back pocket and side pocket rather than from your wallet. The service tax on lease rentals of commercial property announced in Budget 2007-08 has come into effect from June. The aim is to widen the service tax base and impose additional taxes on real estate, even as the developer community and tenants believe it is uncalled for. The move has strong implications for the office and retail market.

"A majority of developers own a large portfolio of assets, and investors have purchased property on a fixed return basis. Their returns will come down because of this," says Sanjay Dutt, Deputy Managing Director, Cushman & Wakefield. Developers or landlords generally enter into an agreement with tenants wherein any future tax liability will have to be borne by the tenant. However some agreements are silent on such additional taxes, and hence there could be disputes and litigation. While companies will write it off as expenditure, retailers will not find it so easy.

Service tax affects two sets of people - those who have already given or taken premises on rent and those who will do so in future. Depending on market conditions, the service tax will have to be borne by the licensor or licensee, or shared. In a booming market, the licensee will have to bear the burden but as the market slows down, the landlord will have to bear it or enter into a sharing arrangement.

Kumar Gera, Chairman, CREDAI and MD, Gera Developments Ltd says, "We are in the midst of looking at possibilities of legal redressal. It is strange that the government is sending mixed signals. On the one hand, it is encouraging infrastructure development and offering incentives for SEZs in order to encourage economic activity but on the other hand it is making input costs higher, which will have to ultimately be borne by the consumer. Spiralling wage bills, real estate costs, and rentals, and over and above the 12.36% service tax, will force many multinationals to move to tier II or tier III cities, and eventually out of the country. "We have competition from China, Philippines, Eastern Europe, Russia and over a five to ten year period we may lose out on our edge, adds Akil Hirani, Partner Majmudar & Co.

Niranjan Hiranandani, MD, Hiranandani Constructions says the lack of rationalisation in taxes would bring in inflationary tendencies. "When you bring in so many taxes, how do you expect property prices to go down?" he questions.

"People should accept this tax is going to stay and hit their bottomline," says a senior official from DLF. "The impact of the 12.36% service tax would mean adding to operating expenses and squeezing margins further, which is a big blow to the retail industry," says Gibson

Vedamani, CEO, Retailers Association of India. Describing the impact of the service tax on multiplexes, Alok Tandon - Chief Operating Officer, Inox Leisure Ltd, says, "The service tax will impact us in a big way and impinge on our bottom line. Approximately 8% of our total revenues are spent on rentals. There is then a huge cost of entertainment tax, over and above this, our service tax outgo would be about Rs 1.5 to 2 crore. Rent is a state subject and service tax is being levied by the Central government at 12.36%, which is very high. It should not be levied at all. We are taking legal advice on how to fight it out."

Property prices have gone up substantially and it is not viable to do business in many places, explains B S Nagesh, Chief Executive Officer, Shopper's Stop. He says the move would have an impact on real estate as more properties are under construction today, and developers will have to bring down their margins, as otherwise, they will not find many retailers to take it up at these costs. He adds that real estate is in a development phase and this will put a strain on this upcoming sector. Three years down the line, with a General Sales Tax regime ushered in, it would have been more welcome. The true picture of all this would, however, only emerge later, he adds.

Developers like Vikas Oberoi, MD, Oberoi Constructions believe that real estate is not a very large component of anybody's business and the rental component will not stop business. "We are well within the limits compared to many of the offices abroad. At the end of the day, it is more important to remove the inefficiencies in the system, like easing of permissions, increasing the supply of the land, which will mean reduced interest costs, project costs, and help bring the prices down," he says. Explaining the rationale behind the government's move to bring in service tax on lease rentals, Sanjiv Swarup, President, Synergy Consultants, says the move is positive for the economy as a whole. The government wants to tax all economic activities, whether it is goods or services. This will help bring into the open all unaccounted activities. At the end of the day, rental is also one kind of service. As of now, there is hardly any transparency in real estate transactions, and this will provide an avenue to check under-reporting. The service tax levied will provide the income tax department an additional data base and reveal the income realised by the particular service provider/landlord, and thus help keep a tab on transactions. "There is a twin purpose, one is to impose tax on the services in real estate, at a time when the sector is booming and the second is to keep record of real estate transactions and transparency," explains Akash Deep Jyoti, Head Corporate and Infrastructure Ratings, Crisil. Nityanath Ghanekar, MD and CEO, JM Financial Asset Management Private Ltd, sums it up saying: “By the end of 2010, the government is planning to club all taxes under one head. Till that happens, service tax will continue to have an impact.”

FOCAL POINT

Þ      The impact of service tax will differ from business to business

Þ      In the case of new businesses, it would be built into the model, while in case of existing businesses it will mean a cost escalation

Þ      In businesses where you cannot pass on the extra cost to the consumer or third party, it will go on to influence the profitability.

SOURCE: ET/20-07-07/P-41