Cleaning the Augean Stables in the Realty Sector

Cleaning the Augean Stables in the Realty Sector
Jan 2017 , by , in Legal Opinion & Counsel

Cleaning the Augean Stables in the Realty Sector

As per World Bank study, the size of the shadow economy, as a percentage of Gross Domestic Product (GDP), in 2006, was around 8.4% in the United States, 12.3% in the United Kingdom, and 11% in Japan. The figures for BRICS are – Brazil-39%, Russia-40.6%, China-12.1%, India-21.4%, and South Africa- 27%. The silver lining is that our 21.4% is a declining rate.

The scourge of black money is the reality of every country. The volume of this unofficial segment depends upon the development level of an economy. The developed world has a smaller parallel market in comparison to the developing countries. It is naïve to assume that, in a mature economy like ours, swathes of notes are hidden under mattresses and carpets. Most of this money has found its way back into the economy in the form of investments in shares, bullion, and real estate.

The demonetisation of more than 80% of the currency in circulation, last month, coupled with withdrawal restrictions, felt more like a blitzkrieg of initiatives as opposed to just surgical strikes. Financial experts and economists have predicted a shrinking of the growth rate by as much as 2 % over the next two quarters, across sectors. Since immovable property has always been a safe haven for parking of unaccounted cash, there were worries of this sector aching at its joints. However, today, the debate has shifted to the surfeit of cash with banks, falling of bond rates, among other worries, thereby making funds available for investment in real estate look like an attractive destination, with higher yields.

realty

Whatever the effects of demonetisation are, they shall be temporary. If you read too much into it you may end up holding the wrong end of the stick. For a sector that has been struggling with surplus inventory, stuck-up projects, no fresh launches for past couple of years, this may just be a flash in the pan. In the painfully long queues and dried up ATMs, we seem to have forgotten that the demonetisation trails the notification of the Benami Transaction (Prohibition) Amendment Act, 2016. Interlinking is manifest.

The Benami Act

The Amendment Act seeks to strengthen the Prohibition of Benami Property Transaction Act, 1988. The 1988 statue had merely nine sections. It lay moribund for the want of any administrative machinery to enforce it. In 30 years, no property was requisitioned, and arrests or prosecutions under the Benami Act are almost unheard. A fuller bodied enactment, comprising of 72 sections, is aimed at giving more teeth to an otherwise atrophied statute. Decks have been cleared for the constitution of an Adjudicating Authority, Appellate Tribunal, and Special Courts for prosecution of offences.

The Finance Minister was indeed asked whether it would have been simpler to pass a new statute rather than have such voluminous amendments. The Minister’s reasoning emanated from within the four corners of our Constitution. Article 20 of the Constitution of India forbids penal law to have a retrospective effect. A new law would have meant giving immunity to everybody from the penal provisions from 1988 to 2016 and thus would not have been in larger public interest.

Larger public interest has also been served by expounding of some vital definitions; including that of a benami transaction. Two basic criteria have been laid down for a transaction to be categorised as benami:  (i) the property is transferred or held by a person, ostensible owner, but the consideration is paid by another, a beneficial owner, and (ii) the ostensible owner holds the property for the immediate or future benefit or benefits, direct or indirect, of the beneficial owner. Transactions in fictitious names, and various other permutations and combinations, are also hit by the definition. But the essence of a “benami transaction” is the dichotomy between ostensible and beneficial ownership.

Of course, the definition is followed by the usual and expected exemptions with respect to transactions by kartas of a Hindu Undivided Family (HUFs), lineal ascendants / descendants, trustees, executors, partners, depositories so on and so forth. Amongst this reasonable list of exceptions, the exclusion of a property held by a director, standing in fiduciary capacity for his company, is a real breather.

Holding of agricultural lands

Some states, till this day, prohibit acquisition of agricultural lands by non-agriculturists. In Maharashtra, the definition of an agriculturist is such that a corporate body, even if its very business is that of farming, cannot be an agriculturist. The prohibition, therefore, appears to be absolutist. Very often companies ended up playing into the hands of a selective group of intermediaries or land aggregators.

Should a corporate acquire agricultural lands in the names of its directors there was always the danger of being afoul of the law. The premium paid to the land agents benefitted neither the farmers nor the corporates. A good seamless system needs the least number of layers between the seller and the buyer. With the balancing of the definition, in one fell swoop, the Damocles Sword overhanging the heads of the directors has forever been done away with.

In spite of the reprieve, many have pressed the panic button. Concerns regarding banking transactions, mortgages, project finance are being raised. Queries have poured in regarding payments made directly by banks to the sellers, on behalf of the mortgagors, in connection with purchase of immovable property. If the legislature could go so far as to exclude transactions effected in part-performance of a contract, then a specific clarification regarding mortgages would not have been amiss. The Central Government can still issue a Notification and put the controversy to rest.

The 1988 Act, however, even in its new avatar, does not address the problem of proper valuations. The Amendment Act has come in the wake of a number of other efforts on the part of the government to ensure that immovable assets are properly accounted for. Accounting Standards have been firmed up so that the balance sheets of real estate companies reflect the true of the assets. But the sector continues to be plagued by the lack of reliable data on prices. There are no credible statistics in this domain. Even public documents such as registered sale deeds, leases, leave and licenses do not capture the actual prices, rents, or license fee. Real Estate Investment Trusts (Reits) has been a non-starter in spite of a series of tax clarifications in the previous Budget. Neither is there much hope for them in the near future.

Vested interests on both sides depress figures to evade tax. Imposition of Government Ready Reckoner rates has improved the situation only to the extent of the rates specified therein. The real value continues to escape the system. For Reits, or organised players to operate in this market, the herculean task is that of proper valuation. And it shall take nothing less than diversion of the mighty rivers to wash out the filth.

 

 

Divya Malcolm

Principal Associate

Kochhar & Co.

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