Get a grip on the grey areas before you purchase real estate abroad
The income-tax (I-T) department has launched a major operation to investigate cases of illegal funds and properties stashed abroad by Indians. There were recent reports that the I-T department has launched investigations against at least 7,500 Indians who have bought properties in Dubai in the last few years.
Purchasing a property abroad can get complex depending on the structure that a buyer uses for the transaction. “The tax department may want to know the source of funds and the Reserve Bank of India (RBI) wants to know whether the individual stuck to the Liberalised Remittance Scheme (LRS) regulations,” says Ashok Shah, partner, N A Shah Associates.
The simplest way is to remit the money in a foreign bank account up to the permissible annual limit and buy a property in your name. But the rules can get complicated if you are borrowing money or if you are planning to form a company abroad to buy and hold property.
Under the LRS, any Indian can remit up to $250,000 abroad in a financial year. A family of four can remit $1 million. The regulator has specified the restrictions on the use of these funds. The money, for example, cannot be used for buying lottery tickets, betting, or other speculative trades. The individual can, however, use it to purchase property, provide for maintenance of relative, invest in stocks, bonds, mutual funds, buy art, set up a company, and so on.
Tax experts feel that many of the individuals who are under scrutiny may have used the grey areas in the law to buy property abroad. Other than inquiring about the sources of funds, the investigating agencies will also probe whether the buyers have stuck to the Foreign Exchange Management Act guidelines.
Around a decade ago, a few remitted the funds, set up a company and bought real estate through the firm. RBI later clarified in the ‘frequently asked questions’ of its website that an entity set up to buy real estate is not allowed. After the clarification, experts took the view that an individual should be able to buy equity in a company that already holds real estate. A few Indians started buying stakes in such firms.
The key reason for routing the purchase through the company structure was to take a loan to buy property. Indian laws don’t allow individuals to borrow money outside the country. Following these developments, the banking regulator started initiating compounding proceedings against individuals who used the company route for real estate. Under compound proceeding, RBI levies penalties and may even order the person to wind up his business within a stipulated time. “The regulator wants LRS to be used primarily for portfolio investment.
It doesn’t favourably look at transactions where the individual controls a company or is the key part of the management of a firm where he has invested,” says Shah.
There are still grey areas that exist today. No one yet knows whether they can pass the regulator’s muster. What if a person is setting up a commercial real estate business abroad, wherein he buys properties through a company and leases them out to earn rental income? Bankers and tax experts feel that RBI has specified that individuals can set up “bona fide business”. Commercial real estate business should be able to pass the muster of the regulator.