Broadly, two kinds of income streams arise from holding any residential property, i.e., income from transfer of property and rental income from letting out of property. The Income-tax Act, 1961 (the Indian tax law) contains specific provisions for taxing the income under both these streams. Under the Indian tax law, income from transfer of residential property is taxed under the head ‘Capital Gains’ and rental income is taxed under the head ‘Income from house property’.
Taxability of income on transfer of residential property
Based on the period of holding of the residential property, capital gains arising from transfer of such property is characterized as a short-term capital gain or as a long-term capital gain. A property held for less than 24 months is treated as a short-term capital asset and the resultant short-term gain on transfer is taxable at the normal tax slabs applicable to the NRI. Gains from a property held for 24 months or more is taxable as a long-term capital gain at a rate of 20% (plus applicable surcharge and cess).
Capital gains are taxable in the year in which the property is transferred, irrespective of whether the sale consideration has been received in full or not. The capital gain is calculated as the difference between the full value of sale consideration and the cost of acquiring and improving the said capital asset. Expenses such as brokerage/commission, etc., incurred exclusively for transfer of property are allowed as a deduction from the sale price.
In case of long-term assets, the cost of acquisition and improvement are indexed to adjust for inflation. The benefit of indexation is not available to residential property held as a short-term capital asset.
No tax on inheritance
It is important to note that capital gain does not arise on inheritance of a property as the tax laws specifically exempt assets received by way of an inheritance. However, capital gains tax shall be applicable when the inherited property is sold.
How to reduce tax out-go on long-term capital gain
The tax laws provide the following deductions from levy of long-term capital gains tax on transfer of residential property, if the gains are invested as specified:
• Where the amount of long-term gain is invested for purchase/construction of a new residential house property in India, a deduction to the extent of the gains invested shall be available. The new property should be purchased either one year before or two years after the date of transfer or the property should be constructed within three years from date of transfer.
In case an individual is unable to invest in a new property before filing the income tax return, the gains can be temporarily invested under the ‘capital gains account scheme’ by opening an account with specified banks or institutions in India. The gains can be held in this account for three years within which period the amount needs to be withdrawn for purchase or construction of the new residential property. Failure to utilize the amount as prescribed would result in the capital gains becoming taxable.
• Capital gain amount to the extent of `50 lakh may also be invested in specified bonds within six months from the date of transfer of the long term capital asset to obtain a deduction from capital gains tax.
Tax on rental income from residential property
Income from renting out a residential property is taxable under the head ‘income from house property’. A step by step computation mechanism is provided in the tax laws for the same.
The first step is to determine the annual value of the property—which would be higher of standard rent the property might be expected to fetch or the actual rent receivable for the said property. Any municipal taxes paid during the year are allowed as a deduction. Next, a standard deduction @ 30% of the annual value is allowed towards repairs and maintenance and a deduction of up to `2 lakh is allowed towards interest payable on any loan taken with respect to the said property.
There is no tax implication in case of one self-occupied property, i.e., property occupied by the owner for his own/family residence or a property which cannot actually be occupied by the owner due to the fact that he has to reside at another place on account of his employment, business or profession carried on at such other place.
However, where the NRI owns more than one residential property which are self-occupied, then only one of the houses will be treated as self-occupied and all others will be treated as deemed to be let out.
In such cases, a notional rent is computed and offered to tax as if the property was rented out.
Other tax implications
Tax withholding obligations on purchase of property:
The income tax laws impose certain tax withholding obligations at the time of purchase of property in India. The rate of tax withholding depends on whether the purchase is from a resident or a non-resident owner.
• Purchase of property from a resident: an NRI investor who purchases a property valued at `50 lakh or more from a resident is required to withhold tax at source @ of 1% of the total purchase value. The tax is required to be withheld at the time of payment of the purchase price or part thereof and is required to be deposited in the government treasury within 30 days from the end of the month in which it was deducted.
• Purchase of property from a non-resident: in case an NRI investor purchases a property situated in India from a non-resident, he is required to withhold tax @ rate of 20% (plus applicable cess and surcharge) of the capital gains if the gain to the seller is a long term. In case of short term capital gain to the seller, tax @ 30% (plus applicable cess and surcharge) on the gain amount is to be withheld. It is important to note that in this case, the NRI buyer is required to withhold tax even if the value of property is less than `50 lakh.
Applicability of tax treaty
India has entered into double tax avoidance agreements (DTAA) with more than 80 countries which broadly provide a framework to ensure that a taxpayer does not suffer double taxation in more than one country on the same income.
Generally, as per the DTAAs entered into by India with various countries, the source state (i.e. the country in which property is situated) has taxation rights in respect of the immovable property (including residential property) for both capital gains and rental income. However, an NRI may claim a credit in his country of residence with respect to taxes paid in India as provided in the relevant DTAA.
An NRI is required to file an income tax return in India to disclose the rent or capital gains arising from the property situated in India and taxes paid thereon within the prescribed due date.
Foreign exchange regulations
In addition to tax implications, certain foreign exchange regulations may also be applicable to transactions related to residential properties held in India, such as limits on the remittances from India, the type of bank account, etc. It is, therefore, imperative that tax and regulatory implications arising from ownership of residential property in India are understood by NRIs so that the benefits from their investments are enjoyed with peace of mind.
1. What are the specified bonds for investment in order to claim deduction from long term capital gains tax?
The investment up to `50 lakh can be made in bonds, redeemable after five years, issued by the National Highways Authority of India, or by the Rural Electrification Corporation Limited, or any other bond notified in the official gazette by the central government for this purpose.
2. How is the tax liability with respect to capital gains or rental income to be discharged?
India follows a ‘pay-as-you-earn’ system for payment of taxes. Advance tax is payable in four instalments during the year, as a specified percentage of total estimated tax due for the year. In case of capital gains, advance tax is payable on the instalment due after the date of transfer. Balance tax liability is calculated at the end of the financial year and paid in the form of self-assessment tax.
Rajashree Sarna contributed to this article.
Vikas Vasal is national leader tax at Grant Thornton India.