Contributed By J. Sagar Associates
The legal system in India comprises civil law, customary and religious law, and common law. Real estate transactions are subject to Central and State legislation, personal/religious laws and judicial precedents. There is also subordinate legislation, such as rules, regulations and by-laws made by local authorities like municipal corporations, gram panchayats and other local administrative bodies. Laws relating to real estate in India can be categorised as follows:
The real estate sector has seen a significant increase in investments in equity instruments, while investments from non-banking financial companies (typically in debt instruments) have reduced.
Legislative trends show continued emphasis on liberalising the Indian economy, with renewed focus on the development of real estate in a transparent manner. Some significant developments are as follows:
In terms of significant transactions, there have been many investments into India, including various investments made by sovereign wealth funds. Large investments have been made into commercial real estate with the intention of moving the interest in real estate assets owned by large developers into REITs.
The documents for leasing arrangements have become significantly more sophisticated and, in several transactions, facilities in excess of 1,000,000 sq. ft. have been taken on lease.
Impact of COVID-19 Pandemic
While we have covered the extant lex loci, it should be noted that due to the prevailing COVID-19 pandemic, several temporary changes across various laws have been introduced, including FDI restrictions, extensions and relaxations for compliance requirements, introduction of moratoria for limitation and application of force majeure clauses in contracts. These affect the real estate sector as well, and should be kept in mind when dealing with specific transactions.
Real estate has been revolutionised by tremendous evolution in information technology in the past decade. Two such technologies are Blockchain and Proptech. Blockchain facilitates an entire real estate transaction (buying, selling or renting) online, without the presence of a middleman, attempting to make this industry transparent and efficient. Proptech streamlines and connects processes for participants in all stages of real estate transactions, including buyers, sellers, brokers, lenders and landlords.
Blockchain and Proptech are set to revolutionise the real estate industry. Blockchain in particular will fast-track the entire process and make it more transparent. It does not require the use of old-time systems like registers and forms, as everything will exist online and will be included within the smart contract.
The State Government of Andhra Pradesh has partnered with a Swedish start-up to build its blockchain-based solution. In 2018, NITI Aayog highlighted its efforts towards IndiaChain, a blockchain infrastructure for managing public records and building social applications, which will also be used for maintaining land records. Many State Governments (Maharashtra, Telangana, Andhra Pradesh and West Bengal) are exploring opportunities to integrate blockchain-based ledgers in the digital land record system.
Despite the introduction of these disruptive technologies in India, there may not be any significant impact on the real estate market over the next year as the Indian government is not currently capable of integrating such technologies.
The government has taken steps to ease the regulations governing foreign direct investment (FDI) in single brand retail trading. While there are no significant indications from the government at this point in time, foreign investors are hopeful that the next progressive step would be in the multi-brand retail trading sphere. Most recently, the government has announced various initiatives to increase investments in warehousing and logistics sectors, and it is expected that this would result in growth in the real estate sector as well. In light of several large investment plans for data centres in 2019, the Finance Minister has recently proposed formulating a policy for setting up data centre parks.
The categories of property rights are freehold rights, tenancy (lease) rights, and licences and easements.
A person acquires absolute right, title and interest (including undivided interest) in a property and becomes the sole owner of the property, with unfettered freedom and the right to deal with the property in the manner deemed fit by the owner.
Tenancy (Lease) Rights
A person acquires limited interest and rights in relation to a property, with the right to occupy and deal with the property in the manner contractually agreed between parties. Indian law also recognises the concept of statutory tenants, who are protected under the applicable rent control statute and can be evicted only on limited grounds. Most modern developments leased to corporates are, however, not affected by rent control legislation as corporates do not generally derive protection under such.
In India, tenancy matters are governed by state-specific statutes/law, and matters not covered by state legislation are governed by TOPA, which is a Central legislation.
In 2019, the Government of India released the draft Model Tenancy Act, 2019, which aims to establish a Rent Authority to: (i) regulate the renting of premises in an efficient and transparent manner, (ii) balance the interests of owners and tenants by establishing adjudicating mechanisms for speedy dispute redressal, and (iii) establish Rent Courts and Rent Tribunals. Each state is required to implement its tenancy act on the lines of the draft Model Tenancy Act, 2019.
Licences and Easements
Licences are governed under the Indian Easements Act, 1882 (Easement Act); easements are also recognised separately in Indian law. An easement is a right that the owner of a property has to compel the owner of another property to allow something to be done or to refrain from doing something on the servient element for the benefit of the dominant tenement. A licensee acquires the permission of the owner to use the property, and use is restricted to contractual terms without de jure possession being granted to the licensee.
Generally speaking, a person can acquire title to immovable property by:
Certain states prohibit companies/firms from purchasing/leasing agricultural land, and prohibit people with income above a threshold or who are not already agriculturalists from purchasing agricultural land. Certain states also have land ceiling laws that restrict the acquisition of land beyond specified limits.
Documents governing rights/transfers of immovable property are registered before the jurisdictional Sub-Registrar of Assurances. Registrations are mandatory for instruments evidencing a transfer of interest in immovable property of a value more than INR100. Once registered, documents become a part of the public record and can be accessed by anyone. Such transfers also require the payment of duties (such as stamp duty, registration fee and other cess applicable to each state) and are recorded by the revenue departments, which maintain a separate set of documents for each property.
Where transfer is effected through succession, revenue records are updated to reflect the inheritance; these become publicly available once recorded.
Insurance companies in India have started to provide title insurance, though establishing title is often very complicated. Measures are being taken to simplify the manner in which title can be verified, and governments are taking steps to make such records electronic, although it will take some time for all the relevant documents to be sorted methodically and made available in electronic form.
Tracing title to property is often complicated, as records are not centrally located and are maintained by different governmental departments. Antecedent documents in each state are often in vernacular languages.
When conducting due diligence, one may not discover all litigation, mortgages by deposit of title deeds and unregistered contracts (which do not require registration under the Registration Act) that have a bearing on the title of the property, so it is important to take detailed representations and warranties. In some States, litigation cases are required to be registered with the Sub-Registrar in order to become binding or be considered as constructive notice to a person buying immovable property subject to litigation.
Taking possession of original title deeds at the time of sale is also very important as they can be used to mortgage/encumber a property. Where the original title deeds are not available, great care needs to be taken to ensure there has been no mortgage/encumbrance by deposit of title deeds by the seller or his predecessor-in-interest.
Due diligence also sometimes requires the issuing of public notices in local papers inviting claims in respect of the property and taking searches before the court offices, also referred to as negative searches. If any claim is made or litigation is discovered, the purchaser then takes a call on whether or not he should still go ahead with the transaction.
Representations and warranties vary depending on the nature of the transaction. In most transactions, representations and warranties are very comprehensive, except where a transfer is on an "as is, where is" basis, and the liability of the seller is limited to the purchase price or a portion thereof. It is common to back representations and warranties by indemnities and, very often, there is no limitation of liability. That said, in India, only direct damages are awarded (ie, damages that naturally arose in the usual course of things from a breach, or which parties knew, when they made the contract, were likely to result from the breach of it). Indian courts do not award indirect, consequential, special, exemplary or punitive damages to plaintiffs for breach of contract.
The important areas of law include:
The buyer will not be responsible for soil pollution or environmental contamination of a property if they can prove that they were not responsible for such an act. Typically, the buyer is indemnified against any action initiated by the government department for contamination of a property prior to its purchase. However, proceedings for environmental contamination are few and far between, although this may change as environmental issues are attracting more recognition.
The buyer can ascertain the permitted uses of a property based on zoning regulations formulated under relevant town and country planning statutes. To aid development of strategic areas, government entities may also enter into agreements with developers whereunder they allot land with certain obligations imposed on its development.
The Constitution of India no longer recognises the right to hold property as a fundamental right. However, Article 300 (A) was included in the Constitution of India to affirm that no person would be deprived of his property except by authority of law.
State Governments are authorised to acquire lands for public purposes. The current land acquisition statute prescribes the following:
Land parcels acquired by the State Governments vest with the State Governments free of all encumbrances and any title defects. As such, the complexity of conducting due diligence reduces as no documents prior to acquisition need to be reviewed.
Any transfer of property requires the payment of duties levied by the government, such as stamp duty and cess (which differ from state to state), and registration fees. Where the asset is under construction and not ready for use, GST is also required to be paid by the seller. However, GST is an indirect tax, so can be recovered from the buyer. In an asset deal, the duties are generally paid by the buyer, unless they are otherwise agreed to be shared between the buyer and the seller. Most stamp acts provide that, where there is no agreement to the contrary, on a sale the stamp duty will be paid by the purchaser, while it will be paid by the lessee on a lease.
For transactions involving the transfer of shares in physical form, stamp duty at 0.25% of the value of consideration for the shares is also payable upon transfer. Where shares/securities are in a dematerialised form, there is no stamp duty payable on the transfer of shares, although there may be some transaction charges (which would in any event be significantly lower than the stamp duty).
Stamp duty under the head of conveyance need not be paid if property is contributed into a partnership firm. However, any exit from the partnership by the original contributor will attract the payment of stamp duty as if it is a conveyance. The rate of stamp duty will vary from state to state.
Exemptions on the payment of stamp duty and certain tax benefits are available to entities operating out of free trade zones known as "special economic zones".
A person who is resident outside India can acquire property or invest in real estate in India only in accordance with FEMA, which prescribes limited circumstances for such matters.
While foreign investment into real estate construction and development has been liberalised significantly, certain restrictions remain. An important restriction is that the investment has to be locked in for three years, calculated with reference to each tranche of investment, except in cases where the construction of "trunk infrastructure" is completed. The aforesaid lock-in is also not applicable to the construction of hotels and tourist resorts, hospitals, special economic zones, educational institutions and old-age homes.
In respect of completed projects, FDI is specifically permitted in certain projects, such as the operation and management of townships, malls/shopping complexes and business centres, with a lock-in of three years (calculated with reference to each tranche of investment) being applicable to investments in such completed projects. Furthermore, earnings of rent/income on the lease of a property, not amounting to a transfer, will not amount to real estate business. This provision enables FDI in completed projects if the building is leased and units are not sold.
Typical fund-raising means for companies engaged in the real estate sector include FDI, REITs, alternative investment funds (AIFs), debt financing and external commercial borrowing (ECBs).
While FDI in real estate business is prohibited in India, it is permitted in construction development projects and the development of industrial parks. "Real estate business" is defined as dealing in land and immovable property with a view to earning profit therefrom but does not include the development of townships, the construction of residential/commercial premises, roads or bridges and REITs registered and regulated under the REIT Regulations. Furthermore, earnings of rent/income on the lease of property, not amounting to a transfer, will not amount to real estate business. Accordingly, FDI of up to 100% is permitted under the automatic route for companies engaged in these sectors, subject to certain limited conditions.
Entities engaged in real estate broking services are also permitted to receive up to 100% FDI under the automatic route.
FDI may be through subscription to equity shares and instruments that are compulsorily convertible into equity and are required to comply with pricing guidelines prescribed by the Reserve Bank of India (RBI).
Each phase of a construction development project would be considered as a separate project, so an investor can potentially exit before the completion of an entire project, subject to a lock-in period of three years, as mentioned earlier.
This is a relatively new mode of fund-raising, with only one REIT having been set up so far, although several developers and investors are looking into REITs as an attractive means of fund-raising or (in case of investors) liquidating investments and exiting. REITs in India are private trusts set up under the Indian Trusts Act, 1882 and compulsorily registered with SEBI. The set-up of REITs would include the sponsor (who sets up the REIT), the manager (who manages the REIT’s assets, investment and operations) and the trustee (a SEBI-registered debenture trustee who is not an associate of the sponsor or manager, and who holds the REIT assets in trust for the benefit of the unitholders/investors). Furthermore, the REIT Regulations have been modified to permit, inter alia, REITs to issue debt securities for raising funds.
Alternative Investment Funds (AIFs)
AIFs are privately pooled investment vehicles that collect funds from investors (Indian or foreign) for making investments, and are regulated by the SEBI (Alternative Investment Funds) Regulations, 2012. AIFs have to be compulsorily registered with the SEBI. AIFs may invest as private equity or debt funds, or both. There are, however, certain restrictions with which AIFs have to comply.
Recently, one INR25,000 Crores Category II AIF has been formed under the Special Window for Affordable and Mid-Income Housing. The fund aims to provide last-mile financing to enable the completion of the construction of stalled housing projects. This scheme was approved by the cabinet on 2 November 2019. The AIF will likely be investing in real estate companies through non-convertible debentures (NCDs).
The most common means of fund-raising for real estate developers is by the issuance of NCDs to non-banking finance companies, banks, financial institutions and other private lenders. Debt investments by banks are subject to certain prudential norms relating, inter alia, to the exposure of banks to such investments, as stipulated by the RBI. While this has motivated several developers to seek investments from non-banking finance companies, financial institutions and other private lenders, which can provide typical loans as well as other structured lending solutions, market conditions have affected investments by non-banking finance companies in recent times.
External Commercial Borrowings (ECBs)
The RBI has recently eased the definition of beneficiaries eligible for ECBs to include all entities that can receive FDI. Funds borrowed under ECB cannot generally be used, inter alia, for real estate activities, except when used for (i) the construction/development of industrial parks/integrated townships/special economic zones, (ii) purchase/long term leasing of industrial land as part of a new project/modernisation of expansion of existing units, and (iii) any activity under the "infrastructure sector" definition. Restrictions on ECBs for funding real estate transactions broadly remain similar under the new framework. In lieu of the existing sector-wise limits, all eligible borrowers are now permitted to raise up to USD750 million or equivalent per financial year under the automatic route.
Typical security includes:
Where security is in the form of a mortgage, the mortgage deed would have to be registered with the jurisdictional Sub-Registrar of Assurances. Where an equitable mortgage is created by the deposit of title deeds, the recording of said deeds may need to be registered in certain states in India. Secured lenders are required to register their security interest created on such assets (whether tangible or intangible) with the Registrar of Companies (ROC) and the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI), which is a central database for all security interests created, established for the purpose of checking and identifying fraudulent activity when loans are advanced against security interests in assets.
FDI in Indian companies cannot be secured and must be treated as equity investments wherein investors take risks typical to equity investments. Accordingly, foreign investors investing under the FDI route are not permitted to have assured returns at the time of exit by the RBI. However, where investments are made in NCDs, the NCDs can be (and typically are) secured, including where the NCDs are issued to permitted foreign investors. Security in such cases is typically created in favour of a security/debenture trustee. In the case of an ECB, a pledge over shares of an Indian company in favour of a foreign lender requires compliance with ECB guidelines and approval of the authorised dealer bank (AD Bank). The creation of a charge over assets situated in India in favour of a foreign lender will be subject to compliance with Non-Debt Rules and Debt Regulations, and approval from the AD Bank.
As far as is known, the reach of the Committee on Foreign Investment in the United States (CFIUS) pursuant to the Foreign Investment Risk Review Modernisation Act of 2018 (FIRRMA) has not had an impact on real estate finance in India.
Stamp duty is payable on all documents. Insufficiently stamped documents may be impounded and may not be admissible as evidence in Indian courts. Some documents need to be registered under the Registration Act, with payment of the applicable registration fees. Certain documents, such as powers of attorney, are also required to be notarised and are subject to notarisation fees.
Necessary corporate authorisations are required under the Companies Act, such as board resolutions and shareholder resolutions. Any charge is required to be filed with the ROC and, in case of non-compliance, such security interest would be held as void against the liquidator and the other creditors of the company in the event of a winding-up of the company, although the obligation for repayment of money secured by the charge will continue to subsist.
Under RERA, there are some restrictions on the ability of companies and real estate developers to secure their borrowings (for instance, on the ability to hypothecate project receivables).
Where the borrower in default is solvent, it is not particularly difficult for a lender to seek to enforce its security.
Where a borrower is insolvent or unable to repay its dues, provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) are applicable.
Separately, banks and financial institutions that have lent monies to a borrower are entitled to enforce their security interest without the intervention of a court/tribunal, subject to strict compliance with the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI). However, it should be noted that action under IBC and SARFAESI cannot be taken simultaneously, since a moratorium is declared upon the admission of an insolvency application under the IBC by a National Company Law Tribunal.
As a general rule, where the priority of security is not contractually agreed between the parties involved, security created earlier in time will rank in priority to security that is created subsequently. A first ranking charge will have priority over a second ranking charge at the time of the enforcement of security. However, it is possible for existing secured debts to become subordinated to new debts when an intercreditor agreement setting out the ranking of debt or a subordination agreement is signed.
Typically, in Indian lending transactions, shareholder/promoter loans are unsecured and subordinated.
Lenders will not ordinarily incur liability under Indian environmental laws simply by holding a security interest. If a lender takes over management and control of the borrower after the enforcement of security, such lender may incur liability as the person in possession of the polluting premises, or as a person responsible for the conduct of the borrower’s business.
The optimum outcome of an insolvency application under the IBC is a successful corporate insolvency resolution process (CIRP). However, when a CIRP fails, liquidation follows. There are also provisions for voluntary liquidation. Where a borrower goes into liquidation, the IBC provides the manner in which secured debt will be discharged. Typically, workmen’s dues are prioritised over dues to lenders who have relinquished their security interest to the liquidation process. Similarly, wages and dues owing to employees (other than workmen) are ranked pari passu with such lenders who have relinquished their security to the liquidation estate.
The exposure of the real estate industry in India to foreign currency borrowings per se has been negligible because of RBI restrictions, and the expiry of the London Interbank Offered Rate (LIBOR) index in 2021 would have limited impact. However, going forward, this topic may need to be analysed, given the recent liberalisation of the ECB regime in India, and alternative interbank interest rates should be used, such as Euro Interbank Offered Rate (EURIBOR). The extant ECB guidelines use the words “LIBOR or any other 6 months interbank interest rate applicable to the currency of borrowing such as EURIBOR”.
Planning authorities are constituted for the implementation and governing of zoning regulations for orderly development of a state. Considering the changing dynamics of a city, every state facilitates the updating and revising of an existing master plan at least once every ten years, by carrying out a fresh survey of the area within its jurisdiction with a view to revising the existing master plan and indicating the manner in which the development and improvement of the entire planning area is proposed.
Certain states facilitate the acquisition of lands by government organisations or agencies for industrial and residential developments. The developments in such areas are mainly governed by the rules and regulations framed by such government organisations/agencies.
Any change in the zoning regulations will require prior consent of the State Government, the process of which is time consuming and does not always result in consent being given.
The construction of new buildings and refurbishments in any state is governed by the National Building Code, the applicable town and country planning statute, and the applicable municipal law, including the building by-laws framed by the respective planning authorities. The building regulations bear out that various approvals are required to be obtained from different authorities for the construction or refurbishment of buildings.
Development is also required to be in compliance with the zoning regulations and building by-laws. Zoning regulations sometimes have provisions for the protection and preservation of properties that are identified as heritage properties. Consents from the pollution control board, the environmental department, the fire department, the airport authority, the water supply and sewerage board and the electricity board are also required.
There is no single regulatory authority or statute to govern the entire real estate sector, so the relevant authorities have been covered separately.
An application is required to be submitted to the jurisdictional planning authority along with all relevant title documents, plans/designs/drawings of the development, and in-principle approvals from the relevant authorities.
Once the planning authority is satisfied that the building, when constructed, would comply with the building by-laws, it provides its consent.
A certificate is also often issued by the planning authority after the pillars are constructed, confirming that the construction has commenced in compliance with the sanctioned plan.
Pursuant to completion of the development, the planning authority also issues a certificate confirming that the building is fit to be occupied. Although minor deviations are compounded by collecting a fee, any major deviations in the development may result in the project not being issued a completion certificate.
The applicable town and country planning/municipal statutes prescribe timelines within which the planning authorities are required to grant approval or reject plans for the development of buildings.
Where a plan submitted for approval to the authority has been rejected or not expressly approved, the applicant may prefer an appeal to a higher authority, which is required to grant or reject the application within a prescribed time period. Where no response is received, the plan is often deemed to have been approved.
In the event of any arbitrary action initiated by a planning authority, the aggrieved party can approach a High Court, invoking its high prerogative writ jurisdiction.
Government entities enable parties to procure land for the development of strategic projects/areas – whether industrial, commercial or residential – by entering into:
The property is conveyed in favour of the allottee only upon compliance with the conditions in the agreements.
Where land is allotted by the government, the process of obtaining approvals for the implementation of the project is generally faster. In some large projects, the developer may be required to lease/relinquish a small portion of the property in favour of the electricity supply company for the setting up of a sub-station to supply power to the development.
For enforcement, parties are given sufficient notice and an opportunity to be heard prior to initiating any action against the developer or the development. The affected parties will have the right to approach a High Court, invoking its high prerogative writ jurisdiction, in the event of any arbitrary action initiated by the planning authority.
Real estate assets can be owned/held by private limited companies, public limited companies, LLPs and partnerships. In addition, REITs are increasingly being considered by investors.
Private and public limited companies are required to be incorporated under the Companies Act and to adopt articles of association and a memorandum of association, which would set out the objects and regulate the operations of the entity.
LLPs are incorporated under the LLP Act. Foreign investment into LLPs engaged in construction development activities requires regulatory approval.
Partnerships can also hold land, but foreign investment requires regulatory approval.
REITs are set up and operated in accordance with the REIT Regulations.
Typically, foreign investors prefer private limited companies, while domestic investors prefer partnerships and LLPs for smaller holdings.
There are no minimum capital requirements for public limited companies, private limited companies, LLPs or partnerships. REITs are required to comply with regulations relating to asset size and minimum offer.
Private limited companies are required to have at least two directors on their board, while public limited companies need at least three directors. Public companies also need to comply with additional requirements, such as having independent directors on their board.
LLPs and partnerships are required to have at least two partners.
Separately, every listed company and certain other unlisted companies that have paid-up capital over a prescribed threshold are also required to appoint a company secretary.
The costs for entity maintenance vary based on the type of entity involved. Annual compliance costs for a private limited company would typically be around GBP10,000, and similar or lower costs can be anticipated for compliance by LLPs.
The law recognises the concepts of leases and licences that permit a person, company or other organisation to occupy and use real estate for a limited period without acquiring the absolute title to said real estate.
The simple difference between a lease (under TOPA) and a licence (under the Easement Act) is that a lease is the transfer of a right to enjoy the premises for a limited time, while a licence is a privilege to do something on the premises which would otherwise be unlawful without permission. The transaction is a lease if it grants an interest in the premises; it is a licence if it gives a right to a permissive user with no interest in the premises.
The law does not differentiate between different types of commercial leases. Most commercial leases are based on a fixed rental and fixed term concept. There are triple net leases where the tenant bears the cost of the property tax, the insurance of real estate and maintenance charges, and profit-sharing leases where the rent is based on a percentage of the lessee’s revenue, but these are not as common.
Other than a few states in India where some properties are regulated by rent control statutes and where there are statutory tenants, rent or lease terms are freely negotiable in contracts entered into between parties. The rent and the lease terms largely depend on the city, the location of the building and the present market rents payable for similar buildings.
Length of Lease Term
The initial term of a lease is generally between three and five years. There are also cases where the tenant opts for a longer lease of ten years. It is common to have an agreement to lease for a longer period (paying nominal stamp duty) and to execute lease deeds thereunder where such arrangements result in a lower stamp duty payment.
Maintenance and Repair of the Real Estate Actually Occupied by the Tenant
Maintenance and repair of the actual premises occupied by the tenant are generally the tenant’s responsibility. In most cases, major or structural repairs (that are not attributable to the tenant) are excluded from the tenant’s scope of responsibility.
Frequency of Rent Payments
In most commercial leases, rents are payable on a monthly basis in advance. For retail leases, malls, hotels, and so on, the lease rent or a portion thereof can be based on the turnover of the lessee’s revenue at the establishment. Where a furnished space is provided, rent may be payable on the furniture and fittings only until the cost of such furniture and fittings has been fully depreciated.
In a typical commercial lease in India, the rent will escalate every three years; the rate of escalation is generally between 10% and 15%.
The concept of a rent review and escalation of rent based on market rent is not common in Indian leases. Where a rent review is agreed to in a long-term lease, the prevailing market rent is determined by an independent expert. The determination of rent is typically subject to certain exclusions, including disregarding (i) any goodwill attached to the premises by reason of the tenant’s business or occupation of the premises, and (ii) the effect of any improvements made by the tenant at the premises.
VAT has been subsumed by GST, which is payable on leases of property/asset for commercial use, and is borne by the tenant. The tenant can claim input tax credit, subject to conditions in law, of such tax paid to the landlord. Also, tax on the lease rent is deducted at source in terms of the Income Tax Act, 1961 (IT Act) by the tenant prior to paying rent to the landlord.
In most commercial leases in India, a tenant is required to pay the landlord an interest-free refundable security deposit, also known as a premium, which is held by the landlord as security for the tenant’s obligations during the lease term. The quantum of the deposit is commercially agreed but the practice differs from state to state and can start at three months’ rent and go up to 12 months’ rent.
In addition to rent, tenants usually pay maintenance charges and a fixed parking fee based on the number of parking spaces exclusively provided to the tenant. The landlord (or a third party nominated by the landlord) generally takes responsibility for the maintenance and repair of the common areas, the cost of which is charged back to the tenants on a fixed-cost basis (with an agreed escalation) or on an actual cost-plus basis, with the landlord receiving a management fee of 15% to 20% of the cost incurred in providing the services.
All such payments (other than municipal taxes borne by the tenant) made to the landlord for use of the property are subject to withholding tax as well as GST. Any non-refundable deposit is subject to the deduction of tax at source as rent.
Utilities (including power, back-up power, water, etc) are paid by each tenant of the building based on the quantities actually consumed.
The policy obtained is, in most instances, a fire and perils policy covering loss of property. The cost of insurance is at times charged back to the tenants as part of the maintenance charges.
The usage of a project/building is dependent on the zoning of the land and any conditions running with the land. At times, land is allotted to a landlord for a determined purpose, like for biotechnology or IT-related uses, and accordingly the landlord would impose the same restrictions on the tenants under the lease. Non-compliance with the usage provision could result in a termination of the lease.
Generally, a tenant is only permitted to perform non-structural alterations at the premises (including fit-outs); structural alterations are only permitted with the prior consent of the landlord. The landlord may impose conditions, such as requiring the landlord’s consent on the contractors to be engaged or the materials to be used. The landlord may also require the tenant to reinstate the premises to the condition prior to the alteration upon the expiry or termination of the lease. Where a tenant takes land on lease for a long period, the tenant would have the right to develop the land as he requires, subject to applicable law. Upon the expiry or termination of the lease, development on the land would revert to the landlord, at no cost or at an agreed cost, based on the contractual understanding. Under Indian law, the owner of the land and the owner of the building constructed thereon can be different people. Gain, if any, on a transfer of development rights in a property is subject to tax as income of the landlord. The transfer of development rights to the tenant for developing the land and for commercial exploitation is subject to GST and is taxable in the hands of the tenant (under the "reverse charge mechanism"). GST payable by the tenant is subject to conditions and calculated in the manner prescribed under law.
Laws relating to leases do not differentiate between residential, industrial, commercial or retail leases, but commercial treatment may differ from market to market.
In most cases, a tenant’s insolvency will result in the termination of the lease as the tenant would not be able to comply with its obligations under the lease.
Payment of a refundable security deposit/premium is the most common security provided to the landlord. At times, the landlord may require the tenant to provide a bank guarantee for securing certain payment obligations.
If contractually agreed, the tenant may have the right to continue to occupy the premises as a monthly tenant after the expiry or termination of the lease or in the specific instance where the landlord does not refund the security deposit paid by the tenant in time. In all other cases, the tenant would have to leave the premises on the date of the expiry or termination of the lease. Where the tenant does not vacate the premises, the landlord would have to approach the court to evict the tenant, who will have the status of a trespasser. The landlord would also have the right to claim mesne profits from the tenant for such unauthorised occupation.
Under Section 108 (j) of TOPA, a lessee may transfer absolutely – or by way of mortgage or sub-lease – the whole or any part of his interest in the property, and any transferee of such interest or part may again transfer it, subject to the lessee not ceasing any of the liabilities attached to the lease and there being no contract to the contrary. In respect of a statutory tenant, state legislation also prescribes restrictions on transfers. Under the Maharashtra Rent Control Act, 1999, for example, a tenant cannot sub-let or assign the interest in the premises without the express consent of the landlord. The sub-lessee has to abide by the lease agreement executed between the lessor and the lessee.
Events of default and termination rights are contractually agreed between parties, including the granting of a cure period following an event of default before the termination rights arise.
Leases of immovable properties from year to year or for any term exceeding 12 months or reserving a yearly rent require mandatory registration at the office of the Sub-Registrar of Assurances that has jurisdiction over the location where the property to be leased is situated. Section 23 of the Registration Act requires the deed to be registered within four months from the date of its execution. An extension of an additional four months may be granted by the Registrar at his discretion, by levying a penalty, provided such non-presentation of the instrument within four months of execution was due to genuine reasons or unavoidable circumstances. After registration, the lease is recorded in the local Registry of Deeds.
Stamp duty is payable on the lease deed before it is registered.
Although licences are not normally required to be registered, certain states require it. For example, under Section 24 of the Maharashtra Rent Control Act, an agreement for leave and licence is compulsorily required to be registered.
Where a tenant has defaulted on the terms of the lease and the landlord initiates eviction proceedings in terms of the lease deed, the process for eviction of the tenant may take between three and seven years. The landlord can seek mesne profits from the tenant for unauthorised occupation. Where termination is during the lock-in period, the landlord may be able to seek lease rent for the balance of the lock-in period.
A third party cannot terminate a lease unless contractually agreed. In the event of a condemnation event by a government body, the lease will stand terminated as the property will vest with the governmental authority concerned. Compensation payable for such acquisition is typically paid to the owner of the property, unless the sharing of compensation is contractually agreed between the owner and the lessee.
Construction industry contracts are typically lump-sum turnkey fixed-price contracts, bill of quantities-based contracts (item-rate contracts) or work package-based contracts.
For projects where a detailed bill of quantities is possible, owners opt for an item-rate contract, which gives them greater control of the contract price. For large infrastructure sector construction projects, lump-sum turnkey construction contracts are common.
In India, fixed-price contracts prove problematic since the prices of raw materials fluctuate quite significantly, being dependent on the rate of inflation (which is in the region of 4% to 7% in India).
Split structure and design and build structures are commonly used for risk allocation and rewards for construction projects. Owners have a right to review and certify the contractor’s compliance. Contractors are often responsible even after completion, and during any agreed defects liability period and latent defects liability period.
In a split structure, owners appoint an architect for design and a contractor for construction. This is prevalent for the construction of real estate or manufacturing units.
For design and build structures, the owner enters into a lump-sum turnkey contract with a qualified entity who is responsible for the entire project, entailing managing, supervising and co-ordinating all other contractors/subcontractors to ensure that work is carried out safely as per the project schedule and to meet the owner’s standards.
The owner may, at the contractor’s cost, have the contract performed through a third party for non-performance by the contractor. This right has been bolstered with the Specific Relief (Amendment) Act, 2018.
Standard indemnity provisions are prevalent in construction contracts, and the limitation of liability usually varies between 50% and 100% of the contract price.
Contractors may be required to provide the owner with a corporate guarantee or a fund-based performance guarantee.
The retention of payments is also common, and such guarantee/retention amount is released after completion of the defect liability period.
Warranties as to workmanship and quality, fit-for-purpose warranties, adherence to technical specifications, and adherence to prudent industry practice are generally undertaken by contractors, subject to industry-specific and technical exceptions.
Lastly, contractors are usually required to obtain and maintain adequate insurance.
It is common to penalise delays in the performance of work by requiring the contractor to pay damages, or by deducting liquidated damages from payments due.
Usually, an "advance payment bank guarantee" (ABG) is required to be furnished by the contractor upon payment of the "mobilisation advance" by the owner. In most cases, the ABG is valid until the completion of construction.
In addition to the ABG, a "performance bank guarantee" (PBG) is also sought by owners to secure the performance of the work/construction commissioned by the contractor. Such a PBG would be required to be furnished on the effective date of the contract along with the ABG, and is usually valid until the expiry of the defect liability period.
Unless contractually agreed, the contractor is not permitted to create a lien on the property.
In most states, a building comprising more than a prescribed number of floors can only be occupied after an occupancy certificate has been obtained from the relevant planning authority.
GST, which subsumes VAT, is applicable on the supply of goods and/or services and is typically payable by the supplier of goods and/or services. GST is payable on the leasing, licensing or transfer of development rights of land (at 18%), and on the transfer of under-construction property. The leasing of residential apartments for residential use is exempt from the levy of GST.
GST on transfers of under-construction property varies for different types of projects. For example, GST on affordable residential apartments is 1%, GST on residential apartments (other than affordable residential apartments) is 5% and GST on commercial apartments can be 5% or 12%, depending on the type of project, with restrictions on the availability of input tax credit. However, GST is not applicable on the sale of constructed property. The burden of such taxes can be passed on to the buyer commercially.
Stamp duty can be reduced by contributing a property to a partnership firm. The partnership firm can thereafter even be converted into a company. By such transfers, the property owned by an individual can ultimately be transferred and owned by a company without the payment of stamp duty and registration fee.
Municipal taxes are generally calculated based on the location, size, age and occupation of the property (self-occupied or tenanted). Sometimes, taxes are based on rents received. There are no exemptions for the payment of property taxes, except for properties used for charitable purposes/religious institutions.
Any income of a non-resident from property situated in India is subject to tax in India, and withholding tax applies. Payment of consideration for the purchase of a property from a person resident in India is also subject to withholding tax at the rate of 1%, subject to certain thresholds. The income of a foreign company is usually taxed at a rate of 40%. However, gain on the sale of real estate held as an investment is taxed at a rate of 20% or 40%, depending on the period of holding. If the property was purchased by bringing foreign currency into India, gains on disposal are computed so as to adjust for changes in the rate of currency.
Where consideration received on the transfer of an immovable property (whether held as a capital asset or as a business asset) is less than 95% of the value of the property for the purpose of the payment of stamp duty as per local laws, the value of the property for the payment of stamp duty is deemed as consideration received for the levy of income tax under the IT Act. Similarly, where the consideration paid for the acquisition of an immovable property is less than 95% of the value of the property for the purpose of payment of stamp duty as per local laws, the difference between the value of the property for the payment of stamp duty and the consideration discharged is taxed as income of the purchaser, at applicable rates. Both these thresholds of 95% are proposed to be revised to 90% with effect from 1 April 2020.
Tax on non-resident taxpayers may, however, be reduced if favourable tax treaty provisions apply.
Rental income also qualifies for the following deductions/rebates:
Loss incurred by renting out residential property is allowed to be set-off, up to a sum of INR200,000 per annum. Balance loss is allowed to be carried forward and set-off in the eight ensuing years.
It is mandatory for parties entering into a purchase or sale of immovable property for a value exceeding INR1 million to obtain and quote their Permanent Account Number (PAN) allotted by Indian tax authorities on the conveyance document.
Depreciation and other business expenses may be claimed as deductions only if the taxpayer is in the business of commercially letting out properties, or where plant and machinery that are inseparable from the property are let out together with the property.