Minimize Tax and maximize returns

hBits helps in Maximising Returns and Minimising Taxes

First of all, what is fractional ownership of property? What this means is that hBits brings together a group of investors who can each invest ₹25 lakh onwards and jointly purchase a premium commercial property. In this manner, investors can now own a share or portion of a Grade A commercial property for a fraction of its cost, enjoying the higher rental income and capital gains while dividing their risk. Basically, a share in a premium (both, quality and rental yield) real estate property can be acquired for Rs. 25 lacs, which could earlier be done only with a minimum investment of Rs. 5 crores.

How we structure your investment

But how do we do this? hBits forms a Special Purpose Vehicle (SPV) for acquisition of the Grade A pre=leased property — this is an entirely separate company in which the individual investors are members and independent professional directors are appointed. hBits merely stays on as the property manager in this arrangement.

This serves various purposes — it helps to pool the funds together, it ensures that ownership and control of the Grade A Property lies with investors, SPV does not have any other asset or liability and consequently the Grade A Property is ring fenced from any third party liability, and also allows the division of profits proportionate to the investment made by each member.

Now the following bit is important to remember, because this is the real ingenious solution. Each investor’s contribution is split in two —

  1. Shares of the SPV
  2. Compulsory Convertible Debentures (CCD), which is simply a financial instrument through which you, the investor, are lending money to the SPV and earning interest income which is linked to the rental yield

Once the property has been purchased, the rental yield will be distributed to investors not as rental income per se, but as interest on their CCD.

How real estate is taxed

Real estate is taxed in three ways in India – (i) Tax on rental income, (ii) Tax on capital gains and (iii) Property tax.

i) Property tax: This is the tax paid to the municipal authorities or local government body. The tax rate varies by location and is decided by the local authorities and imposed annually or semi-annually.

Property tax is the first to be levied on the total rental income or Gross Annual Value of the property. Upon subtracting property tax, we arrive at Net Annual Value, based on which we calculate deductions

ii) Rental income tax: Any rental income received from a property that has been let out is taxed under the head ‘Income from house property’. As per Section 24 of the Income Tax Act, 1961, all rental income is to be taxed under this head, be it residential or commercial.

  • The same Section also allows every taxpayer a standard deduction of 30% from the rental income. This 30% is chalked up to expenses and is exempt from taxation — irrespective of whether the actual expenses (electricity, repairs, insurance, etc.) are higher or lower.
  • It is under the same Section that interest paid on loans can also be claimed as income tax deductions.

Let’s do some hypothetical number-crunching, and compare a regular rental property in a SPV/holding company and a property that has been purchased and structured as per hBits’ formula. (In both cases, let’s assume property tax has already been paid).

Ⅰ. Regular rental property

Rental income or Net Annual Value: ₹100
Standard deduction at 30%: ₹30
Taxable rental income: ₹100 – ₹30 = ₹70
Rental income tax: (Depends on your income tax slab, let’s assume 30%) 30% of ₹70 = ₹21

Ⅰ. Fractional property with hBits’ structuring formula

Rental income: ₹100
Standard deduction: ₹30
Deduction of interest on borrowed capital (paid out as interest on CCD): ₹70
Taxable rental income: ₹100 – (₹30 + ₹70) = ₹0

Conclusion: As readers will no doubt have noted, hBits’ structuring formula allows the SPV or the holding company to pass on the full income and maximum benefits to the investors. Moreover, this is not the only way hBits helps investors to save on tax, so let’s move on to capital gains next.

iii) Capital gains tax: This is a tax on the growth in value of the investment, or quite simply put, it is any profit or gain that arises when the asset is sold at a higher price than which it was bought. It is classified as Long-Term Capital Gains (LTCG) if the property is held for 36 months or more (24 months for shares, 36 months for CCD). If the holding period is less, it is termed Short-Term Capital Gains (STCG).

hBits holds all assets under its management for 4-6 years before selling them. This is done primarily to achieve a good appreciation in the property value and has an added advantage of capital gains being taxed as long-term gains which attract lower tax rates (20%) and also allow for indexation for computing cost of acquisition.

Illustration of long-term capital gains tax with indexation*

Property X was purchased on December 1, 2016 for ₹100 and sold on December 1, 2019 for ₹150. A layperson might assume that tax will be calculated on the gross profit or ₹50. However, the following method is more accurate and tax-efficient:

Purchase price: ₹100
Indexed cost of acquisition:  ₹100 (purchase price) x 289 (CII for 2019-20)  = ₹110
264 (CII for 2016-17)

Selling price: ₹150
Net gain: ₹150 – ₹110 = ₹40
LTCG Tax: 20% of ₹40 = ₹8
Effective tax rate: ₹8 x 100 = 16%

Illustration of short-term capital gains tax*

Property Z was purchased on December 1, 2016 for ₹100 and sold on December 1, 2019 for ₹150.

Purchase price: ₹100
Selling price: ₹150
Net gain: ₹50
STCG Tax: (As per applicable slab rates, let’s assume 30%) 30% of ₹50 = ₹15
Effective tax rate: ₹15 x 100

* for simplicity the tax calculation are done at base rate, ignoring applicable surcharge and cess.

Conclusion: It is immediately clear that there is great benefit in holding the asset till investors can enjoy the benefits of long-term capital gains, as it can mean paying nearly half the tax they would have paid for short-term gains.

Bonus pro tip: To optimise your capital gains even more, it is best to re-invest your profits in real estate again, or in bonds or similar tax-friendly assets.

Freedom and security

As explained above, hBits has strategised and calculated how best the investors can maximise their returns and minimise tax. These measures include virtual pass through of rental yield with any tax in the hands of SPV, holding the asset for long-term gains, as well as endeavor to sell the entire SPV, rather than selling merely the property (this is also more tax-effective).

That said, hBits also values the investors’ need for liquidity and ease of exit. Keeping this in mind, hBits has structured the investment in a manner (shares & CC) that allows individual investors to cash out whenever they want by selling shares & CCD of the SPV —  even if it is before the sale of the asset or entire SPV.

* The above taxation rates and calculations apply only to resident investors; non-resident investors can contact hBits to find out more about tax rates applicable to them.