RERA: Some Issues

At the outset, it must be confessed, that the Act is an evolving statute and at this stage, there may be more questions than answers. Having said that, the RERA in the State of Maharashtra (“MahaRERA”) is quite proactive and has been issuing clarifications on several issues.

Promoter: Land Owners also covered

The Act requires a Promoter to register a real estate project with the RERA. As on the deadline of 31st July, 2017, over 10,000 projects were registered with the MahaRERA.

The Act defines a Promoter in an exhaustive manner by giving a very far reaching definition. It covers any person who acts (himself) as a builder, coloniser, contractor, developer, estate developer or who claims to be acting as the holder of a power of attorney from the owner of the land on which the building or apartment is constructed or plot is developed for sale.

An interesting issue arises as to what would be the position of a land owner who enters into a joint development agreement with a developer for say, a share in the revenue from the sale of flats or a share in the area to be developed? For instance, a landowner executes a development rights agreement with a developer and in lieu of the same would receive a 40% share of the revenues ( to be)  received from the Project. Alternatively, he agrees to  receive 40% of the built-up area in the project. Would such a land owner also be treated as a Promoter? The answer to this is Yes! The MahaRERA in its Order has coined the definition of the term “Co-Promoter” and defined it to mean and includes any person(s) or organisation(s) who, under any agreement or arrangement with the Promoter of a Real Estate Project is allotted or entitled to a share of the total revenue generated from the sale of apartments or share of the total area developed in the real estate project. Thus, every land owner who receives an area / revenue share would be treated as a Promoter of the real estate project. It would be permissible for the liabilities of such Co-Promoters to be as per the joint development agreement with the developer. However, for withdrawal from the RERA Account, they shall be at par with the Promoter of the Real Estate Project. The land owner would be required to give an undertaking to the RERA, including an undertaking relating to the title to land and the date of completion of the project. Consequently and most vitally, the Order holds that the cost of land payable to land owners by the Promoter cannot be regarded as cost of Project and cannot be withdrawn from the RERA Account and that such land owners must open a separate bank account for deposit of 70% of the sale proceeds from the allottees! An intriguing part about this Order is its interplay with the Act. Section 4 of the Act mandates that 70% of the realisations from flat allottees shall be deposited in a separate designated account which would be used only to cover the cost of construction and the land cost. In a joint development agreement, the share payable to a land owner by a developer is the developer’s land cost. However, the MahaRERA’s Order expressly prohibits payment of this land cost from the separate designated account!

Recently, some land owners have approached the Bombay High Court challenging this Order of the MahaRERA. The final outcome of this case would be eagerly awaited by several land owners.

After the advanced capital gains tax liability on a land owner (started by the decision of the Bombay High Court in Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom)) and indirect taxes (GST/VAT/service tax as on a works contract) for the portion constructed by the developer for the land owner, this would be the final straw which breaks the proverbial camel’s back! Of course, the newly introduced section 45(5A) of the Income-tax Act seeks to provide some solace to land owners who are individuals and HUFs by postponing the capital gains tax liability. However, for a great majority of land owners they would be staring at a scenario, where on the one hand, they are asked to pay capital gains tax on the execution of a development agreement once the conditions specified in Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom) are triggered and on the other hand, they cannot withdraw the money received from the flat allottees!! It may be noted that this is a restriction imposed by the MahaRERA and hence, only applies in the State of Maharashtra and not in other States (unless the Authorities in other States also issue a similar Order). Further, this Order only applies when the consideration for the land owner is in the form of a revenue / area share. If the transaction is one of an outright sale / conveyance, then this restriction is not applicable and the developer can easily use the sale proceeds to pay off the land owner. Having said that, finding a developer, in the current real estate market, willing to buy a land on an outright basis is akin to finding a needle in several haystacks. Something which even google.com would find very difficult to search. If a land owner does find such a developer, then he kills 3 birds with one stone – he can pay tax (since he has the funds), there would not be any GST liability (since there is no works contract component) and he would not be classified as a Promoter under the RERA Order. Truly an Utopian scenario!

Promoters: Contractors
A question arises whether a building contractor is required to be registered as a Promoter? The definition includes a contractor or person by any name who acts as the holder of a power of attorney from the land owner on which the building / apartment is constructed. However, the overarching requirement for registration is that the Promoter must sell one or some of the apartments. Section 3 which mandates registration makes it clear that no Promoter shall sell or offer for sale any apartment or building without prior registration. Hence, if there is no sale or offer for sale, then there should not be any requirement for registration as a Promoter. Section 3 similarly provides that any renovation, repair or redevelopment which does not involve marketing, sale or new allotment of any apartments would not require registration. Hence, a building redevelopment which does not have any free sale component would be outside the purview of registration. The FAQs issued by the MahaRERA also support this view where the answer given states that if there are 16 apartments in a society redevelopment project, registration would be required provided there are some apartments which are for sale. Hence, it stands to reason that if there is no sale component, then there would not be any requirement for registration. 

Promoters: Financiers and Private Equity Funds
A similar predicament as that of the land owners may also be experienced by lenders / private equity funds who have contributed funds to the real estate project. In most cases, such financiers have step-in rights, i.e., in the event that the developer is unable to complete the project, then they would step-in to his shoes and complete the project.  In addition, financiers more often than not, have strong investor protection rights which enable them to participate in the control and management of the developer’s entity.  The definition of the term Promoter is extremely wide. Hence, it is a moot point whether such financiers may also be roped in within the definition of a Promoter / Co-Promoter? This may even hamper any exit to be provided by the developer to the financier since payments to Promoters do not fall within the permissible uses from a designated bank account. It may be possible to contend that mere presence of such rights may not make a lender to be treated as a Promoter till they are actually exercised.

This may force financiers to utilise secured debt structures in which only the project is mortgaged in their favour without any exotic rights. In such an event, the financier would not be treated as a Promoter and the designated bank account can be used to repay the lender. In any case, the obligations would be attracted once the mortgage is foreclosed and the financier proceeds with the incomplete tasks.

Designated Account to be maintained

The Act requires that the Promoter must maintain a separate designated bank account. 70% of all realisations from flat allottees must be deposited in this account to cover the cost of construction and the land cost and must be utilised for that purpose only. The balance 30% may be withdrawn without routing the same to the designated account. For making withdrawals from this account, 3 Certificates are required. The provisions applicable in the State of Maharashtra in this respect are spread over the Central Act, the Rules (framed by the Maharashtra State Government), the Regulations  (framed by the Maharashtra RERA), the Forms (issued by the Maharashtra RERA) and the Clarifications (issued by the Maharashtra RERA). All these diverse provisions have been harmonised and analysed below for the ease of ready reference:

(a)   Designated Bank Account – 70% of all amounts realised for the real estate project from the allottees, shall be deposited in a separate bank account to cover the cost of construction and the land cost and shall be used only for that purpose. These deposits may include advances received against allotment.

(b)   Procedure for Withdrawals – The Promoter is entitled to withdraw amounts from the designated bank account, to cover the cost of the project (land and construction and borrowing), in proportion to the percentage of completion of the project. Withdrawal is permissible only after it is backed by 3 certificates stating that the withdrawal is in proportion to % completion of the project. The Promoter is required to submit the following 3 certificates to the bank operating the designated account:

–   Firstly, a certificate in Form 1 from the project Architect certifying the % completion of construction work of each of the buildings/wings of the project;

–   Secondly, a certificate in Form 2 from the Engineer for the actual cost incurred on the construction work of each of the buildings/wings of the project; and

–   Thirdly, a certificate in Form 3 from a practicing Chartered Accountant, for the cost incurred on construction and the land . The practicing Chartered Accountant shall also certify the proportion of the cost incurred on construction and land to the total estimated cost of the project. The total estimated cost of the project multiplied by such proportion shall determine the maximum amount which can be withdrawn by the Promoter from the separate account.

The Promoter is required to follow the above at the time of every withdrawal from the separate account till Occupancy Certificate in respect of the project is obtained. On receipt of the Completion Certificate in respect of the project, the entire balance amount lying in the separate account can be withdrawn by the Promoter.

However, as a concession, MahaRERA has allowed a Promoter to do away with the practice of submitting 3 certificates for every withdrawal from the designated bank account. He may obtain the same and retain them on record and furnish them to the auditor at the time of the annual audit. The Promoter would have to submit a self-declaration to the bank once every quarter and this would suffice for the withdrawals.

(c)   Contents of CA’s Certificate: Form 3 requires the CA to certify the following:

–   Total Estimated Cost (Land Cost + Construction Cost) of the project based on the Form 2 issued by the engineer.

–   Total Cost Incurred (Land Cost + Construction Cost) of the Real Estate Project based on an actual verification of the books of account by the CA.

–   % completion of Construction Work (as per the Architect’s Certificate in Form 1). However, the MahaRERA has clarified that this need not be filled in by the CA for all ongoing certificates and should be filled in only in the final certificate issued after 100% of the construction work has been completed.

–   Proportion of the Cost incurred on Land Cost and Construction Cost to the Total Estimated Cost. (Total Cost Incurred / Total Estimated Cost).

–   Amount which can be withdrawn from the Designated Account (Total Estimated Cost * Total Cost Incurred / Total Estimated Cost)

     Less: Amount withdrawn till date of this certificate as per the Books of Accounts and Bank Statements

–   Resulting figure is the Net Amount which can be withdrawn from the Designated Bank Account

The CA certifying Form 3 should be different than the statutory auditor of the Promoter’s enterprise.

(d)   Components of Form 3:

(A)  Land Cost includes all costs incurred by the Promoter for acquisition of ownership and title of the land, including premium payment; Premium for TDR/ FSI; stamp duty, transfer charges, etc.

In cases, where the Promoter, due to inheritance, gift or otherwise, is not required to incur any cost for the land, then his cost is determined on the basis of the Stamp Duty Ready Reckoner value of the land prevailing on the date of registration of the real estate project with the MahaRERA.

In respect of the land cost, the MahaRERA has clarified that the fair market value of the acquisition cost shall be the indexed cost of acquisition of the land computed as per the Income-tax Act provisions. One wonders how should this indexation be applied while issuing a certificate because the term “fair market value of the indexed cost” is not to be found in Form 3. A suitable clarification on this would be appreciated.

Further, it has been clarified that interest specifically done for land acquisition should be added. Interest for construction of rehab component in a project is also treated as land cost. Costs incurred for slum rehab, relocation of tenants in a redevelopment project, etc., are all includible in land cost.

(B) The Cost of Construction includes all costs, incurred by the Promoter, towards the on-site and off-site expenditure for the development of the Real Estate project, including payment to any Authority and the Principal sum and interest, paid to certain lenders.

     In respect of the Cost of Construction, the MahaRERA has clarified that:

(i)  The term “incurred” means products or services received creating a debt in favour of the supplier or received against a payment made. It is a moot point whether payment of advances towards cost is permissible? A suitable clarification on this would be appreciated.

(ii) The development / construction cost should not include marketing, brokerage expenses incurred for the sale of flats. These, though part of the project cost, should not be met out of the designated account but should be met from the other accounts / funds of the Promoter.

(iii) While principal sum should be shown in brackets it must not be treated as a part of the construction cost.

(iv)Income-tax payable by the Promoter is not a part of the construction cost.

(v) Cancellation amounts paid to allottees who cancel their bookings can be treated as a part of the construction cost and can be withdrawn from the designated account.

(e)   Annual Audit; The Promoter must get his accounts audited by 30th September of every financial year and must produce a statement of accounts duly certified and signed by auditor to the MahaRERA. The Annual Report on statement of accounts must be in Form 5.

Form 5 requires the auditor to certify that the amounts collected for a particular project have been utilised for that project alone and that the withdrawal from the designated bank account has been in accordance with the proportion to the percentage of completion of the project. If not, then the Form must specify the amount withdrawn in excess of the eligible amount or any other exceptions. MahaRERA has clarified that auditor must certify that 70% of the realisations have been used for the project (the balance 30% could be used for any purpose).

(f)   Mismatch  in  Certificates and  Audit: The Regulations contain a very important provision. They state that  if the  Form 5 issued by the auditor reveals that any Certificate issued by the project architect (Form 1), engineer (Form 2) or the chartered accountant
(Form 3):

–   Has false or incorrect information and

–   the amounts collected for a particular project have not been utilised for the project and

–   the withdrawal has not been in compliance with the proportion to the percentage of completion of the project,

then the MahaRERA, in addition to taking penal actions as contemplated in the Act and the Rules, shall also take up the matter with the concerned regulatory body of the said professionals of the architect, engineer or chartered accountant, for necessary penal action against them, including dismemberment.

Thus, while % of completion of work needs to be mentioned in ongoing Form 3 issued by a CA (as per the relaxations given by the MahaRERA), the withdrawals must be in sync with the proportion to the percentage of completion of the project. In fact, the Auditor is required to specifically report on this issue and if it is found that this condition has been violated, then the RERA may even complain to the ICAI against the CA issuing Form 3. Thus, there is a unique scenario where the CA need not report on % completion but he must ensure withdrawal is in compliance with % completion. Hence, it would be in the interest of the CA to always ensure that his certificate clearly specifies whether the withdrawal is in proportion with the percentage of completion of the project.

The abovementioned rules will have to be followed by the co-promoter as well, to the extent applicable.

Conclusion

The Act is a major reform in India’s real estate sector and as is the case with any transformation, there are bound to be teething problems and unsolved queries. As the sector progresses on the learning curve, lessons will be learnt and issues may get resolved.
 
At this stage, it would be worthwhile to alert CAs issuing certificates under the Act, to remember Shakespeare’s quote “Discretion is the Better Part of Valour!” Thus, they should exercise due care and caution while certifying and in cases of doubt or ambiguity, consider asking the Promoter to obtain a legal opinion. Avoid acting in haste and repenting in leisure!!