India's uphill battle against 'black money' in real estate

Ulwe, a village of dusty, uneven streets on the outskirts of Mumbai, lacks basic

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amenities like water supply and electricity, but a two-bedroom, 1,000 sq ft house costs about Rs 5 million, beyond the reach of many middle-class Indians.

According to prospective buyers, many developers will demand up to 30% of that price in cash, a small slice of the ubiquitous, unaccounted "black money" that costs India's straitened exchequer billions of dollars in lost taxable income.

Legislation that would bring more transparency to the industry will be considered during the winter session of India's parliament, which starts on Thursday.

However, investors, tax officials and bankers Reuters spoke with were sceptical the Law would stamp out illegal practices they say are closely entwined with politics.

"Four out of 10 developers were ready to do it in full white and six were asking for a black component," said 35-year-old Umesh Kolhapure, who was looking for a three-bedroom house around Ulwe, near the proposed site of a new international airport serving the country's financial capital.

Recent high-profile scandals in the coal and telecoms sectors involving large corporate houses and politicians have rattled investors in Asia's third-largest economy, where undeclared wealth has long been rampant.

Real estate accounts for a large share of illicit transactions, thanks to lax regulation and the numerous approvals needed for projects, making many ordinary people party to corruption and pricing some of the emerging middle class out of the market.

That has prompted the newly-appointed housing minister, Ajay Maken, to push a real estate regulation bill.

Designed to bring greater accountability, transparency and prevent fraud and delay, the bill proposes appointing the sector's first national regulator. However, it will not have control over land deals, which is where illicit activity is widely believed to be rampant.

"The bill is not going to help solve the issue of black money," said Anurag Mathur, chief executive officer of project and development services at Jones Lang LaSalle.

"Black money is tied in or shifted through land transactions and the regulator will have no jurisdiction over that."

Tax Avoidance

In the year to June 2012, about $6 billion, or 30% of total transactions in the property sector, were executed using black money, according to Liases Foras, a consultancy.

Real estate accounts for more than a 10th of India's $1.85 trillion economy.

The government says black money, a term widely used in INDIA to describe undeclared funds, often meant to avoid taxes, can be present in every stage of a project from land acquisition to home sales.

For the purchaser of a Rs 5 million home like those in Ulwe, a developer might typically ask for Rs 1.5 million in cash while making out a sales agreement for Rs 3.5 million.

With banks willing to lend up to 75-85% of the "official" sale price, the buyer will then need to fund anything from 45 to 60% of the total cost from savings, which is difficult for many salaried, middle-income househunters.

"It is unfair on the buyers," said Kolhapure, who has put his search on hold in the hope of a price correction that will help him afford a home for his family of five.

If the bill comes into force it might go some way in solving Kolhapure's problem.

The draft says developers will have to get accreditation for projects from the regulator, make public disclosure of details including the price of units, and maintain a separate bank account for each project to collect payments from buyers.

However, there is widespread cynicism about whether it can stamp out the practice given the belief that a large share of illicit money sloshing around the sector is tied to politicians.

"There can't be a legal measure to put an end to black money ... because ultimately it ends up in the political cycle. That is where the requirement is," said a Mumbai-based income tax official, who did not wish to be named.

Allegations last month of improper dealings between the son-in-law of ruling Congress party chief Sonia Gandhi and DLF , India's biggest property developer, underline the perception of a nexus between developers and politicians.

Activist group India Against Corruption accused DLF of arranging favourable loans and real estate transactions for Robert Vadra, a businessman married to Gandhi's daughter, who had previously announced a possible move into politics. The company and Vadra both deny wrongdoing.

Corrupt Officials

Central bank rules prohibit bank loans to fund purchases of land, a regulation designed to curb speculation and reduce balance sheet risk for banks. To fill that void, wealthy individuals, including politicians, are widely believed to invest "black money" in real estate.

Some of that money can later be poured into election campaign donations from developers, say private equity investors, real estate consultants and sector analysts.

Those same developers might be awarded with plots of land at attractive prices or assisted in getting project approvals.

Black money comes in handy for bribing corrupt officials.

"There is a cost of pushing the file. But what is the alternative?" said Lalit Kumar Jain, chairman of the Confederation of Real Estate Developers in India (CREDAI).

For a typical residential project in Mumbai, developers need about 55 approvals from more than a dozen departments. Delays in consents add 40% to a project's cost, said Jain.

At least 10 developers Reuters tried to reach including DLF Ltd , Oberoi Realty , DB Realty Sobha Developers , and Hiranandani did not respond to emails, declined to comment or did not make officials available.

CREDAI backs the pending legislation that would create a single-window clearance for approvals, which it says will reduce the temptation to pay bribes. Getting consents in time would make homes cheaper by 25%, Jain said.

"Our biggest problem is the approval process," said Jain, who is also the managing director of Mumbai-based property company Kumar Urban Development.

"That is the only corruption we know of and where we are victimised and exploited. Otherwise developers are clean."

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