Which is the correct way of taxing properties?

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Property tax has become the single largest source of revenue for municipal corporations following the abolition of octroi. Municipal corporation across the country complain short of funds, which is why they cannot provide civic services adequately but they do not tap property tax fully and nowhere is this gap as glaring as in Delhi.

Town Hall in Delhi’s Chandni Chowk is a 142 year old building, which came up soon after the rebellion of 1857. It houses one of the largest municipal corporations in the world that is responsible for providing civic services to nearly 14 million people.

Radisson Hotel near Delhi airport used to pay Rs 2.5 crore as property tax now its tax is 83% lower at Rs 42 lakh a year. Uppal Orchid’s bill at Rs 50 lakh is just 15% of what it was being charged earlier and Videocon Tower that at one time housed the studios of CNBC-TV18 pays just Rs 1.9 lakh, which is less than 1% of its earlier bill of Rs 2.21 crore. These are not isolated examples; the illustrative flow in tax and property is by area rather than value. According to PK Mohanty, who holds Doctorate degree in Urban Finance from Boston, Harvard the unit area method is more suited for residential properties that are homogenous than commercial ones.

PK Mohanty, Mission Director, National Urban Renewal Mission said, “There are three types of hotels support you consider; a five star hotel and a four star hotel and three star hotel. If you average the rates for the three types of hotels; four star is the average and if you adopt that rate to apply to five star, four star and three star you are basically subsiding the five star hotel and penalizing the three star hotel. So, in Hyderabad when we introduced the self assessment of property tax with unit area method we did not go for unit area in the case of commercial properties.”

Delhi shift in April 2004 to taxation according to area was well intended and correct. The earlier system of taxing according to rental value with a discount for self occupied ones resulted in similar properties being differently taxed depending on the age of tenancies. That gave huge discretion to municipal officials and scope for misuse. But, the new system was poorly designed. Upscale neighbourhoods like Hauz Khas were among 400 of Delhi’s 1,985 colonies whose rates were lowered under populist pressure.

All industrial properties were placed sixth on the list of seventh from the bottom in terms of rates as a further sweetener a 15% discount was given for taxes paid in one go within the first two months of the year. Property tax payment suddenly became less taxiing.

Shobhit Mahajan, Professor-Physics and Astrophysics, Delhi University said, “I was very happy with the unit area method because it was completely transparent; the area that you belong to, size of your flat determines how much property tax you paid. It was not dependent on some clerk sitting somewhere who is going to make a small change in your register and change your property tax. This also meant by the way that if you had a small flat in a not so fancy colony of Delhi you would end up paying much less property tax than if you had a huge house in Greater Kailash (in south of Delhi). So finally, I thought that there was some fairness in the system and it was much needed fairness.”

As a result, Delhi’s collection in 2006-2007 at Rs 800 crore were the same as in 2001-2002 despite an increase in number of properties and their value. If inflation was factored in, Delhi would have earned less in real terms. After the shift to unit area, collections dropped to Rs 817 crore from Rs 920 crore the previous year. This is because of a shift to voluntary payment or self assessment from the earlier payment by demand but collections were Rs 1,007 crore last year and is projected to rise to Rs 1200 crore this year as assessment and payment can now be done online saving tax payer from harassment and queues. Close to 1 lakh paid online last year, this year the number is expected to more than double.

Mahajan said, “The step - the online tax things is a very revolutionary idea because in one shot you have got rid of people having to go anywhere. You can actually print the assessment form by giving all the details, on the net you can get a printout; you can either pay on the net if you want.”

Ahmedabad claims a distinction of being the first municipal corporation to adopt the unit area method in 2001. The change was necessary because 72% of the properties were exempt from property tax as their annual treatable value was less than Rs 600. So, they were only paying for the water and tax of Rs 254 a year. The remaining 28% of properties bore the brunt and the tax paid was 110% of rental value.

IP Gautam, Commissioner, Ahmedabad Municipal Corporation said, “There is a room to improve, we have more than 30 civic centres, authorised certain banks, we are collecting online, anybody can deposit from their home. But, we have a different kind of problem in property taxes. This is a textile capital of India in past and most of the textile mills closed their taxes and taxation before 2000 and 2001. Lot many recoveries were pending and slowly we are discussing with them our new clients. If they are disposing or auctioning that recovery is coming very slow and we have to expedite that particular amount due to 18% interest- the old arrears have mounted to a certain extent. We have concentrated on that. We can give some concession and recover more and more. As far as new demand is concerned, we do not have any problem of that kind.”

The tax on tenanted properties was as high as 15 times than that of self occupied one’s. There was rampant corruption, evasion and litigation ever since it moved to a simplified version, collection efficiency has improved. It is as much as 90% in the core 190 square kilometre area of Ahmedabad.

Nilakshi Patwa, Home Maker, Ahmedabad said, “Now the tax system is much better because you know what you are paying and every thing is very clear. If you want to even rent out a property, it doesn’t make much of a difference because you know what you will have to pay to the corporation.”

In free annual instalment in February this year, another 276 km have been brought within the purview of Ahmedabad Corporation, while property owners have gained from higher property prices and also higher floor space index and that has allowed for construction. There has been a steep rise in property tax liability as well. To soften the blow Municipal Corporation is giving a rebate for the first three years.

IP Gautam said, “Whatever 276 km area came in our Municipal Corporation, today we are giving 50% discount because we have not done much in that particular area. Next year we will give 25% discount but after two years that area will pay 100% tax.”

But, Ahmedabad does not rely on trust alone. Every four years a survey is conducted to record changes in carpet area and usage. Ahmedabad claims its rates are the lowest in the country but even then there are murmurs of discontent. The city must get a trophy for its ambition because of the ablation of Octroi last November. It has to double up on property tax collections against Rs 281 crore collected last year. It has set a target of Rs 560 crore for this year rather steep but the owner of this 32 year old shop seems to take it sportingly.

Taxing properties according to constructed area might not capture the vibrancy of a city’s property market. Karnataka has therefore adopted a system that is in practice internationally. Very soon, Delhi’s Municipal Corporation will move from its historic buildings to a modern one, but the property tax system will still be stuck in the past. It must learn from Karnataka which taxes according to capital value, taxes there are denoted as a percentage of guidance value which is average of purchase prices paid in an area in the previous year. These are the same rates that are applicable for payment of stamp duty for registration of property.

S Subramanya, Commissioner, Bangalore Municipal Corporation said, “As the capital value changes, the tax-flow also changes. So, this is a system where buoyancy is near one and so it is supposed to be an efficient system. That is why the government of Karnataka amended the act and said this capital value system should be applied for the whole state.”

Bangalore’s attempt to adapt the capital value system for new properties has backfired, the commissioner decided on a dual property tax system after court held out notices to owners of 300 commercial properties for evasion of tax were bad in law. But, the state government developed cold feet when they faced resistance from property owners who saw a huge increase in the tax bill. It did a return on the tax covered on square foot basis. The commissioner says there is not much on a legal basis for such a tax as the tax pays on property prices was legislated for the entire state including Bangalore in 2003.

Subramanya said, “The government has a right to give me directions, so they have the right to withhold the taxation system but that doesn’t mean automatically I go back to a system which is not there in law. Therefore, we do not have a taxation law as of now. However, the government has constituted the cabinet sub committee which is looking into all this details and there is an in principal agreement to implement the earlier system.”

A tax linked to property prices can promote such a development not only by improving revenue collections but also by compelling owners to put it to better use. But, it could be harsh on people who are property rich but cash poor.

Mohanty said, “Capital renew method is a good method all over the world and that is mainly because the capital value goes with the swing of the economy. If there is an off swing, there is inflation, then the service costs increase, the Municipalities need to meet those service costs and if the property tax is linked to the capital value then they can meet the needs of cost to services. But capital value in a country like India where there are lots of distortions in the cities, for example people having old and dilapidated buildings, they are not able to develop because of the zoning restrictions, if you put tax on capital value of those, they wont be able to pay because they are property rich but cash poor. Therefore, although we have to go for a capital value system in the long run we have to go in phases.”

Whatever the method of valuation, cities across the country is not tapping valuations of property taxes, only 5% of properties are escaping taxes in the previous set limit of 250 sq. km, that share is more than 60% after another 550 sq km was appended last year. In Delhi, only nine lakh properties are said to be in the tax net, a survey has been conducted but on the basis of water and electricity connections, it is estimated that there should be 16-18 lakh properties. They have now set up a company to map properties by satellite. A physical survey would still have to be conducted to determine views and size of properties.

KS Mehra, Commissioner, Municipal Corporation of Delhi said, “We are introducing property mapping for conducting joint surveys so that all the properties in the city could be brought under the property tax net.”

Rajesh Lakhoni, the Commissioner of Chennai Municipal Corporation says even those properties that are within the tax net are paying less than they should. Last year, Chennai shifted to the unit area system on a pilot basis. This has been extended to the whole city this year. Chennai has 5.85 lakh properties. Satellite mapping has been done, and the city is now doing house to house surveys. Though most of the properties have been listed, the Corporation estimates underassessment of residential properties to be as high as 40% or Rs 120 crore. That is high considering that last year Rs 280 crore was collected from this source.

Rajesh Lakhoni, Commissioner of Chennai Municipal Corporation said, “Leakages in the tax is a major challenge than actually capturing the land value, change in the land value. If your leakage is more than 100% or 200% then 20% variation in land value doesn’t really lead you anywhere. If the tax assessment system is so complicated that you cannot be sure whether the tax is right or not, then the leakages will be a challenge.”

Bangalore collected Rs 370 crore as property taxes in the year ending March 2007. The city’s High Value Assessment cell estimated that there are more than 300 buildings that should have paid Rs 1 crore each in taxes, but did not.

The comparison of returns filed before and after a new tax system was introduced in 2004 revealed that many owners had made false declaration to gain from the 50% discount that self-occupants are entitled to. The Corporation believes that taxpayers can be shamed into honesty.

Subramanya said, “Once you are able to say a lie and be with that, people continue to say lies. It is normal.”

So, what we are trying to do is, right now we have got health centres, and in these centres they propose a list to publicly advertise the taxation assessment return filed by a person. So, then transparency will show that somebody is a liar and he is my neighbour.

Chennai Municipal Corporation says it can attach properties in default but that provision is seldom invoked. There is no clarity either in the Delhi Municipal law whether attachment means possession of title deeds or physical property. An amendment has been proposed. A provision is also being made to disconnect water and electricity connections, which could be invoked against commercial and industrial properties without provoking an outcry.

Mehra said, “As of now, we can attach but we cannot take possession of the property. We can only attach and there are no teeth in that law. So, we will have to do something to make it really effective.”

Here is a verbatim transcript of the exclusive interview with Ramesh Ramanathan, Co-Founder of Janaagraha on CNBC-TV18. Also watch the accompanying video.

Q: We have been discussing property tax reforms across cities Ahmedabad, Delhi, Chennai, Bangalore but one thing we find common in many of these places is that counsellors and corporaters who also have to go back to taxpayers are reluctant to increase the tax threat or tax properties properly. How do we fix the local politics problem?

A: I think it’s a very valid point that is the local government because they are closet to the people and they face the heat of public push back that they do feel reluctant to raise property taxes or bring them to the right levels and so we see a lot of distortions on the ground on property taxes commercials properties not paying as much as they should, revisions not happening as frequently as they should.

There are a couple of reasons for this. The first is that we are not fully empowering cities which means if you empower city governments to say, “You are responsible for everything that the city needs.” Then the elected representative of the city will also feel the pressure and see the need for them to raise their revenues. So, that’s one part of it. Today what we are doing in India is we are not empowering the cities fully and therefore are getting the elected representatives or the corporaters to behave sub-optimally. They are gaming the system, they are not responsible to build the infrastructure, they don’t feel the pressure of raising the resources and so they act in their own interest or in an interest of a very local community need.

The second part of it is that the citizens don’t see the value for the money. The view of the citizen is why I should pay you my money for you to cheat me better I cheat you.

Q: We have now moved to the unit area system and to self assessment but you can trust a taxpayer only up to a certain point and I have seen from my own experience of reporting on the Finance Ministry that unless there is an element of fear people do not pay up? How do you make sure that self assessment is also backed up with efficient enforcement?

A: People are more than willing to come in and report but you need a characteristic, which means there must be the threat of government saying on some percentage maybe 1-2% of the case is, we are going to come and check and if you are caught having under reported you have a high penalty. The problem is if you do not trust the citizen enough and if you don’t penalise or you don’t have that random checking done well enough then that system of self assessment doesn’t work.

Q: The Bangalore Municipal Commissioner told us that he is going to put it out all into the open, advertise who has paid what. What are your views on the same?

A: I have a problem – there are two parts; one is to publicise and I think that’s a good thing and second is, today what Bangalore is doing, is planning to do rather to retrograde. We were in an environment where self assessment was done in a healthy way. Central to self assessment was a fact that the citizen actually says I have assessed and this is my belief of what my property tax is due and the system accepts that. If you say, I still have the discretion of government to say whether what you self assess is correct or not then that is not self assessment.

Q: You are saying you have self assessment but also have random checking?

A: Absolutely and in that random checking if somebody gets caught – god help you because you should be penalised.

Q: We also find that most municipal corporations have not made an inventory of the properties that they have and they are going in for satellite mapping, GIS (Geographic Information Systems). Do you think that they are right?

A: Flavour of the month today is GIS; every department of government wants to install its own GIS system and central to the logic of GIS is the fact that you need to have a common system because GIS is about having a base map and having layers and the logic of that is you have a service provider within government which is I will provide special data services to various municipal service providers, it could be city corporation for property taxes, it could be the water supply board for water supply, electricity and so on.

In order to do that correctly you need to have common formats, which means one can’t be on a scale of 1:10 the other on scale of 1:100 that’s the kind of illogic that we are seeing today in how government is implementing GIS systems. We are going to end spending a lot of money on which we get no returns.

Property taxes, Central and State devolutions will go only so far. It is important for municipal corporations to be able to leverage their balance sheets and borrow for income generating assets.