Broadly there are two categories of development
contracts/transactions; i.e.,
-
Joint Venture
Development contracts between owner of the land and the developer.
-
Contracts
entered into during the course of carrying on the business of development
and sale of properties.
Tax Issues, which normally arises in above category of
contracts are being discussed herein.
Joint Ventures contracts may further be of two types; i.e.,
-
Contracts in
which after development of property area of built up structure is shared
between land owner and the developer.
-
Contracts in
which sale proceeds of developed property is shared by the land owner and
the developer.
Tax implications in respect of above types of Joint Venture
contracts have to be seen with reference to land owner as well as the
developer.
Following questions arise in the case of land owner and
developer:—
-
Taxability of
income whether as capital gain or business income
-
Stage/time when
sale/transfer will be considered for the purpose of chargeability of tax
-
Cost of
acquisition of capital asset or cost of stock-in-trade, how to be
determined.
Tax implications in the case of Land owner when there is
sharing of Developed Property; i.e., built up Structure
— Normally profit will be in the nature of capital gain. It
will however depend upon facts of each case and intention of the land owner.
In the case Sathappa Textilers P. Ltd. vs. CIT, 263 ITR 371 (Mad.) assessee
claimed that by passing the resolution it had converted land into
stock-in-trade and therefore, there was business income. Court held resolution
was not genuine and it was only capital gain.
— Transfer of land rights (proportionately) in favour of
developer will take place at the stage when structure is completed and
exchange takes place. Section 2(47) of Income-tax Act defines the transfer as
including exchange. In this case though possession is given to developer
immediately on entering into agreement but in terms of section 2(47)(v) of the
Act possession will give rise to transfer only if conditions of section of
section 53A of Transfer of Property Act are satisfied. Terms of agreement with
developer are also required to be examined. In the case of CIT vs. Smt. Radha
Bai, 272 ITR 264 (Del) it was held that though possession had been given to
the developer along with right to start the booking of various flats and to
receive sale price etc. from prospective buyers, land owners/assessee
continued to be the owner of the land till development and receipts were not
in the nature of business income from joint business venture with developer.
In the recent decision of Authority of Advance Ruling in the case of Jasbir
Singh Sarkaria reported in 294 ITR 196 (AAR) scope and implication of clause
(v) of section 2(47) of the Act has been analysed in order to decide whether
giving of possession with GPA in favour of developer amounts to transfer to
give rise to chargeability of capital gain. In the fact of above case
initially agreement was entered into with developer for sharing of built-up
area. Subsequently, supplementary agreement was executed to sell agreed share
in built-up area also to developer for money consideration, payable in
instalments. In pursuant to above agreement GPA was executed to give total
control to developer along with power to execute further agreements for sale
of flats to buyers. AAR held that in view of the facts and terms of the
agreement, there was transfer of capital asset and capital gain was payable in
the year of execution of GPA, notwithstanding that some of the instalments for
the consideration were yet to be received. It is stated that by virtue of
supplementary agreement this was a case of outright sale of land and not a
case of development of property. Recently in the case of CIT vs. Ashok Kapoor
(HUF) (ITR No. 395 of 1985) decided on 24-9-2007 (not yet reported) a question
regarding transfer of rights in property and chargeability of capital gain had
come up for consideration before the Hon’ble Delhi High Court. In the above
case the Hon’ble High Court has taken a view that transfer has taken place at
the time of entering into the Agreement with the developer for the reason that
as per the agreement the dealer had agreed to allocate 50% of share in the
property to be built and the builder was allowed to sell the area comprised in
the builder’s allocation. On the basis of clauses of the agreement the Hon’ble
High Court has held that clause of agreement have all the elements of transfer
at the stage of entering into the agreement and, therefore, there was
inescapable conclusion that there was transfer of property by the owner to the
developer. Further the Hon’ble High Court observed that even if the agreement
did not spell out the value of the property in the hands of the assessee the
valuation of the property in question indicated by the assessee itself in its
accounts should be sufficient for the purpose of computation of capital gain
tax. In the facts of the above case assessee had firstly converted its capital
assets to stock-in-trade. Then it had entered into development contract with
developer. A.O. had taken a view that entering into agreement had resulted in
partnership firm and therefore, considering transfer of asset by partner to
firm, he had levied capital gain. CIT(A) had upheld order of A.O. ITAT,
however, held that there was no partnership. Further, it was held that no
transfer had taken place at the stage of agreement with developer and no
capital gain was leviable at that stage. Before the High Court there was no
question regarding transfer to partnership firm. Questions for consideration
before the Hon’ble Court were to the effect that whether there was transfer of
property rights pursuant to agreement under which built-up area was to be
shared between land owner and developer in equal proportion and whether
capital gain was chargeable at that stage.
In this connection, with due respect to Hon’ble High Court
of Delhi, it is submitted that certain important legal aspects have not been
brought to the attention of the Hon’ble High Court during the course of
arguments of above case. In fact, matter was not represented on behalf of
assessee. Firstly, the term “transfer” has been defined in the Act in section
2(47) including sale, exchange, relinquishment, extinguishment etc. Clause (v)
is applicable in case of possession only in the circumstances when it is a
case of part performance in terms of section 53A of the Transfer of Property
Act. Above Act provides that transfer would be deemed when possession has been
given and consideration has been passed on to the transferor and the only
thing remains is registration of the documents. In the case before the High
Court consideration has not been passed on to the Transfer at the stage of
agreement. Therefore, possession would not give rise to transfer under this
clause. As per clause (vi) any transaction which has the effect of
transferring or enabling the enjoyment of any immovable property would amount
to transfer. Above clause is applicable in the cases of transfer by agreement
or arrangement by becoming a member of society, company etc. where
registration of documents is not required. Further, above clause read with
Explanation and provisions of clause (d) of section 269UA of the Act excludes
the transactions of sale, exchange or lease from its scope. Hence, above
clause would not be applicable in case of arrangement/agreement between the
land owner and developer, as it is a case of exchange of property rights. In
this regard it is also stated that as per provisions of Transfer of Property
Act rights in immovable property would stand transferred only on execution of
a Conveyance Deed. Right in immovable property cannot be transferred just by
giving possession. Even entries in the account books are irrelevant. In this
regard reference can be made to the decision of Supreme Court in the case of
Alapati Venkataramiah vs. CIT (1965) 57 ITR 185 (S.C.) It has, further been
held by the Courts that date of registration of such document is not relevant
for the purpose of transfer under section 2(47) of the Act [CIT vs. Mormasji
Manchorji Vaid (2001) 250 ITR 542 (Guj.) (F.B.)]. Further, it has been
repeatedly held by the courts that as regards transfer of immovable property
date of sale deed is relevant not the date of agreement to sell. [Hall &
Anderson (P) Ltd. vs. CIT (1963) 47 ITR 790 (Cal.); CIT vs. F.X. Periera &
Sons (Travancore) (P.) Ltd. (1980) 184 ITR 461 (Ker.) and CIT vs. Ghaziabad
Engg. Co. Ltd. (2001) 116 Taxman 268 (Del.)]. Further, in case of exchange of
property asset should be in existence. In the case of arrangement between the
land owner and the developer, property would come into existence later and not
at the stage of entering into the agreement. Therefore, it cannot be said that
exchange of the capital asset resulting in transfer in terms of section 2(47)
of the Act has taken place at the time of entering into the agreement.
Further, in order to determine the amount of capital gain pursuant to transfer
of capital asset, “Full value of consideration” should be available. It has
been held by the Supreme Court in the cases of CIT vs. George Henderson & Co.
Ltd., 66 ITR 622 and CIT vs. Gillanders Arbuthnot & Co. 87 ITR 407 that full
value of consideration has been used in the law for the reasons that law does
not deal only with case of sale in which case consideration in money would be
available. Further, it has been held that full value of consideration is
different then fair market value of the capital asset transferred.
Accordingly, in the case of exchange in determining the amount of capital gain
“Full value of consideration” would mean the value of the asset which has been
received by the transferor in exchange of the capital asset transferred by
him. In the case under consideration the land owner would transfer the land
rights in exchange of built up area and, therefore, value of built up area
which will be received by the land owner from the developer after completion
of construction would be “full value of consideration”. In case transfer is
considered to be at the stage of entering into the agreement, it will be
difficult to determine the full value of consideration at that stage for the
obvious reason that property is yet to be constructed and there would be no
basis available to determine the market value of the same. Moreover, time gap
between the date of agreement and when the property will be ready for giving
possession to the land owner would be uncertain and practically it has been
seen that many times because of various reasons it takes quite long time to
develop the property and make the same available to the land owner in exchange
of land rights. Many times because of dispute between the parties the project
may have to be abandoned. More importantly, the land owner would have no
resources for making payment of capital gain at the stage of entering into the
agreement because at that stage he had not received any consideration from the
developer in case agreement provides for sharing of built up area after the
development of the property. Keeping in view above issues, in view of the
author exchange would take place only at the stage when the property would be
ready and built up area is actually made available to the land owner in
exchange of land rights by him and relevant documents for transfer of property
are executed.
— Cost of acquisition of proportionate land right
transferred in exchange of built up area will be determined as per section
55(2)(b) of the Act and will also be indexed as per Section 48 of the Act.
Fair market value as on 1-4-1981 will be adopted in case of land/property
acquired prior to above date. In case land/property has devolved on the
present owner by any of the modes specified in Section 49(1) of the Act, cost
of previous owner will be taken. In case of corporate entities also when asset
has been acquired on merger, demerger or succession, cost of acquisition of
earlier company may have to be adopted.
— Consideration for exchange of land rights will be fair
market value of built area acquired by the owner of the land, which can be
reasonably determined on the basis of proportionate cost incurred by the
developer on construction. Accordingly, capital gain would arise at the stage
of transfer of proportionate land rights based on fair market value of
proportionate built-up area received after excluding therefrom cost of
acquisition of proportionate land rights transferred by the owner to
developer.
— Cost of acquisition of the land owner for capital asset
acquired/remained; i.e., built-up area along with remaining land rights will
be fair market value of built-up area plus cost of acquisition proportionately
of remaining land rights.
— In case land owner also transfer/sell his portion of
built-up area, capital gain would arise as and when sale takes place. It can
either be immediately or after a gap of time. Profit arising on transfer of
his part would also be capital gain in case owner continues to hold the same
as capital asset. Profit so arising can, however, depending upon circumstances
be treated as “profit or gain from business and profession”. In that case
profit up to the stage of acquiring built-up area on exchange will be capital
gain and thereafter, it will be business income.
Position in case of Developer when there is a sharing of
built up Area
— In case of developer the profit arising on sale of built
up area will be in the nature of business income.
— In case of developer cost of acquiring built up area
would be the amount spent by the developer in construction of total area,
including the area transferred to the land owner in exchange of land right.
Business receipts would be the actual sale price obtained by the developer
from the sale of the property. All the expenses incurred by the developer in
connection with sale etc. would be business expenses.
— In case, however, the developer does not intend to sell
the property. In other words his intention is to hold the same for long-term,
it can be claimed that built up area acquired by him is capital asset. In that
case cost of acquisition of the property would be the actual cost incurred by
the developer. Date of acquisition would be the date on which property was
ready and exchange between the land right and built up area has taken place.
Position of Land owner as well as developer in case sale
proceeds of the Property are shared by them
In case contract is for development of property and sharing
of sale proceeds between the land owner and the developer, position as
mentioned hereinabove as regards sharing of built up area can be claimed.
There is, however, a very high probability that in such a case the Income-tax
Department can take a view that it is a case of joint venture by association
of persons or it is a case of carry on of business in Partnership.
Accordingly, business income is chargeable to tax as A.O.P or Firm. In this
case land owner would be deemed to have converted his asset in stock-in-trade
on the date of entering into the joint venture contract and accordingly till
that time profit would be in the nature of capital gain on the basis of fair
market value of the land as on that date. Subsequent thereto profit will be in
the nature of business income. It can, however, be claimed that it is not a
case of AOP or partnership as contract is on principal to principal basis and
the intention of the land owner is to share the proceeds for the reason to get
better sale consideration and profit of land owner as well as of developer are
chargeable to tax separately. Sometimes even the assessees may like to claim
that they have constituted partnership firm or AOP for the purpose of carrying
on the activities of development and the land owner has contributed his land
to the partnership firm or AOP. After constitution of the firm or AOP income
would in the nature of business income from the activities of development. In
this regard, reference can be to the provisions of section 45(3) of the Act,
which provides that in a case where a person transfers his personal property
to the firm or AOP, capital gain shall be chargeable to tax as income of the
previous year in which such transfer takes place. Further, above section
provides that for the purpose of determination of capital gain amount recorded
in the books of account of the firm or AOP as value of capital asset shall be
deemed to be full value of consideration received or accruing as a result of
transfer of the capital asset. Above section makes a specific provision to the
effect that capital gain will be determined with reference to value of the
capital asset recorded in the books of the firm or AOP. In this case the
Assessing Officer will have no discretion to disregard such value and adopt
some other value for the purpose of computation of capital gain. Hence, in
certain circumstances, it may be advisable to constitute a partnership firm or
AOP and pay tax on capital gain determined accordingly by the partner. This
would avoid the controversy regarding quantification of capital gain as well
as the date on which transfer takes place.
Tax implications in regard to real estate business
Transactions/Contracts
During the course of carrying on the business of real
estate developer there are many issues which arises under Direct Tax laws in
the case of real estate developer. These issues are briefly being discussed
hereunder:—
— The first issue which normally arises in case of
developer is regarding commencement of business. In this trade many times the
developer acquires the property and start developing the same. Development of
the property takes substantial time. During this period there may be no sale.
Accordingly, the question repeatedly arises whether business has been
commenced and expenses being incurred by the developer are allowable as
business expenditure or not. In the case of Tetron Commercial Ltd. vs. CIT,
261 ITR 422 (Cal) assessee acquired land and commenced construction. It was
observed by the court that there are 3 stages : one is the acquisition of land
and the other is the process of construction of building and the third is
actual sale. Assessee had stepped into the second stage as soon as
construction was started. Accordingly, business had commenced. Sale is not
necessary. In the case of CIT vs. Dalmia Promoters Developers (P.) Ltd. 281
ITR 346 (Del) interest earned on fixed deposit of fund received as security
deposit taken from co-developers and interest earned on fixed deposits of
margin moneys was held to be business income. Assessee was following projects
completion method for determination of income from real estate project and
therefore, there was no income from real estate projects during the year.
— The other important aspect in the case of real estate
business is determination of profit. There are two methods recognized as per
accounting principles for determination of profit; i.e.,
-
Project
completion method;
-
Percentage
completion method
In the case of project completion method the profit of a
project is determined only on completion of project. All the expenses incurred
in connection with development of project are debited to a separate account
and receipts relating to that project are credited to that account. As and
when the project is completed then only the profit is determined and offered
for tax. In this case determination of profit is normally postponed for number
of years in the case of big projects. Therefore, department generally disputes
this method. This method is acceptable only in the cases where projects are
for short durations. The other method adopted for determination of profit is
percentage completion method. In this method percentage of profit with
reference to the percentage of work completed and/or percentage of revenue
received is recognized as income in the Profit & Loss Account as well as for
taxation. Under this method normally the difficulty arises in determination of
cost of the project and also in quantification of escalation in the cost. In
this method estimate is required to be made in respect of the cost to be
incurred on the project till its completion. Cost is to revised/reassessed
every year for determination of project. Institute of Chartered Accountants of
India has now prescribed that only percentage completion method should be
followed. It has also been prescribed in the Accounting Standard (AS 7) that
revenue as well as cost is to be re-worked out every year. In this case
reference can be made to the decision of Delhi High Court in the case of
Tirath Ram Ahuja (P.) Ltd. vs. CIT, 103 ITR 15 (Del) in which case Hon’ble
High Court observed that in case of contracts, one need not wait till the
contract is completed in order to ascertain the income and it is open to
revenue to estimate the profit on the basis of receipts in each year of
construction though contract is not complete. Further, in the facts of above
case, when there was impossibility of completion of project due to out-break
of war with Pakistan, it was held that total receipts including advance
deposit and total expenses should be taken as income and expenditure of
relevant year. Profit or loss of the project was not required to be
determined.
— The other important point which arises for consideration
in the real estate business is the treatment of advance bookings made in the
project. As per one view advance bookings taken by the developer in the
property to be developed should normally be treated as advance against sale.
Sale should be recognized only at the stage when the property has been
developed and possession of the same has been given to the buyer. The other
view, however, is that as soon as booking has been accepted by the developer,
he has transferred rights in the property to the buyer and notwithstanding
that possession will be given only after the property has been developed, it
has to be considered as sale. One can also take a extreme view in this regard
that the total amount for which sale has been made should be recognized as
sale notwithstanding that amount will be receivable in subsequent periods
corresponding to the development of the property. These aspects are subject
matter of litigation and will have to be decided in each case with reference
to the facts and circumstances. It, however, appears to be more appropriate
that after the work on the project has actually commenced by the developer and
developer is incurring cost, receipts from buyers should be considered as
revenue receipts proportionate to the cost incurred on the project and profit
should be determined following percentage completion method.
— Another aspect which normally arises in case of real
estate business is allowability of payments made to tenants for getting the
property vacated, getting the unauthorized occupants removed and also to
parties assisting in the process of getting the property vacated. As a matter
of principle all the expenses incurred in order to obtain the vacant
possession of the property so as to develop the same would be allowable as
business expenditure and/or will be considered to be the cost of the property,
difficulty, however arises for the reason that such payments are made to
persons who after getting the payments are generally not available to the
Income-tax Department for verification/confirmation. Payments are also many
times quite substantial. Many times these payments are also required to be
made in cash because of business necessity. These points give rise to
litigation. There is no ready solution to these problems. It can only be said
that as far as possible complete evidence of the persons to whom payments are
made should be kept and payments should be made through account payee cheques.
— In connection with purchase of property many times the
developers have to make payment of brokerage at a much higher percentage for
the reason that these middle men are quite influential and are instrumental in
arranging the purchase/sale of the land/property for the developer. Normally
the dispute arises and Income-tax Department doubts genuineness of these
payments. It is normally disallowed saying that payment is excessive. In this
regard reference can be made to the decision of Delhi High Court in the case
of CIT vs. Gopal Dass Estate, 267 ITR 149 (Del). The court held in the above
case that amount of brokerage in each case is market driven and depends on the
demand and supply situation. Dissallowance cannot be made on surmises,
conjectures and suspicion.
— Dispute in case of real estate business also arises in
respect of damages/penalties received/paid for non-fulfilment of commitments.
Dispute, therefore, arises in regard to allowability or taxability of amounts
paid/received under these heads. It can generally be said that all these
amounts should be allowed/taxed as business expenditure/income. Dispute would,
however, arise when the amount paid/received is quite substantial. In many
circumstances it can be received as a result of cancellation of contract which
can be construed to be profit earning apparatus and, therefore, may be in the
nature of capital receipt. Similarly, sometimes payments can also considered
to be of capital nature not related to regular business.
Position in the case of buyers of the property from the
real estate developer
Property developer engaged in the business invites buyers
for purchase/bookings of property at the much earlier stage than construction
thereof. Accordingly, the intended buyers book the property rights and advance
payment for booking is made. Further, payments are made to the developer as
and when demanded and also with the progress in the construction. Possession
of the property is made available to the intended buyers after 3-4 years of
the booking and may be sometime even longer period. In between many times
intended buyers transfer their rights to other parties. Similarly, many buyers
transfer the property after they have obtained possession from the developer.
The issue normally arises in the context of transfer of rights in the property
under construction as well as transfer of property after taking the possession
thereof as regard the point whether gain on transfer is short- term or
long-term. In other words, question normally arises as regards date of
acquisition of rights in the property. In this context it is stated that at
the stage booking is made by the intending buyer with the developer many times
even the specifications/description of project are not available and
confirmation as regards the property rights is given by the developer after a
lapse of time. In this regard one view can be that the intended buyer has
acquired the rights as soon as he has given the initial advance though
specification in regard to project/property are not available. The other view
can be that the right would come into existence when the developer confirms
the bookings and issue necessary allotment letter to the intended buyers after
the project has been properly described. It is stated that the date of
acquisition of the rights would depend upon facts of each case and the
documents executed/provided by the developer to the intended buyers. In case
of initial advance if there is no commitment or allotment by the developer,
same may not amount of acquisition of rights in the property. Property rights
may generally be acquired by the intended buyer only when an allotment letter
specifying the project etc. has been issued.
In case the intended buyer transfers his rights in the
property during the period when construction is in progress and he has not
obtained possession of the property, the right of the buyer would be in the
nature of capital assets and accordingly, gain arising on such transfer would
be in the nature of long-term or short-terms gain depending upon the period of
holding. Indexation would be available with reference to each payment made by
the buyer to the developer.
In case of transfer of property after possession has been
obtained by the buyer from the developer on construction of the project, a
question normally arises whether the period prior to taking of possession of
the property, during which period it was only the right available to the
buyer, is to be reckoned for the purpose of determining whether the capital
gain is short-term or long-term or not. In this regard contention is normally
raised that rights in the property is a capital asset of different nature than
the property. Therefore, period prior to taking of possession is not to be
considered. It is, however, stated that the buyer gets possession of the
property in continuation of his holding of right in the property. It cannot be
said that in terms of section 2(47) of the Act assessee has transferred his
rights in the property held earlier to acquire the actual property. It is not
a case of sale or exchange. Buyer continues to hold the capital asset. Only
its form changes on getting actual possession of the property. Therefore, it
cannot be said that period of holding would be counted only from the date of
getting the possession. Accordingly, the earlier period is also to be counted
for the purpose of determination of nature of the capital gain, whether
short-term or long-term.
In conclusion, it is stated that there are lot many other
issues in regard to property development projects. Attempt has been made
hereinabove to discuss some of the issues and views expressed hereinabove are
personal views of the Author and in any case the conclusion in regard to each
of the issues discussed hereinabove would depend upon the facts and
circumstances of each case.
Source : Published in 14th National Convention held on 7th,
8th & 9th December, 2007 at New Delhi.