By Anup P. Shah | Chartered Accountant
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Introduction A popular mode of developing property, especially in Mumbai, is by way of an Agreement granting Development Rights, popularly known as ‘Development Agreement’ or a ‘DA’. Instead of the land-owner executing a conveyance in favour of the builder, he enters into a DA with a developer. Thus, the landowner remains the owner of the land but he gives permission to the developer to enter upon the land and develop it. Since this is a very important way of doing business in the real estate sector, we must familiarise ourselves with this instrument.
Meaning
In the case of a DA, the owner of the land grants development rights to a builder/developer. The roles and responsibilities of the developer include the following:
(a) To obtain the necessary permissions and to be responsible for the concept, design and planning of the project.
(b) To appoint architects, engineers, various contractors and other professional personnel required for the project, and be responsible for the control, management and co-ordination of the project.
(c) To construct the building(s), infrastructure and facilities as per the sanctioned plans.
(d) To market and sell the flats/offices.
(e) To form a society/association of flat purchasers.
(f) Generally to be responsible for the construction management, contract management, material management and overall management and supervision of the project.
Along with a DA, the owner also executes a Power of Attorney in favour of the developer to enable him to carry out the above acts.
Consideration
The consideration of a DA may involve the following:
(a) Lump sum
In consideration for the above rights, the owner is given a lump sum consideration.
(b) Area sharing
In some cases, the owner decides to split the constructed area with the builder, instead of getting the monetary consideration. For example, a DA may provide that the owner would get 49% of the flats, free of cost, as a consideration for granting the DA and the builder would be entitled to the balance 51% of the flats. The builder may also agree to market the flats of the land-owner since the land-owner may not have the necessary infrastructure and expertise for the same. The entire revenue from the sale of the owner’s flats would belong to him.
(c) Revenue sharing For various reasons, the land-owner and the developer may agree that the consideration for grant of the development rights would not be a fixed sum of money. The consideration payable by the developer to the land-owner for the development rights may consist of two components as follows:
(i) certain minimum amount, plus
(ii) a percentage(s) of the revenue received from the development and sale of the property.
Thus, in this arrangement the land-owner takes on a major risk of the property not being sold or being delayed, but also has the potential of maximising his income. For instance, there may be a revenue sharing arrangement of 40: 60 between the owner and the developer. Hence, for every Rupee realised from the sale or lease of the flats/offices, the owner would earn 40% of the same.
(d) Profit sharing arrangement In several cases, the owner and the builder enter into a profit sharing arrangement, which is quite similar to that under a partnership. An issue in such a case would be, whether the arrangement is one of a Development Rights Agreement or is a partnership? The income-tax and stamp duty consequences on the owner and the developer would vary depending upon the nature of the arrangement. In this arrangement the land-owner takes on the maximum risk coupled with the potential of the maximum returns.
However, it must be noted that a mere profit sharing arrangement does not make it a partnership. Section 6 of the Indian Partnership Act is relevant for this purpose. It provides that the sharing of profits or of gross returns arising from property by persons holding a joint or common interest in the property does not by itself make such persons partners. In the case of Vijaya Traders, 218 ITR 83 (Mad.), a partnership was entered into between two persons, wherein one partner S contributed land, while the other was solely responsible for construction and finance. S was immune to all losses and was given a guaranteed return as her share of profits. The other partner who was the managing partner was to bear all losses. The Court held that the relationship was similar to the Explanation 1 to section 6 of the Partnership Act and there were good reasons to think that the property assigned to the firm were accepted on the terms of the guaranteed return out of the profits of the firm and she was immune to all losses. The relationship between them was close to that of lessee and lessor and almost constituted a relationship of licensee and licensor and was not a valid partnership.
At the same time, though mere sharing of profit does not automatically make it a partnership, profit sharing is an essential ingredient of partnership. In addition to profit sharing, mutual agency is also a key condition of a partnership. Each partner is an agent of the firm and of the other partners. The business must be carried on by all or any partner on behalf of all. What would constitute a mutual agency is a question of fact. The Supreme Court decisions in the cases of K. D. Kamath & Co., 82 ITR 680 (SC) and M. P. Davis, 35 ITR 803 (SC) are relevant in this respect.
The Bombay High Court in the case of Sanjay Kanubhai Patel, 2004 (6) Bom C.R. 94 had an occasion to directly deal with the issue of whether a DA which provided for profit sharing was a partnership? The Court after reviewing the Development Rights Agreement, held that it is settled law that in order to constitute a valid partnership, three ingredients are essential. There must be a valid agreement between the parties, it must be to share profits of the business and the business must be carried on by all or any of them acting for all. The third ingredient relates to the existence of mutual agency between the concerned parties inter se. The Court held that merely because an agreement provided for profit sharing, it would not constitute a partnership in the absence of mutual agency.
Transfer of Property Act Section 53A of the Transfer of Property Act provides that where a person contracts to transfer for consideration any immovable property by writing and the transferee has, in part performance of the same contract, taken possession of the property or a part thereof, and he is willing to perform his part of the obligations under the contract, then even though a formal transfer has not yet been executed, it would be treated as a part performance of the contract and the transferor cannot claim any right in respect of the property. However, rights endowed by the contract can be enforced by the transferor. A DA is an example of a contract of part performance.
It is important to note that after the amendment by the Registration and Other Related Laws (Amendment) Act, 2001, any contract for part performance shall not be effective unless it is registered with the Sub-Registrar of Assurances. Earlier, section 53A provided that such contracts did not have to be registered.
Section 53A is a shield and not a sword and can be used only to defend the transferee’s possession — Bishwabani P. Ltd. v. Santosh Datta, (1980) 1 SCC 185. Further, it is important that the transferee (the developer in case of a DA) is willing to perform his part of the contract. If he fails to do so, then he cannot claim recourse u/s.53A — J. Wadhwa v. Chakraborty, (1989) 1 SCC 76.
Stamp duty on a DA
Very few States expressly provide for a levy of stamp duty on a development agreement. Maharashtra, Gujarat and Karnataka are a few instances of such States. Under the Bombay Stamp Act, 1958, any agreement under which a promoter, developer, etc., is given authority for constructing or developing a property or selling/transferring (in any manner whatsoever) any immovable property is exigible to stamp duty. The Stamp Acts of most States do not contain an express provision for levying stamp duty on a DA. They are generally stamped as agreements not otherwise provided for, e.g., Rs.100.
Till a few years back, such agreements in Maharashtra attracted duty under the provisions of Article 5(g-a) of Schedule-I @ 1% of the market value of the property. However, now the ad valorem rate of duty has been increased to rates applicable to a conveyance, e.g., 5% in Mumbai. Thus, as far as stamp duty is concerned now a DA is at par with a conveyance. The market value of the immovable property should be found out from the Stamp Duty Ready Reckoner.
When a power of attorney is given to a promoter or a developer for constructing or developing a property or selling/transferring (in any manner what-soever) any immovable property, it is chargeable with duty. If stamp duty has already been paid under Article 48(g) dealing with a power of attorney in respect of the same property, then stamp duty on a Development Agreement would only be Rs.100. Article 48 levies duty on different types of powers of attorney. A power of attorney, if authorising the holder to sell an immovable property or if given to a promoter/developer for constructing/developing or selling/transferring immovable property, attracts duty as on a conveyance on the fair market value of the property. Till a few years ago, this also attracted duty @ 1%. However, if duty is paid under Article 5(g-a) on the Development Agreement, then duty under Article 48 shall only be Rs.100.
Owner’s Taxation
The consideration received by the land owner would normally be taxable as capital gains in his hands. A variety of High Court and Tribunal decisions have dealt with this issue. The most prominent decision in this respect is the Bombay High Court’s decision in the case of Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom.) — which has laid down the conditions necessary to attract section 53A of the Transfer of Property Act and hence, be treated as a transfer for the owner: (1) there should be a contract for consideration; (2) it should be in writing; (3) it should be signed by the transferor; (4) it should pertain to immovable property; (5) the transferee should have taken possession of the property, and (6) the transferee should be ready and willing to perform his part of the contract. It further held that if under the Development Agreement a limited power of attorney is intended to be given to the developer and even if the actual power of attorney is not given, then the date of such Development Agreement would be relevant to decide the date of transfer u/s.2(47)(v) read with section 53A of the Transfer of Property Act. For this purpose, the date of the actual possession or the date on which substantial payments are made would not be relevant.
Other important decisions in this respect, include, Avtar Singh, 270 ITR 92 (MP); Zuari Estate Develop-ment & Investment Co. P. Ltd., 271 ITR 269 (Bom.) Asian Distributors Ltd., 119 Taxmann 171 (Mum.); ICI India Ltd., 80 ITD 58 (Cal.); Tej Pratap Singh, 127 ITD 303 (Delhi).
In view of the above decisions, it is very important to draft the DA very carefully and to properly structure the transaction regarding granting of licence, power of attorney and the possession of the property. In this connection, it may be noted that the Supreme Court in the case of Vimal Lalchand Mutha, 248 ITR 6 (SC) has held that interpretation of an agreement involves a question of law.
In Meera Somasekaran, (2010) 4 ITR (Trib) 271 (Chennai) and Arif Akhatar Hussain v. ITO, (ITAT- Mumbai) ITA No. 541/Mum./2010, it was held that section 50C would even apply to a development agreement. Thus, if the land is held as a capital asset by the owner, then section 50C would apply. It was held that the transfer of development rights amounts to a transfer of land or building and therefore section 50C is applicable, since u/s.2(47)(v) the giving of possession in part performance of a contract as per section 53A of the Transfer of Property Act is deemed to be a ‘transfer’. The fact that the assessee’s name stands in the property records is immaterial. Once the land-owner received the sale consideration and parted with possession of the property under the DA, section 53A of the Transfer of Property Act was attracted and hence, it was a transfer under the Income-tax Act.
One of the ancillary issues which arises is that whether Transferrable Development Rights (TDRs) arising by virtue of the Development Control Regulations for Greater Mumbai, 1991 or on account of society redevelopment is liable to tax? A spate of judgments, such as Jethalal D. Mehta v. DCIT, 2 SOT 422 (Mum.), have held that since TDRs qualifying for equivalent Floor Space Index (FSI) have no cost of acquisition and so sale thereof does not give rise to taxable capital gains. Other relevant decisions in this respect include, Maheshwar Prakash 2 CHS Ltd., 24 SOT 366 (Mum.), New Shailaja CHS Limited, (ITA No. 512/Mum./2007) (Mum.), Om Shanti Co-op. Hsg. Soc. Ltd., [ITA No. 2550/Mum./2008] (Mum.), Lotia Court Co-op. Hsg. Soc. Ltd., [ITA No. 5096/ Mum./2008] (Mum).
Auditor’s duty
The Auditor should enquire of the auditee, in case the auditee is dealing in property which is under a DA, whether the covenants of the DA, etc. have been duly complied. In case of any doubts, he may ask for a legal opinion. This is all the more relevant in case the client is a real estate developer. Non-compliance with this could have serious repercussions for the developer.
By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby add value to his services. He can caution the auditee of likely unpleasant consequences which might arise. It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an Auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’.
