By M. K. Mehendale, Ashok L. Sharma, Chartered Accountants
Lecture Meeting
Subject : Real Estate Development Agreements — Tax
Issues including Deduction u/s.80IB.
Speaker : T. N. Manoharan, Past President,
ICAI
Venue : IMC Hall, Churchgate, Mumbai
Date : 27th June 2008
1. The learned speaker Mr. Manoharan said that the topic of
discussion was not only very wide, involving high financial stakes, but also
involved various legal aspects right from titles to property, tax implications
from the point of owners vis-à-vis developers, year of assessability,
judicial views and decisions, consideration of direct tax laws as well as allied
laws and multiple other issues. He therefore divided the subject by giving
consideration to :
(i) Legal aspects as to title.
(ii) Incidence of levies under direct tax laws as well as
allied laws like Stamp Duty, Registration, Service Tax.
(iii) Impact of Accounting Standards, method of accounting
for developer.
(iv) Tax implications affecting land owners, year of
assessability, exemptions.
(v) Quantification of consideration receivable.
(vi) Determination of year of transfer.
(vii) Case laws & judgments applicable to the owners.
(viii) Deductions u/s.801B (10), conditions precedent for
developers and issues thereunder.
(ix) Inflow of foreign investments in real estate.
(x) Emerging professional opportunities from booming real
estate development trade.
2. After setting out the broad spectrum and coverage, the
speaker moved to deal with each aspect.
3. Legal aspects concerning title to property :
The study of professional begins with examination of
documents conferring perfect and marketable title to property; by examining
antecedents, family tree of owner, whether title is derived by intestate or
testamentary succession, family settlement or by gifts and whether the documents
are properly worded and registered; study of pending litigations affecting clear
title, etc. As per the Supreme Court’s decision in Chandersen case, the son
deriving title from his deceased father in intestate succession succeeds it as
his individual property and not HUF property. The exception is where directions
are given in the Will bestowing the title in HUF capacity. Another exception is
family settlement. Such transaction is not liable to Gift Tax. In any case gift
in kind is outside the purview of S. 56(v) from donee’s point of view.
4. Incidence of levies :
Under the Stamp Act in Maharashtra, the Stamp Duty rate is
concessional i.e., 2% only on market value. In other States also, the
concessional rate is applicable. In Karnataka, the duty on gifts of immovable
properties to relatives is only Rs.1,000, irrespective of value of property. In
Tamil Nadu it is 1% with a ceiling limit of Rs.10,000. Therefore, through gifts
of immovable properties to close relatives, by incurring very reasonable cost,
it is possible to make income-tax and wealth-tax planning within the family.
The speaker then observed that the stigma attached to
transaction in immovable properties, viz. existence of unaccounted money
is gradually vanishing. This is due to increasing foreign investment in real
estate market, exemptions to capital gains through investments in notified bonds
and purchase of new properties, thirdly, reasonable levy of Stamp Duty and
fourthly impact of S. 50C introducing presumptive receipt of consideration.
5. Tax implications as applicable to developer :
The earnings that a developer would be making are governed by
Accounting Standard 7. In 2002, AS-7
got revised. The chance of completed contract method was given a go-by. Now, if
the developer is acting as contractor in charge of development, he has to
quantify profit on percentage completion method. However, if the developer is
acting as builder taking risk and reward on his account, then AS-7 is not
applicable but AS-9 (Revenue Recognition) will apply. Accounting Standards’
interpretation 29 clarifies that revenue should be recognised by considering
factors of risks and rewards, substantial completion of project and other
relevant factors like method of accounting regularly followed.
In transactions of dealing in land, the land becomes
stock-in-trade for the purchaser, attracting S. 40A(3) if any part of payment is
paid otherwise than cheque. For small value constructions, benefit of S. 44AD is
available to contractor.
6. Tax provisions applicable to owner of land :
Generally speaking proper documentation assumes great
importance since terms and conditions will determine the correct year of
assesability, the year of transfer, the claims of exemption under one or more
Sections, quantification of capital gain, opening of capital gain account, dates
for payment of advance tax. More specific issues in this regard are :
(a) Consideration : When owner agrees to convey his land, very rarely he recovers entire money consideration at the time of executing the contract. It is received mostly by instalments or is paid partly by money and partly in kind like built-up area. In case of joint ventures it is received only when the project is complete. The value of constructed area allotted to the owners towards purchase consideration is determined on basis of cost of construction and not at a price charged to outside flat purchasers. In the process, if the owner has to bear compensation to the occupants/tenants of his property, it will be legitimate deduction from capital gain accruing to him. The owner has to take note of S. 50C; in cases where consideration stated is less than market value adopted by Stamp Duty authorities. Prior to insertion of S. 50C, chapter XXC was on the statute book putting a curb on circulation of black money by understating apparent consideration. The chapter XXC was applicable to some cities and to transactions over certain monetary limits. Those provisions were withdrawn. S. 50C applies to all transactions in land and building, irrespective of situs and consideration amount.
b) Year of transfer: Prior to A.Y. 1988-89, the Supreme Court decision was holding the field, fixing the taxability to the year in which conveyance is executed and registered. To overcome the practical difficulties and to plug the loophole, S. 2(47) defining transfer was amended by inserting sub-clauses (v) and (vi). Newly inserted sub-clause (v) takes in its fold transactions where the possession of the subject property is taken or retained by the transferee in part performance of contract as per S. S3A of the Transfer of Property Act. In such cases, the transfer will be deemed to be complete even if the deed of conveyance is not executed and registered. Sub-clause (vi) deals with transfer of flats in co-operative societies. In these cases, where the owner/transferor’ executes a general power of attorney in favour of transferee, authorising him to carry out all acts and deeds in furtherance of the project, it will be deemed that the transfer is complete.
c) Joint development agreement between the owner and builder/developer: where owner gets consideration in the form of built-up area. Though one can argue that such transaction is covered by clause ‘exchange’ in S. 2(47)(i), still liability to capital gain will crystallise on basis of sub, clause (v) due to granting possession and power of attorney to builder. Therefore, at least to the extent of funds required for investment in notified securities u/s. 54EC and for tax amount, suitable provisions for receiving money consideration from the builder should be made in agreement. By executing limited power of attorney in stages and by keeping control/domain over property, the owner can defer immediate tax liability.
d) Following case law on year of Transfer and year of taxability needs very careful consideration.
i) Chaturbhuj Dwarakadas Kapadia, 262 ITR 491 (Bom.)
ii) Jasbir Singh Sarkaria, 294 ITR 196 (AAR holding that execution of general power 6-attorney results in transfer
iii) Receipt of substantial consideration by the landowner. Mumbai Tribunal in Geetadevi Pasari’s case, 104 ITJ 375 (Mum.) has considered ratio of Chatubhuj Dwarkadas Kapadia. It has distinguished the case before it and held that where the transferee has not observed condition of S. S3A of the Transfer of Property Act, the deeming fiction of sub-clause (v) does not get triggered as substantial consideration remained un-paid.
The learned speaker therefore stressed the need of proper documentation. By making specific provisions in development agreement that effective control and possessory rights over the property will remain with owners at least till transferee makes substantial payment of agreed consideration. The owner should also refrain from giving general power of attorney to the builder.
Alternatively, the owner should ensure receipt of money consideration enough to cover investment in securities prescribed u/ s.54EC and tax liability.
7. Exemption from tax is available to developer on compliance of conditions precedent, listed in S. 80IB(10).
After considering the tax issues applicable to owner, an equally important issue applicable to builder is compliance of S. 80lB(10) entitling him to complete tax exemption. Though, it is not applicable to projects approved after the cut-off date of 31-3-2007, still ongoing project can merit exemption if local authorities have approved the project as residential housing project prior to the cut-off date. However for the projects undertaken for slum clearance and notified by the Central Government, the conditions of area of plot and cut-off date are not applicable. The developer of ongoing eligible projects should strictly adhere to and comply with the conditions of area of plot, area (built-up) of flats and obtaining completion certificate from local authorities within 4 years from the date when the building plan is first approved. So also the commercial area should not exceed 5% of total built-up area or 2000 sq.ft., whichever is less. The promoter / developer need not own the land to avail benefit of deduction. Where the project is of merged nature i.e., housing and commercial, the judicial opinion as per reported judgments is divided. Varying from stricter version of total denial to milder version of pro-ration. The following decisions as well as CBDT clarification need careful attention. The citations are:
a) 113 TTJ (Ahd.) 300 – ownership of land by developer is not precondition
b) Case law on housing cum commercial projects:
105 ITD (Mum.) 657
108 ITJ (Che.) 71
109 ITJ (Mum.) 335
ITA No. 1735 (Cal.) – Bengal Ambuja 108 TTJ (Che.) 71
8. Alternative remedies available to landowners to avoid litigations on year of taxability, practical difficulties in availing funds for investments u/s.54EC, The speaker discussed the following alternative modes. If the landowner converts his property as stock-in-trade, there will be capital gain on the date of conversion, but the year of taxability as per S. 45(2) gets postponed to the year in which he realises the consideration. The excess, of course, will be business income. For capital gains, clause (iv) of S. 2(47) will apply and not clause (v). The Jodhpur Bench in 298 ITR 97(AT) has held that S. 53 applies only when the document is registered. Second mode is that the landowner, after conversion of capital asset into stock-in-trade can enter into partnership or joint venture with builder. By this he can reap the benefit of sharing the surplus with the builder. The capital gain element can be invested in prescribed securities within 6 months from the date of realisation. It is also possible to spread over the realisation in more than one year and benefit of investment can be availed, for each such year.
9. Recent development that needs attention is increased flow of funds by foreign investing institutions in real estate trade. As a by product, such development will provide increased and challenging professional opportunities to members of profession.
The meeting ended with a vote of thanks to the learned speaker.
