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Capital Gains Tax & Joint Development Agreement The scope of Capital Gains in Joint Development Agreement is a vast

one and is made with an eye on the tax consequences of the transaction. The last decade has viewed the tremendous growth in the Real Estate; it also witnessed the growth in legal disputes regarding tax matters. A Joint Venture between the landowner and a Developer is considered the most preferable way for the development of property. In a Joint Development Agreement between Landowner and Developer for construction of residential buildings on a land measuring X acres of landowner, the common issues which generally arises are as following a) When does the Capital gain Tax arise for the landowner and developer? Is it at time of signing the joint development agreement, at the time of receiving the constructed residential buildings, or at the time of selling the residential buildings? b) In case, if there is breakdown of joint development project, does landowner has to pay the capital gains tax. As per S.45 (1) of the Income Tax Act, any gain arising from the transfer of a capital asset during a previous year is chargeable under the head Capital Gains in the immediately following assessment year. However, S.45(2) of Income Tax Act, gives certain exemptions to not to treat certain assets as capital assets like any stock in trade, consumable stores or raw material held for the purposes of business or profession. And, as per the facts Developer is engaged in Construction business, so for him, constructed property is stock-in-trade. It cannot be treated as a capital asset. Any surplus that is generated by developer on sale of stock-in-trade would be chargeable to tax as business income. Therefore, Developer is not liable to pay capital gains tax. In case, in the Joint Development Agreement, arrangement between the landowner and developer is such that developer has to bear certain portion of capital gains tax, then only developer will be liable for the payment of capital gains tax which is to be borne by the landowner or else the landowner has to bear the capital gains tax. Now, the question arises when the incidence of capital gains tax arises? The point where the capital gains are deemed to accrue will purely depend on the terms of Joint Development Agreement. Where the agreement is of such nature that possession is given in part performance of a contract, the liability of capital gains tax will arise on the handling over of such possession to the builder. If the possession is not transferred but deferred until the construction is completed, the liability to capital gains tax will arise in the year in which the developer completes the construction. Where the landowner and builder execute joint development agreement, if the consideration is receivable in builtup area to be constructed and handed over by the builder to the landowner, it is advisable to avoid the applicability of section 53A of the Transfer of Property Act. This can be achieved by mentioning in the agreement that license is granted to the builder to enter the premises and construct the building. The possession is retained by the landowner, which will be handed over as and when the built-up area is constructed and delivered. By this stipulation, the transfer will take place only in the year in which the built-up area is received and not before. In the case of In re Jasbir Singh Sarkaria, [2007]164 TAXMAN 108 (AAR- New Delhi) , it has been held that1) Where the agreement for transfer of immovable property by itself does not provide for immediate transfer of possession, the date of entering into the agreement cannot be considered to be the date of transfer within the meaning of sub-clause (v) of section 2(47) of the Income-tax Act. 2) To attract sub-clause (v) of section 2(47), it is not necessary that the entire sale consideration upto the last installment should be received by the owner. 3) In the case, having regard to the terms of two agreements and the irrevocable GPA executed pursuant to the agreement, the execution of GPA shall be regarded as the transaction involving the allowing of the possession of land to be taken in part performance of the contract and therefore, the transfer within the meaning of section 2(47)(v) must be deemed to have taken place on the date of execution of such GPA.

4) Once it is held that the transaction of the nature referred to in sub-clause (v) of section 2(47) had taken place on a particular date, the actual date of taking physical possession need not be probed into. It is enough if the transferee has by virtue of that transaction a right to enter upon and exercise the acts of possession effectively. In case, the Joint Development Agreement between the Landowner and Developer breaks down and the project is not completed, then whether Landowner is liable to pay capital gains tax? (i). If the developer is liable for the breaking down of the joint development agreement, then either the landowner will get compensation from the developer for the breach of contract or developer have to do specific performance as per the terms of the Joint Development Agreement, in both cases landowner will acquire. And, for charging what landowner has acquired from the developer under capital gains tax, it should be first comes under the definition of capital asset In the case of CIT v. Vijay Flexible Containers [1990] 186 ITR 691 (Bom.), the assessee a firm entered into an agreement with a person to purchase the property at a particular rate. The assessee also paid a sum of Rs. 17,500 as earnest money. As the vendor failed to perform his part of the contract, the assessee was constrained to file a suit for specific performance of the agreement for sale, or in the alternative, for damages for its breach. Consent terms were arrived at in the suit and a decree was passed in favour of the assessee for the sum of Rs. 1,17,500 and interest. The question arose whether that amount received by the assessee was a capital asset. A Division Bench of the Bombay High Court held that under the agreement to purchase the property, the assessee had acquired the right to have the immovable property conveyed to him and under the law, he was entitled to exercise that right not only against his vendors but also against a transferee with notice or a gratuitous transferee. The assessee could have also assigned that right. Hence, what he acquired under the said agreement for sale was therefore property within the meaning of the Income-tax Act, 1961, and consequently a capital asset. The Court further held that his giving up of the right to claim specific performance by conveyance to him of the immovable property was a relinquishment of the capital asset and therefore there was a transfer of a capital asset within the meaning of the Income-tax Act. (ii). In a Joint Development Agreement, when the project starts, the Developer pays a consideration to the Landowner for starting the project. Even if the project is not completed because of breakdown of Joint Development Agreement, then whether the consideration paid by the Developer at the beginning of project will be treated as capital asset for Landowner? In the case of K.R. Srinath v. Asst. CIT,[2004] 141 Taxman 268 (Mad.), Where the assessee initially paid advance under an agreement for the purchase of a property, reserving right to specific performance of the agreement, and later received consideration under another agreement under which the earlier agreement was cancelled and the vendor was allowed to sell the property to any person at any price, there was a relinquishment of right by the assessee which amounted to transfer, and the resulting gain was assessable as capital gains. Since the assessee had paid a sum for acquiring the right to acquire the sale deed, it could not be said that there was no cost of acquisition so as to take the view that there could be no assessment to capital gains. Hence, even if the Joint Development Agreement between the Landowner and Developer breaks down, if the landowner has acquired due to Joint Development Agreement, then what landowner has acquired will come under the definition of capital asset and Income Tax department can levy capital gains tax on that capital asset.

All about capital gains taxation


T. Banusekar This week, `Tax Talk' answers the elaborate query of a reader, Mr K. Pani, on the capital gains taxation arising out of joint development and transfer of a house property. A, B, C and D are the co-owners of inherited property at Hyderabad owning 30,000 sq ft of land and a building being a residential house. They gave it for joint development in 1991. The documents executed are joint development agreement and unregistered power of attorney. The terms of joint development stipulate that the owners have to get 50 per cent of the super built up area aft er construction. The total super built up area expected was 60,000 sq ft and share of A, B, C and D was 30,000 sq ft in the form of four flats of 1,875 sq ft each. The builder, on signing the joint development agreement (mainly to compensate for the re-location of the families), paid a non-refundable deposit of Rs 40 lakh. The flats were supposed to be constructed and handed over within three years. The No Objection Certificate was applied in form 37-I for Rs 160 lakh as given below: *Value of 30,000 sq ft at Rs 400: Rs 120 lakh. *Non-refundable deposit: Rs 40 lakh. *Total consideration for 50 per cent share of undivided interest (UDI): Rs 160 lakh. The appropriate authority granted the NOC in 1991 based on the Joint Development Agreement. The developer got the plan approved, wherein the approved super built up area came to 42,000 sq ft only. The construction could be completed only in 2000. The developer progressively handed over the completed flats, before March 2000 and the balance was completed by July 2000. Ultimately, each of the co-owners got three flats of 1,750 sq ft each. None of the flats was sold, either by the developer or by the owners. It is likely the flats will be sold in 2000-01. In this case, from the point of view of the owners of land: Query 1: When does the capital gains tax arise? Is it at the time of signing the joint development agreement, at the time of receiving the constructed flats, or at the time of selling the flats? Reply: The point where the capital gains is deemed to accrue will purely depend on the terms of agreement between the promoter and the land-owners. Where the agreement is of such nature that possession is given in part performance of a contract, the liability to capital gains tax will arise on the handing over of such possession to the builder. If the possession is not transferred but deferred until the construction is completed, the liability to capital gains tax will arise in the year in which the construction is completed by the developer. This will be so, for in such a case the builder is given only a right to enter the premises for the purpose of construction, and the ownership will continue to remain with the land-owners.

Even in this case, capital gains will arise when the possession of the constructed area is given to the land-owners or when conveyance is registered, whichever is earlier. In any event the capital gain arising out of such joint development cannot be deferred until the time of selling the flats that are allotted to the landowners. Query 2: If the capital gains tax liability is at the time of receiving the constructed flats, what is the basis of reckoning the value of flats (being the sale consideration)? Reply: If the capital gains accrues at the time of receiving the constructed flats, the full value of consideration to be reckoned would be the cost of construction of flats actually allotted. That is, of the three flats to each co-owner ad-measuring 1,750 sq ft each. Though the reader has stated that the consideration in the form of built up area has been reduced, there is no indication that this reduction has been compensated in some other manner. One would, therefore, presume that the consideration has been reduced by way of revised agreement by the developer and the land-owners. If this be the case, the Appropriate Authority would have to be re-approached for the NOC for revising the terms of agreement. Where, however, capital gain accrues at the time of the agreement between the landowners and the builder, the full value of consideration would be the cost of construction of the flats originally agreed to be allotted, that is, four flats to each co-owner, measuring 1,875 sq ft each. Query 3: Is exemption available under Section 54 since there was a house when the property was handed over to the builder or is it under Section 54F? Reply: Section 54 provides for an exemption on the transfer of a long-term capital asset being a residential house subject to certain other conditions being satisfied. Section 54F provides for an exemption on the transfer of a long-term capital asset not being a residential house subject to satisfying certain other conditions. In case of joint development agreements, a doubt oft en arises if the transfer is that of a residential house or only of land. As stated earlier, if capital gain accrues when possession is handed over to the builder, no dispute can arise and it can be said that the exemption would be available under Section 54. This would be so because the transfer would clearly be of the residential house. However, if the capital gains accrues only when the construction is completed, the doubt could arise for the possession and if the transfer by the land-owners is only of land and not of the residential house. The land-owners would normally be registering only the undivided share of land in favour of nominees of the builder. However, in such a case also, it is a substance of the transaction that needs to be looked into and not its form. If this is done, then it can be easily said that the land-owners can claim exemption under Section 54. Query 4: How do we compute the capital gains for some of the flats delivered before March 2000 and let out by this individual? Reply: In the answer to the first query, it has already been stated that the gains may arise at the time of handing over of possession by the builder or when the conveyance is registered, whichever is earlier. If this be the case, in respect of the flats delivered before March 2000, the capital gains tax would arise in 1999-2000. The capital gains will have to be computed on a proportionate basis, by taking the proportionate cost of acquisition of the

property. The proportion being arrived at on the basis of the consideration in the form of flats received to the total consideration receivable by way of flats. Query 5: Will exemption be limited to one property under Section 54F or two, as amended from April 1, 2000? Reply: The reader has misunderstood the amendment made to Section 54F by the Finance Act, 2000. Section 54F continues to allow exemption only in respect of one property. It is just that the law has been amended to provide that the exemption will be available, even if the assessee were the owner of one residential house other than the new asset. Though this question has been answered, as a matter of academic interest it may be noted that the columnist has stated that the exemption would be available under Section 54 and not under Section 54F. Query 6: Can we have the option to invest in 54EA, 54EB or 54EC and got the tax exemption? If so, what is the investment to be made? Please note that we have only received flats, but do not have funds to invest, as we have not sold the flats. Reply: The option to invest in specified assets for exemption under 54EA or 54EB (if the gains accrues before April 1, 2000) or 54EC (if the gains accrues on or aft er April 1, 2000) is available to the assessee. To get the exemption in full, the amount to be invested would be: *In the case of Section 54EA -- the net consideration. *In the case of 54EB or 54EC -- the capital gains. The fact that the consideration is only in the form of flats is not material if the exemption is to be availed. The investment must be made within six months from the date of transfer. The assessee is, however, free to borrow the money or invest out of his other sources, and the exemption would still be available, though the investment is not made out of the consideration received from the transfer. Query 7: When we sell the flats later, will the gains be long-term or short-term? Reply: When the flats are sold later, a capital gain will arise. The gain would be short-term or long-term depending on the period of holding of the flats. If the flat was held for a period exceeding 36 months, the gain would be long-term or else short-term. If exemption under Section 54 has been claimed earlier in respect of the flats transferred, the capital gains earlier exempt would be reduced from the cost of acquisition of the flat, in arriving at the capital gains. This will apply only if the flat is transferred within three years of its acquisition. Query 8: One of the co-owners, A, passed away, leaving a will that his share is to be shared equally by the children of the rest (B, C and D). The children are minors. What is the capital gains tax liability in the hands of legal heirs? Reply: The capital gains tax liability in the hands of the legal heirs can be analysed in three different situations.

Situation 1: Where the capital gains liability has arisen to the deceased co-owner at the time of the agreement with the builder, there would be no capital gain tax liability in the hands of the legal heirs. Situation 2: Where the capital gains tax liability is to arise on the handing over of possession by the builder, or on registering the conveyance, and where the co-owner has died aft er getting the flats, the capital gains tax liability would be that of the deceased coowner. There would be no capital gains tax liability in the hands of the legal heirs. Situation 3: Where the capital gains tax liability arises on the handing over of possession by the builder, or on registering the conveyance and where the co-owner dies before the liability arises in his hands, the heirs of the deceased would automatically become the coowners along with B, C and D. The gains would be computed as though the property were co-owned by six persons -- B, C, D and three minor children. It may be observed here that the income of a minor child is to be clubbed with that of the parent in accordance with section 64(1A). It may also be noted that the tax liability of the deceased may be recovered from the legal heirs (Section 159) if the deceased is liable to tax. (The author is a Chennai-based practising chartered accountant. This column appears on the first and third Sundays of every month.) Business Line invites queries on personal taxation issues to this column. They will be answered in the first Sunday's issue of Business Line every month. Queries may be addressed to Tax Talk, Business Line, Kasturi Buildings, 859, Anna Salai, Chennai 600 002, or by e-mail to vaidy@thehindu.co.in

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