3900TH POST
Taxation of real estate development transactions is a
very complex subject. Income tax and Service tax issues concerning both the landowner
and developer are discussed here.
INCOME TAX ISSUES
CONCERNING THE LANDOWNER
The issues can be categorized under the following
heads
1
To be
taxed as capital gain or business income
2
Point
of accrual of income
3
Amount
of income
4
Whether
any exemptions are available
1 To be taxed as capital gain or business
income
The answer to this question depends upon the nature of
transaction undertaken. In most of the cases the resulting gain would be
treated as Long Term Capital Gain. However, if the activity undertaken is in
the nature of a trade, even if it is a solitary transaction, the same would be
treated as a business transaction and accordingly the resulting gain would be
business income.
2 Point of accrual of income
The question to be decided is at what point of time
the transfer is complete as far as the landowner is concerned. The various
points of time which can be considered are:
a. The date of execution of the Development
Agreement
b. The date of handing over of possession of
land to the developer
c. The date of handing over of possession of
land to the developer together with a GPA authorizing the developer to transfer
his share of the property.
d. The date on which the first sale deed is
executed for undivided share in land for the developer’s share.
e. The date on which the first sale deed is
executed for undivided share in land for the landowner’s share.
f. The date on which the building is completed
and share of the landowner is handed over.
The questions are not easy to answer. Let us discuss
these situations in brief :
The date of execution of the Development Agreement
Does a mere execution of development agreement satisfy
all the conditions as are given in Section 2 (47) of the Income Tax Act. The
answer is no. The transfer would not be complete unless the contents of the
agreement give an indication that conditions laid down U/s 2 (47) together with
provisions of Section 53A of the Transfer of Property Act have been fulfilled.
Section 2 (47) (v) of the IT Act reads as under:
Any transaction involving the allowing of the possession
of any immovable property to be taken or
retained in part performance of a contract of the nature referred to in S 53A
of the Transfer of Property Act, 1882.
The date of handing over of possession of land to the
developer
If the development agreement contains a clause which
says that possession has been handed over to the Developer and he is free to
deal with the land as he desires, it leads to a situation where the AO can say that
transfer is complete. The drafting of development agreements is very important
here and they should be drafted in such a way that the transfer is not complete
at the time of handing over of property for construction purposes.
Let us assume the following clause appears in the
Development Agreement
‘It is hereby expressly agreed that till the time the
building is not complete in all respects and the Landowner’s share of the
builtup area is not handed over to him, the Developer shall only be a licensee
on the Scheduled Property and it shall not get any ownership rights over the
scheduled property. It is also clearly understood that permitting the Second
Party to enter upon the scheduled property and construct the building shall not
be construed as delivery of possession in part performance of the contract as
understood under the provisions of Section 53A of the Transfer of Property Act
or under the provisions of The Income Tax Act.’
The above clause will go a long way in defending the
stand of the assessee that there is no transfer on the date of development
agreement or on the date of handing over of possession.
The date of handing over of possession of land to the
developer together with a GPA authorizing the developer to transfer his share
of the property.
This is a very interesting situation wherein the
developer is given a GPA to register sale deeds for his portion of the
undivided share and builtup area. Even if a clause as stated in the earlier
point exists, it would lead to a contradictory situation wherein on one hand
the Landowner says that till the time he gets his share of builtup area there
is no transfer and on the other hand the developer is given possession as well
as a right to execute sale deeds. In such a case the transfer would be complete
as far as the Landowner is concerned and capital gain would be attracted.
The Bombay
Hight Court
The AAR, in the case of Jasbir Singh Sarkaria ( 2007) 294 ITR
196, examined the various clauses in the development agreement and came to the
conclusion that capital gains for the landlord accrued when irrevocable GPA was
given in favour of the developer. This decision really puts the Landowners to
great hardship as they will have to shell out capital gains tax even before any
construction takes place on their land.
The date on which the first sale deed is executed for
undivided share in land for the developer’s share.
In a situation where GPA is not given to the developer
but sale deeds are executed for undivided share in land for the developer’s
share it would be safer to offer
proportionate capital gains tax as and when sale deeds are executed.
The date on which the first sale deed is executed for
undivided share in land for the landowner’s share.
When the Landowner himself sells a portion of his
share of land and transfers a right to a third party, will it not amount to
transfer of property. Here there will be a transfer of a portion of undivided
share in land and capital gain will have to be computed accordingly. It is
worthwhile to remember that the transfer would not be of the portion which is
being given to the developer.
The date on which the building is completed and share
of the landowner is handed over.
With a protective clause stated in the development
agreement as given above and with no GPA given to the builder this is the date on which the transfer would
be complete and the transaction would be subjected to capital gains tax.
The decision of the Delhi Bench A in the case of Smt
Vasavi Pratap Chand Vs DCIT 89 ITD 73 is worth noting. It was held in this case
that :
No conveyance deed had been executed by the assessees.
From the nature of the agreement, it was clear that the assessees were bound to
transfer the land after the possession of built-up flats was given by the
builder to the assessees. The possession of flats was given in financial year
1991-92. There was simultaneous transfer of possession of 44 percent of land by
the builder to the assessees in financial year 1991-92 in terms of section 2
(47) read with section 53A of the Transfer of Property Act. Hence, the
contention of the assesses that land was transferred on the date of
collaboration agreement was to be rejected.
Conversion of
Capital Asset into Stock-in-trade
In view of the Bombay High Court judgement in the case
of Dwarkadas Kapadia and the AAR ruling in the case of Jasbir Singh Sarkaria an
alternative to the ‘Development Agreement’ which comes to mind is that the
Landowner converts his land into stock in trade and if he does this, the
provisions of Section 45(2) would become applicable and the tax is postponed to
the year in which the actual sale takes place. The fair market value of the
land on the date of conversion shall be adopted for purposes of section 48.
3 Amount of income
In a development agreement what the Landowner is
transferring is a portion of his land. And the consideration he is getting is
in the form of builtup area on the portion of land retained by him.
The consideration in a development agreement can be
computed in two ways. Firstly it is the market value of proportionate share in
land which the landowner is transferring.
Looking at it from another angle, it is the value of builtup area he is
getting.
As the registration value of land would be lower than
the market value the AO would resort to the second method in arriving at the
value of sale consideration. Here, the value of builtup area is the cost of
construction of the builtup area which the builder has incurred. It would be
advisable to obtain a letter from the builder stating the per sq ft cost of
construction incurred by him. This cost obviously will not include any interest
cost or other expenses debited in the profit or loss account which are not
directly related to cost of construction.
If the landowner has sold his share of the builtup
area even before the construction is completed the consideration received on
such sale would form part of the consideration for the original transfer of
land. If he has sold part of his share of builtup area this will give rise to
some complications in arriving at the total sale consideration. Because, in
such a case it would be the sum of consideration received on sale and the cost
of construction of the unsold portion.
If the landowner sells his portion of the builtup area
just after construction, this will give rise to one more capital gain
transaction. The first capital gain transaction would be a long term gain and
the second one would give rise to long term gain as far as undivided share in
land is concerned and a short term gain as far as builtup portion is concerned.
The decision of the Madras High Court in CIT Vs Dr Ramachandra Rao ( 236 ITR 51
) is relevant in this regard.
4 Whether any exemptions are available
If the land or property has been held for more than 3 years,
the development agreement transaction will result in a long term gain and the
landowner can claim benefits U/s 54, 54 EC and 54F.
Property purchased in joint names would also qualify
for exemption.
Purchase or retention of more than 1 residential flat
would also qualify for exemption provided the flats are adjacent to each other
or they are used as a single dwelling unit. The decisions rendered in D Anand
Basappa V ITO ( 2005) 92 TTJ 597 (Bang),
K G Vyas V ITO ( 1986) 26 TTJ (Bom) 491 and Smt Fulwanti C Rathod V ITO
( ITA No 1092/Mum/1995 dated May 3, 2002 ) are relevant in this regard. However there is a
contrary decision given in Gulshan Banoo Vs JCIT ( 87 ITD 649 ).
It is interesting to note that in Ratanlal Murarka’s
case ( ITA No 4485/Mum/1999 reported in BCAJ, 2003, the assessee had purchased
one house in Pune and the other one in Thane and exemption was allowed for both
the purchases U/s 54 holding that the expression ‘a residential house’ in
section 54(1) includes two houses.
Another interesting decision is in the case of Mrs
Prema P Shah Vs ITO (2006) 282 ITR (AT) 211 ( Mum.) wherein it was held that
the requirement of section 54 was satisfied even where the residential property
was purchased abroad.
INCOME TAX ISSUES
CONCERNING THE DEVELOPER
The following issues need to be discussed as far as
the Developer is concerned.
a. Year of taxability of income
b. Computation of income
c. Deductions available
A Year
of taxability of income
The question which arises is as to when income becomes
taxable. Is it the year of completion of the project. Or should the income be
offered on a year to year basis. If the income is to be offered on a year to
year basis should it be computed on percentage of completion method or should it
be estimated.
For the purposes of income tax income has to be
determined on a year to year basis. This was so decided by the Supreme Court in
the case of P M Mohammed Meerkhan Vs CIT (1969) 73 ITR 735
However the department has been accepting the ‘completed
contract method’ also and the Bombay High Court, in the case of Shree Nirmal
Commercial Ltd V CIT 193 ITR 694 has accepted the completed contract method.
It is also interesting to note that the scrutiny norms
announced by the CBDT for picking up cases for scrutiny also state that all
cases of builders following the completed contract method should be picked up
for scrutiny.
Should Accounting Standard AS-7, which applies to construction contracts, be
followed while computing the income of a real estate developer. The answer is
‘No’. AS 7 applies to accounting for
construction contracts in the financial statements of contractors and not to
enterprises that are constructing properties on their own account. Therefore
revenue recognition and valuation of inventories should be in accordance with
AS 9 and AS 2 respectively. In other
words AS – 7 would apply when contract is being executed on behalf of a third
party.
B
Computation of Income
What income should be offered to tax by a developer
? If the profits are to be offered to
tax on a year to year basis profits have to be estimated till the project is
not complete. Income can be estimated as a percentage of work completed or as a
percentage of advances received.
The department has been accepting an 8 % profit on
gross receipts or work completed when the project is incomplete. Balance of
profit has to be offered in the year of completion. For partnership firms, out of the 8 %
profits, interest and remuneration to partners can be deducted to arrive at
taxable income of the firm.
Section 44AD is applicable only in the case of civil
contractors ( executing civil work for third parties ) having less than Rs 40 Lakhs of receipts and
hence this section cannot be made use of by developers who are selling
residential flats or office spaces on their own.
C
Deductions available
The only deduction available to developers is for
construction of housing projects U/s 80-IB (10).
100 % of the profit derived in any previous year is
exempt from tax if the following conditions are satisfied.
a. The project is approved by a local
authority before March 31, 2007.
b. The size of the plot of land is a minimum
of one acre
c. The project should be completed within 4
years from the end of the financial year in which the housing project is first
approved or before 1/4/2008, whichever is earlier.
d. The builtup area of shops and other commercial establishments
included in the project shall not exceed 5 % of the total area or 2,000 sq ft
whichever is less.
e. The builtup area of each residential unit
should not exceed 1000 sq ft within local limits of Delhi & Mumbai or 1500
sq ft in other areas.
ISSUES
IN SERVICE TAX
Before proceeding
to the specific topic of applicability of service tax to developers and
builders it would be worthwhile discussing some basic issues in service tax.
Threshold Exemption
From the financial year 2008-09 onwards, threshold exemption on the aggregate value of
taxable services provided during a financial year is available to a service
provider upto a maximum of Rs 10 Lakhs.
Exemption linked to preceding year’s turnover :
Exemption is available if the aggregate value of
taxable services provided has not exceeded the taxable limit in the preceding
financial year.
Tax payable for turnover over Rs 10 lakhs in the first
year :
Service tax is payable only on the turnover exceeding
Rs 10 lakhs and not on the entire amount in the first year. Thus in the first
year of exemption, if the turnover is Rs 10.40 Lakhs, service tax is payable
only on Rs 40,000/-. However, from the
next year tax is payable on the entire turnover. It would be worthwhile to note here that if
any service tax is collected which is not required to be collected or if any
excess service tax is collected, the same has to be immediately paid into the
account of the Central Govt.
In arriving at the limit of Rs 10 Lakhs only taxable
services are to be counted. Thus if a person has turnover of Rs 5 lakhs for
non-taxable service and a turnover of Rs 6 lakhs for taxable service, he can
still enjoy tax exemption.
New services brought into tax net during the year
If a service is made taxable from a date in the middle
of the year ( say from July 1 ) the turnover of the service provider upto the
date of introduction of service would not be counted as part of the Rs 10 lakhs
threshold limit.
Construction Services
Service Tax @ 10 %
plus education cess @ 3 % of service tax ( total 10.30 % of the value of
taxable service ) is applicable to the following two categories of construction
services :
1 Commercial or Industrial construction
services
2 Construction
of complex service
1 Commercial
or Industrial construction services
Section 65 (25b) of the Finance Act, 2005 defines the
service as follows :
(25b) ‘commercial or industrial construction service’
means –
(a) construction of a new building or a civil
structure or a part thereof; or
(b) construction of pipeline or conduit; or
(c) completion and finishing services such as
glazing, plastering, painting, floor and wall tiling, wall covering and wall
papering, wood and metal joinery and carpentry, fencing and railing,
construction of swimming pools, acoustic applications or fittings and other
similar services, in relation to building or civil structure; or
(d) repair, alteration, renovation or
restoration of, or similar services in relation to, building or civil
structure, pipeline or conduit,
which is -
(i)
used,
or to be used, primarily for; or
(ii)
occupied,
or to be occupied, primarily with; or
(iii)
engaged,
or to be engaged, primarily in,
commerce or industry, or work intended for commerce or
industry, but does not include such services provided in respect of roads,
airports, railways, transport terminals, bridges, tunnels and dams’.
Who is covered under this
head :
-
Persons
engaged in constructing shopping malls, commercial complexes, multiplexes etc.
-
Persons
engaged in repairing, altering or restoring of any building or civil structure.
-
Persons
engaged in construction of hoardings, construction of pipelines or conduit.
-
Persons
engaged in completion and finishing services such as glazing, plastering,
painting, floor and wall tiling, wall covering and wall papering, wood and
metal joinery and carpentry, fencing and railing etc.
Who is not covered under this head :
-
Persons
engaged in constructing the building or civil structure for self-use or for
renting out, or for sale
-
Persons
engaged in construction of roads, bridges, airports, railways, transport
terminals, tunnels and dams.
As stated above, it is very interesting to note that
developers, builders who are constructing commercial complexes for renting out
or for sale are not covered for service tax purposes. Para No12 of Circular No
80/10/2004 ST dated 17/9/2004 clarifies that
‘ ….. estate builders who
construct buildings / civil structures for themselves ( for their own use,
renting it out or for selling it subsequently ) are not taxable service
providers. However, if such real estate owners hire contractor / contractors,
the payment made to such contractor would be subjected to service tax under
this head…..’
This means that if a builder makes a sale deed for the
commercial spaces which he is building, there will be no service tax. However,
if sale deeds are made for undivided
share in land or semi finished structures and then ‘ Agreement of construction’
is made for constructing or finishing the structure it will attract service
tax.
Abatement of Tax
Any service provider liable under this head can opt
for availing abatement to the extent of 67 % of the gross receipts and pay tax
only on the balance 33 % of the gross receipts. Other conditions like not
availing Cenvat credit on inputs or capital goods or on input services are
applicable.
2 Construction of complex service
Section 65 (30a) of the Finance Act, 2005 defines the
service as follows :
(30a) ‘construction of complex ’ means –
(a) construction of a new residential complex
or a part thereof; or
(b) completion and finishing services in
relation to residential complex such as glazing, plastering, painting, floor
and wall tiling, wall covering and wall papering, wood and metal joinery and
carpentry, fencing and railing, construction of swimming pools, acoustic
applications or fittings and other similar services; or
(c) repair, alteration, renovation or
restoration of, or similar services in relation to, residential complex
(91a) ‘residential complex’ means any complex comprising of –
(i)
a
building or buildings, having more than twelve residential units;
(ii)
a
common area and
(iii)
any
one or more of facilities or services such as park, lift, parking space,
community ball, common water supply or effluent treatment system
located within a premises and the layout of such
premises is approved by an authority under any law for the time being in force,
but does not include a complex which is constructed by a person directly
engaging any other person for designing or planning of the layout, and the construction of such complex is intended for
personal use as residence by such person.
Explanation – For the removal of doubts, it is hereby
declared that for the purposes of this clause, -
(a) ‘ personal use’ includes permitting the
complex for use as residence by another person on rent or without
consideration;
(b) ‘residential unit’ means a single house or
a single apartment intended for use as a place of residence;’
Are builders / developers of residential complexes
covered ?
The CBEC has clarified that where a builder, promoter
or developer engages a contractor for construction of residential complex, the
contractor shall be liable to pay service tax on the gross amount charged for
construction services provided to a builder, promoter or developer. However, if
no contractor is engaged and the job of construction is undertaken by the
builder, promoter or developer himself, then in such cases, in the absence of service
provider and service receiver relationship, the question of providing taxable
service to any person by any person does not arise.
In other words if a builder is making sale deeds for
the completed residential flats, he will not be liable to service tax. If
‘construction agreements’ are made with the intending buyers service tax will
be payable.
The Authority for advance ruling ( in the case of
Harekrishna Developers – Ruling AAR 4 of 2008 in Application No 10 of 2007
decided on 7-4-2008 ) has observed that builders who are executing
sale deeds for residential portions on completion of building are also liable
to service tax if the sale deed is executed in pursuance of an agreement to
sell between the builder and the buyer. The AAR
also observed that the situation covered by the Board circular is one of
outright sale of a residential unit
after the construction, the construction having been done without reference to
any agreement between the builder and buyer and the developer and buyer come
face to face after the entire process of construction is complete. This judgement comes as a surprise and could
cause lot of hardship to builders.
However the Guwahati
Hight Court
Abatement of Tax
Any service provider liable under this head can opt
for availing abatement to the extent of 67 % of the gross receipts and pay tax
only on the balance 33 % of the gross receipts. Other conditions like not
availing Cenvat credit on inputs or capital goods or on input services are
applicable.
Service tax on works
contracts under the composition scheme
Under the works contract ( composition scheme for
payment of service tax) Rules, 2007 the builder has an option to pay service
tax at 4 % on the gross amount.
(Introduced
vide Notification No.32/2007-Service Tax, dated 22nd May,
2007)
1 comment:
Thanks Manish ji....for sharing such a Practical Aspect of Real Estate Transactions.... Really good efforts.........
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