Authority Settles Tax on Capital gains by Real Estate Developers

AIT News Network

NEW DELHI. Vide a landmark ruling AIT-2007-344-AAR, delivered by Justice PV Reddy Chairman, Authority for Advance Rulings (Income-Tax) has settled several significant issues relating to tax liability on capital gains by Real Estate Developers as under:

·               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 clause (v) of Section 2(47) of the Income-Tax Act.

·               To attract 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.

·               In the instant 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.  The irrevocable GPA was executed on 8.5.2006 i.e. during the previous year relevant to the assessment year 2007-08 and the capital gains must be held to have arisen during that year.  Incidentally, it may be mentioned that during the said year, i.e. financial year 2006-07, a final licence was granted and the applicant/owners received nearly 2/3^rd of the consideration.

·               Once it is held that the transaction of the nature referred to in 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.

T H E    F A C T S: 

The question that has to be answered in this case turns on the year chargeability of the income attributable to capital gains. The applicant, who is a citizen of USA, is the co-owner of agricultural land of an extent of 27.2 acres. The other co-owners are his brother and sister. The applicant is entitled to 4/9^th share therein. The applicant and other co-owners having decided to develop the land by constructing a residential complex thereon though a ‘entered into a ‘Collaboration agreement’ on 8.6.2005 with M/s. Santur Developers Pvt. Ltd., New Delhi. On behalf of the applicant, the agreement was signed by his brother and Power of attorney holder Mr. Karanbir Singh Darkaria. According to the terms of the agreement, the developer should obtain the ‘letter of Intent’ from the concerned Government department and obtain other permissions and sanctions for developing the land at its own risk and cost. The developer will have 84 per cent share of the entire built up area and the proportionate land area whereas the owners’ share will be 16 per cent. The mode of apportionment of the built up area is indicated in clause 21 of the agreement. The consideration for the agreement is the portion of the built up area to be handed over to the owner free of cost. Owners are entitled to visit the site in order to review the progress of the project. It is clarified in clause 18 that the ownership would remain exclusively with the owners till it vests with both the parties as per their respective shares on the completion of the project. The other clauses and the steps contemplated in the agreement are the following:

(i)            Payment of earnest money of Rs. 1 crore at time of entering into agreement.

(ii)           Execution of Special Power of Attorney in favour of developer to enable it to deal with the statutory authorities etc. for obtaining approvals/sanctions.

(iii)          Obtaining ‘Latter of Intent’ not later than 8.3.2006. In case of failure to do so, the agreement shall stand terminated. (‘latter of Intent’ is license granted by the Director of Town Planning to develop the land for the proposed purpose subject to payment of prescribed charges and compliance with other conditions).

(iv)          On fulfillment of the requirements laid down in the ‘Letter of Intent’, owners will have to execute irrevocable general Power of Attorney in favour of the developer, inter alia, authorizing it to book and sell dwelling units out of developer’s share and collect the money for the same. However, the sale deeds can only be executed after the owners receive their share of the constructed area. [Vide clause 15]

(v)           After filing application for change of land  use (licence), the developer shall take steps to earmark the built up area of the owners in accordance with the tentative building plan and both the parties are entitled to lease out or sell the area filing to their respective shares as per the agreed allocation and to respect payments. [vide clause 26]

(vi)          The owners, on completion of the construction of their built up area, shall grant power in favour of the developer to enable it to rights, title and interest to the extent of its share in favour of buyers of the units.

(vii)         Subject to the fulfillment of the obligations enjoined upon the developer, the owners shall not interfere with the execution of the development and construction work.

There months later, an agreement styled as ‘Supplementary Agreement’ was entered into on 15.9.2005 between the applicant and other co-owners on the one hand and M/s. Santur Developers Pvt. Ltd.(is hereafter referred to as “developer” or “transferee” for the sake of brevity) on the essence, it is an agreement to sell the 16 per cent share of the owners in the built up area to the developer or its nominee for a consideration of Rs. 42 crore.

The salient features of the 2^nd Agreement are:

                Apart from Rs. 2 crores which the owners have received under the collaboration agreement, the balance sum of Rs. 40 crore is payable by the developer to the owners in six installments starting from 8.3.2006. The time for payment of installment money may be extended subject to payment of interest/liquidated damages as per clauses 8 and 9. The last installment of Rs. 10 crore was payable on or before 8^th June, 2007 subject to maximum extension of there months. Thus, the entire consideration should be paid within 27 months from the date of Collaboration agreement. Under clause 10 it is provided that if the payment is not made within the maximum period of extension, the owners shall be at liberty to terminate collaboration agreement by given 30 days’ notice and thereupon it is incumbent on the developer to forthwith cease the development activity on the land and remove itself and its agents therefrom. On receipt of all payment within the prescribed or extended time, the owners shall have to transfer all the right, title and interest in and over the owners’ developed share alongwith proportionate land and basement underneath by executing requisite documents. The owners shall also grant powers to the developers enabling tem to transfer rights and possession and to execute sale deeds etc. in respect of the developer’s 84 per cent share together with proportionate land and basement underneath. The GPA executed earlier in favour of the developer will become inoperative after the title gets transferred to the developer. In the last clause it is stated that all other terms and conditions of Collaboration Agreement not inconsistent with the provisions of the supplementary Agreement will continue to be binding on both parties.

                The Supplementary Agreement has substantially altered the legal relationship and right and obligations of the parties. The transaction is not the usual development agreement under which the developer constructs on the owner’s land and hands over a part of the built up area to the owner as consideration. It is an assorted type of arrangement under which the developer builds on the land of the owners and ultimately, in consideration of payment of stipulated price to the owners, the developer requires the owner to part with his title in favour of the developer or his nominees. Instead, the developer could have straightway purchased the land out-right by paying consideration to the owners and utilized the land in whatever manner he pleased. But, that was not done for the apparent reason that the developer either wanted t avoid or reduce the stamp and registration expenses, or to get over the possible difficulties in obtaining the licence/permission.

T H E   Q U E S T I O N S

Following questions were formulated by the applicant:

i.              Whether on the facts and in the circumstances of the case, the capital gains accrue/arise to the applicant (assessee) during the financial year 2006-07 and accordingly subject to tax in the assessment year 2007-08 on grant of CLU (Change of Land Use) as detailed in the letter dated 8.3.2006 (Annexure P-3)?

ii.             Whether on the facts and in the circumstances of the case, the capital gains accrue/arise to the applicant (assessee) during the financial year 2007-08 and accordingly subject to tax in the assessment year 2008-09 on completion of construction and on receipt of final payment of installment when the share of the Developer is eligible for transfer as agreed vide Collaboration Agreement dated 8.6.2006?

iii.            Whether on the facts and in the circumstances of the case, the capital gains accrue/arise to the applicant (assessee) partly during the assessment year 2006-07, assessment year 2007-08 and the assessment year 2008-09 respectively, on receipt of consideration amount in proportion to its payment by the Developer, who is allowed to carry out the development activity after grant of CLU and other required permissions?

• Authority answered the first question in the affirmative; that is to say, the capital gains arise during the financial year 2006-07 and shall be subjected to tax for the assessment year 2007-08.  Consequentially, questions No. 2 and 3 were answered in the negative.

Click here for full text of landmark ruling AIT-2007-344-AAR