Taxation of gains on development agreements a grey area

The property would be valued on the basis of the stamp duty valuation in the year of completion of the development.


Ankit Agrawal/Mint
Ankit Agrawal/Mint

The subject of taxation of capital gains of a property owner on entering into an agreement for development of an immovable property has been the matter of substantial litigation over the past two decades. Most of the tribunals and courts had been following a decision of the Bombay High Court, which had held that capital gain arises to the owner of the property on the date that the development agreement had been entered into. 

This had created substantial difficulties for property owners, as they were liable to pay capital gains tax on the entire consideration upfront, while most of the consideration would generally be received by them over the period of development of the property. At times, this resulted in situations where the capital gains tax would be paid, but the development would remain stuck on account of legal or financial issues, resulting in payment of tax by the owner without realization of income. 

Under certain circumstances, tribunals and courts had held that the incidence of capital gains would be deferred to a later date, but the issue was hotly disputed by tax authorities, with consequential litigation. Fortunately, this year’s Union Budget has brought in an amendment, which will ease the burden for property owners, and help remove uncertainty in this regard. 

The amendment applies only to property owners who are individuals or Hindu Undivided Families. The property should be: in the nature of land or building, owned by the person, and held as a capital asset and not as stock-in-trade of a business. Therefore, a developer who owns land for the purposes of development would not get the benefit of this amendment. The property could be either a residential property or a commercial property. 

The amendment would apply only to a situation in which the property owner receives at least a part of the consideration in the form of land or building in the developed project. Besides land or building, the property owner can also receive consideration in money. However, if he is only entitled to receive consideration in money, even though it may be as a percentage of the sales proceeds of the developed property, he would not be entitled to the benefit. 

What is the benefit that the eligible property owner gets under the amended law? His capital gains tax liability is postponed to the year of completion of development of the project. This, therefore, removes subjectivity as to the year of taxability of capital gains, and also eliminates the problem of having to pay capital gains tax without receipt of the consideration. 

The amendment also has a disadvantage for the property owner. For computation of capital gains, the consideration is the sum total of the money receivable plus the value of the developed property receivable by the property owner in exchange for his property. Computation of the consideration that is receivable in the form of immovable property is generally based on valuation in the year in which the capital gains arise. If capital gains were taxable in the year of signing of the development agreement, the valuation of the property to be received would be based on valuation as of that date. The amendment now provides that the property receivable would be valued on the basis of stamp duty valuation (ready reckoner or circle rates) in the year of completion of the development. This would, in most cases, be higher than the value in the year of signing of the development agreement. 

Which would be the year of completion of the development? The amendment provides that this would be the year in which the certificate of completion of the whole or part of the property is issued by the authority empowered to approve the building plan under the law (normally, the municipal corporation or municipality). Though not specifically provided, logically, if a completion certificate is received for a part of the property, the capital gains relatable to only that part of the property would be taxed in that year. 

In some cities, such as Mumbai, the completion certificate is not obtained for a long period of time, and flat purchasers are given possession of the new property based on an occupation certificate. Does this mean that the capital gains will not get taxed till receipt of the completion certificate, even though possession of the developed property is received by the property owner? While this may seem to be a strict interpretation of the law, it is advisable to take the safer view and pay the capital gains tax at least in the year of receipt of possession of the developed property. 

If the right to receive the developed property is transferred by the property owner before completion of the development, the amended law will not apply and capital gains tax will be payable in the year of such transfer. 

While the amendment is certainly a welcome one, removing substantial uncertainty associated with the taxation of capital gains arising on development of a property, the amendment will apply only in cases where the development agreement is entered into on or after 1 April 2017. Earlier agreements will continue to face litigation.

Besides, there are certain types of development agreements, such as revenue-sharing arrangements, where the amendment does not apply and the uncertainty continues. There are also some grey areas in the amendment. One only hopes that some clarity will emerge in those cases as well.

Gautam Nayak is a chartered accountant.

More From Livemint