The incidence of taxation by way of capital gains on execution of a development agreement of an immovable property by an owner of an immovable property has been a much litigated issue after the Bombay High Court decision in Chaturbhuj Dwarkadas Kapadia’s case, until the recent amendment in the 2017 Union Budget. Till the amendment, which provides for taxation of such gains on completion of the project under certain circumstances, a view was being taken by the tax authorities that, in all cases, the capital gains arise on signing of the development agreement. A recent Supreme Court decision in Balbir Singh Maini’s case provides some much-needed clarity on such taxation.
There were two aspects of the issue, in respect of which the Supreme Court laid down the law. The first aspect related to whether giving of possession for purposes of development under an unregistered joint development agreement could be regarded as giving rise to capital gains. The Supreme Court, after referring to the 2001 amendment to the Registration Act, 1908, categorically held that an unregistered agreement was not covered by section 53A of the Transfer of Property Act, 1908.
Therefore, part performance of such an unregistered agreement by the owner, by giving possession of the property for the limited purpose of development, would not amount to a transfer, and hence did not give rise to capital gains.
Further, the Supreme Court also considered whether the signing of the joint development agreement or giving of possession could be said to be a transaction, which had the effect of transferring or enabling the enjoyment of the immovable property, which could also give rise to capital gains. According to the Supreme Court, the purpose of this provision was to bring those transactions within the tax net, where, though title of the property was not transferred in law, there was, in substance, a transfer of title in fact. On a reading of the joint development agreement, the Supreme Court noted that the owner had continued to be the owner of the property throughout the development of the property, and had at no stage sought to transfer rights similar to ownership to the developer. At the most, only possession was given under the agreement, and that too, for the limited purpose of development. The Supreme Court, therefore, held that this clause also did not apply to the transaction, and that there was no transfer giving rise to capital gains.
The other aspect which the Supreme Court considered was as to whether there was an accrual of the consideration, since capital gains is computed with reference to the consideration accruing or arising as a result of transfer of the capital asset. Under the agreement, the right of the owners to receive consideration arose only on receipt of the necessary approvals and permissions for development of the property. In fact, ultimately no approvals were obtained, since the High Court prohibited the development.
The Supreme Court held that income from capital gain on a transaction which never materialised was, at best, a hypothetical income. Since, on account of lack of permissions, the entire transaction of development fell through, income did not result at all. The owner did not acquire any right to receive income, as such right was dependent upon the necessary permissions being obtained. There was no debt owed to the owners by the developers. Therefore, according to the Supreme Court, no profits or gains arose from the transfer of a capital asset, which could give rise to capital gains. On this ground as well, the Supreme Court held that there were no taxable capital gains from the transaction.
The Supreme Court has laid down an interesting aspect of taxation of capital gains, as this could apply to various other transactions where there is no entitlement to receive any amount on transfer of the asset. Of course, when there is a transfer of asset in 1 year and an accrual of income in a subsequent year due to such transfer, the issue as to whether any gains are taxable and in which year they are taxable, still remains an open issue, which may ultimately again have to be decided by the apex court. This is because capital gains is taxable in the year of transfer of the capital asset, and the consideration accruing as a result of the transfer is the starting point for computation of the capital gains.
One more interesting aspect is that the Supreme Court seems to have indicated a distinction between giving of possession for the limited purpose of development, and giving of possession in part performance of an agreement to sell a property. This, however, not being the main basis of deciding the case, may still be the subject matter of litigation in the future.
The Supreme Court decision, however, does bring about a clarity on certain issues. In situations where the payment of consideration is linked to approvals and permissions being received, and such approvals have not been obtained, no capital gains can be taxed. Similarly, no capital gains can be taxed in the case of possession given for development under an unregistered development agreement
Gautam Nayak is a chartered accountant