Tax on Real Estate Sector

Tax Issues : Real Estate Sector

The contribution of real estate sector is significant to the economic development of our country. While we understand that the Government’s moto is “Housing for all”, unfortunately in recent past, this sector is going through a gloomy patch with plethora of challenges piling up. In line with the Government’s moto & to boost this sector, various amendments have been made under the Income Tax Act, 1961 (‘the Act’). However, the tax aspects of this industry are not free from ambiguity. This article seeks to highlight & redress the tax issues specifically focusing on the Joint Development Agreements, profit linked deduction u/s 80IBA of the Act & Valuation of real estate companies.

I. Taxation of the Joint Development Agreements

In recent past, Joint Development Agreements(JDAs) has emerged as an effective & a trending business model, wherein the land owner transfer the development rights to the Developer who in turn develops the project. Typically, the Land owner either gets a share in the constructed units or a consideration in money or a combination of both for transferring the development rights. Since, this transactions different from the traditional model; following are the grey areas which needs to be focused upon:

a. Determination of Date of Transfer:

The most litigated tax issue arising in JDA is the determination of date of transfer for land owner, who will be subjected to capital gain tax.Section 2(47) of the Act defines transfer, which inter alia includes “any transactions 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 in Section 53A of Transfer of Property Act, 1882”. Based on these provisions, revenue contends that the date of transfer is effectuated on giving the possession of the land to the developer. However, it is very draconian to charge tax in the year of transfer, as the land owner in reality has not earned any income by virtue of entering into the JDA.

Generally real estate projects run into years, therefore deferring the taxability in the year of completing the project is very essential. Finance Act, 2017 inserted Section 45(5A) to redress this issue, but unfortunately it extended the benefit of deferment only to Individuals & HUF.

Therefore, following Judicial precedence may be still relevant while dealing with this issue, wherein the courts have held that the tax will not be levied in the year in which the JDA is entered or when the land is handed over to the Developer:

i. PCIT, Jalandhar-I vs Chuni Lal Bhagat [2019] 103 taxmann.com 379 (SC),

ii. PCIT, Kolkata-1 Vs Infinity Infotech Parks Ltd. [2018] 96 taxmann.com 274(Calcutta)

iii. Smt. Lakshmi Swarupa Vs ITO, Ward 4 (4), Bangalore [2018] 100 taxmann.com 148(Bangalore - Trib.)

Also, from the way the courts have opined the date of transfer, it is very critical to note the way in the which the JDA is drafted.While, this has been a long-litigated issue, Government should extend the benefit of deferment to all assesses considering the liquidity crisis.

b. Capital Gain Tax arises even if Part CC of project is received

 As discussed above,the new Section 45(5A) inserted by the Finance Act,2017 extended the benefit of deferment only to Individuals and HUF. Furthermore, if we do a minute reading of this Section one will note that, the tax is levied on the whole project even if completion certificate for part of the project is received. While the term “project” is not defined under the Act, in case of big projects consisting of many towers, the land owner may be burdened with the tax liability in the initial year itself if the part CC of the project is received; therefore, the benefit of deferment in reality is not practically met.

c. Ambiguity on tax treatment for assesses holding the land as “Stock in Trade”

In case the Land is appearing as “stock in trade” of the assessee who enters into a JDA, then the income arising by virtue of JDA, may be charged as business income. However, the Act does not contemplate a specific computation mechanism unlike the provisions of capital gain under section 45(5A) of the Act.

It is worthwhile to note that there is no specific ICDS (Income computation and disclosure standard) governing the Income recognition on the real estate projects, therefore there is an ambiguity on the quantum of income and the time of chargeability as discussed below:

As regards to the time of chargeability the assessee may opt to defer the tax by following project completion method which may be litigated by the revenue. Also, there are no provisions in the Act to govern the quantum of income that would be taxed. One may take a view that the stamp duty value of the constructed units be considered as the business income &  other may consider the stamp duty valuation on registering the JDA. Clearly,the Government should come up with specific ICDS to govern revenue recognition on real estate projects addressing these issues & reduce the scope of litigation. However, it is important to note that the provisions of the Section 50D of the Act may not be applicable as the asset held is not the capital asset.

II. Profit Linked deduction for developing and building housing projects

The current law exempts 100% profits arising on the developing and building housing projects.Section 80IBA was inserted in Finance Act 2016 in line with the Government’s objective of “Housing for all”. While the section seems attractive, there are still some tax issue and ambiguity that needs to be addressed.

a. Restriction of allotting one unit is only applicable in case of Individuals

Currently, the section 80IBA provides for various conditions that needs to be satisfied in order to claim the tax exemption which inter alia stipulates a condition that, only one residential unit can be allotted to an Individual, his spouse and a minor child. However, this restriction is not applicable to other assesses. For instance, if the assessee sells more than one unit to HUF of an individual, then the provisions of this section have been said to be complied with. Going further, the developer may also allot all the units of the project to a single assessee other than individual & claim deduction. However, if one goes by the intent of “Housing for All” this may be questioned.

b. Sale & lease back transactions may also be eligible for deduction

Presently, this Section does not preclude sale and lease back transaction,implying if the Developer sells the units to Investors who in turn lease back the units to the Developer for earning rental income, then also the deduction may be allowed. However, as stated going by the intent of housing for all which was clearly mentioned in the Memorandum to Finance Bill 2016, tax authorities may invoke GAAR (General Anti Avoidance Rules) on such transactions.

c. No clarity on charging back Income claimed in previous years if any of the other provisions are not complied

Presently, the deduction claimed under this section for previous years is charged back only in case when the project is not completed within a period of 5 years. However, there is no clarity as to what happens if the assessee fails to comply with any other provisions of this Section. Let us say, the assessee claimed exemption under this section for initial 4 years, however in year 5 it has contravened the provisions of this Section by say allotting 3 units to an Individual. Now, the important question is whether the exemptions claimed in earlier years be taxable in the year of contravention. Possibly a view may exist that, as there is no specific clause under the Act, the previous exemption may not be charged back.

d. SPVs may not benefit from this section

The provisions of this Section may not be attractive in case of SPVs specifically formed for this project as the assessee may be subject to MAT/AMT which will not be utilized in future years leading to an effective tax cost of 15% plus cess & surcharge.

III. Valuation of shares of a Real Estate Company in accordance with Rule 11UA

As per the provisions of Section 50CA & 56(2)(x) of the Act, the transferor and transferee cannot transact less than the fair market value as per Rule 11UA(1)(c)(b). There are certain challenges that may be encountered while valuing the shares of a real estate company which may be as under:

a. No mechanism to protest the stamp duty valuation

As per the valuation mechanism prescribed under Rule 11UA, immovable property is valued at the value adopted or assessed or assessable by any authority by the Government for the purpose of payment of stamp duty. As per the provisions of Section 50C, if an assessee transfers a land or a building & the sale consideration is less than the Stamp Duty Valuation, then he has the right to ask the assessing officer to refer it to the Departmental Valuation officer. However, there are no such provisions while valuing the shares of a company which has a immovable property, therefore there may be unwarranted exposure to tax.

b. No Clarity on WIP valuation

The real estate companies typically have an inventory of work in progress (WIP) which is nothing but the capitalization of the project related expenses. There is no clarity on valuation of WIP as to whether WIP qualifies as an immovable property? While the term immovable property is not defined in Rule 11UA, one may take a view that, WIP cannot be considered as immovable property & therefore to be valued at cost.

c. Whether TDRs qualifies as an immovable property?

Another dilemma that needs to be addressed is how the valuation of TDR (Transferable Development Rights) is to be determined. In case of SRA projects or a rehabilitation projects if the developer fulfills its obligation by constructing units to the Slum Dwellers or society members, then certain amount of TDR/FSI is generated for the sale building. Now the question arises is whether the definition of immovable property includes TDR or FSI? It is interesting to note that the term immovable property is not defined in the Rules. However, Section 269UA of the Act defines immovable property which inter alia includes any rights in land or building which is constructed or which is to be constructed. 

Therefore, one may take a view that stamp duty valuation might be considered. However, it is worthwhile to note that this definition is applicable only for that chapter, therefore one may take a view that it cannot be extended to Rule 11UA and not to be treated as Immovable Property.