Introduction
As a fast-paced economy, India is witnessing rapid urbanization and as per an estimate, 42.5% Indians are expected to live in urban area by 2034. This is apparently a driving factor for fuelling the demand for residential properties in different cities in the country and simultaneously the need for the commercial properties is being fuelled by the rapidly developing economy.
It has become more and more difficult to develop new real estate projects in the metro cities as also in large non-metro cities. While prices of the limited land parcels in the metro cities of the country have skyrocketed, individual owners who themselves or their forefather having purchased land parcels before decades do not have any other resources or technical knowhow for developing a project on such land parcels and at the same time the developers are reluctant to pay cash consideration for outright purchase of land parcel to develop a project owing to liquidity and commercial risks involved.
The difficulties have given rise to the concept of what is popularly known as Joint Development Agreement (JDA), under which, land owner makes contribution of land parcel for construction the real estate projects or grants a license to the project developer for e development of the project on the land parcel with the developer taking complete responsibilities for developing property ranging from apply for necessary government approvals, arranging financial and other resources for development of the project, marketing activities, constructions, RERA and other legal compliance.
Under such arrangement the developer will pay certain cash consideration to the owner at the beginning of the project along with share from the revenue generated from by sales of the unit in such projects or the share in constructed units to the land owner.
While the Joint Development Agreement arrangement enables the owners of the land parcel and developer to pull the resources and work for mutual benefits, it is important to understand tax implications, legal and contractual issues, other surrounding issues concerning this arrangement, which we seek to discuss in this series. In this part I, we seek to discuss tax implications out of JDA arrangement and in next part, we will discuss drafting considerations and other issues. To read the same, you may visit https://rdlawchambers.com/research-articles/.
Tax Implications
A. Capital Gains for the Land Owner
Capital gain tax in terms of the provisions of Section 45(1) of the Income Tax Act is levied on any profit or gains arising from the transfer of the capital assets effected in the previous year.
As transfer in terms of Sec. 2(47) of the Income Tax Act will include not only the sale of the land but also “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 section 53A of the Transfer of Property Act, 1882 ” or “any transaction which has effect of transferring or enabling the enjoyment of any immovable property in terms provisions of Sec. 2(47)(v) and 2(47)(vi) respectively. This meant that Joint Development Agreement having different attributes could be considered as transfer within the meaning of Sec. 45(1) of the Income Tax Act leading to capital gain tax for land owner arising in very same year in which transfer might be consider to take place.
Whether a given arrangement was a transfer or not within the meaning of provisions of Sec. 45(1) of the Income Tax Act became a highly contentious issue between the tax department and the land owners at occasion leading to even the demands for capital gains tax before receipt of actual consideration and such situation apparently was not good for the development of the real estate sector in India.
Introduction of Sec. 45(5A) and Capital Gains after the same:
To take care of this situation, the government introduced the provisions of Sec. 45(5A)of the Income Tax Act through finance act, 2017 making taxability of the capital gain tax on Joint Development Agreement arrangement more rational.
The provisions of Sec. 45(5A) are reproduced hereunder:-
“Notwithstanding anything contained in sub-section (1), where the capital gain arises to an assessee, being an individual or a Hindu undivided family, from the transfer of a capital asset, being land or building or both, under a specified agreement, the capital gains shall be chargeable to income-tax as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority; and for the purposes of section 48, the stamp duty value, on the date of issue of the said certificate, of his share, being land or building or both in the project, as increased by 83[the consideration received in cash, if any,] shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset :…………….”
It is noteworthy this section doesn’t use the word Joint Development Agreement; rather it uses the words “Specified Agreement” which is defined to mean “registered agreement in which a person owning land or building or both, agrees to allow another person to develop a real estate project on such land or building or both, in consideration of a share, being land or building or both in such project, whether with or without payment of part of the consideration in cash”
Subject to satisfaction of the conditions contained in the Sec. 45(5A), the capital gain arising to the assessee will not be chargeable to income tax, as the income of the previous year in which the transfer of the property takes place but in year in which certificate of completion for whole or part of the project is issued by the competent authority.
Calculation of Capital gain tax:
Sec. 48 provides that the capital gain shall be computed by taking full value of consideration received or accruing as a result of transfer of capital asset and deducing the expenditure incurred wholly and exclusively in connection with such transfer, the cost of acquisition of the asset and cost of improvement from full value of consideration.
Sec. 45(5A) provides that the full value consideration in case of the Joint Development Agreement arrangement for the purpose of calculation of capital gains will be stamp duty value on the date of issuance of the certificate of completion for whole or part of the project of the share of the land owner in the nature of land or building or the both in the project as increased by the consideration received in cash.
Thus the capital gains tax liability for the land owner will be deferred in the year in which certificate for completion for whole or part project is issued by the competent authority.
Conditions required to be satisfied for obtaining the benefit of Sec. 45(5A) of the Income Tax Act:
- As is evident from reading of the section, benefit of deferred tax is available only to an individual or Hindu Undivided Family (HUF) assessee and is not available to a partnership firm, an incorporated company or any other vehicles owning the land.
- The Individual/HUF must transfer the capital asset being land or building to the developer under a specified agreement i.e. a registered agreement in which the Individual/HUF owner of land or building or both agrees to allow the developers to develop the real estate projects on the same in consideration of share being land or building or both, with or without payment of the part of the consideration in cash.
- In terms of the proviso to Sec. 45(5A), the benefit of deferred capital gain tax will not be available to assessee where the assessee transfers his share in the project on or before the issuance of the certificate of completion. In that case capital gains shall be deemed to be income of the previous year in which the transfer takes place and provisions of Income Tax Act other than Sec. 45(5A) will apply for determination of full value of consideration received or accrued as result of such transfer.
- Taxability for developer of the Project:
For the developer, the projects and units that will be ready in the project will not be a capital asset but will be stock in trade and the income which will arise to the developer out sale of units will be considered to be his income from Business and Profession.
The income will be computed by calculating the consideration of sale of the units of the real estate property and deducting business expenses incurred for development of the property including any cash consideration paid to the owner of the property.
The developer however should be mindful of the fact that in terms of Sec. 28(via) the fair market value of the inventory as on the date on which it is converted into or treated as a capital asset will be taxable as developers income as profit and gains from business and profession if the developer intends to utilise the constructed units for renting out or for generating income through them by holding such units on a long term basis. To avoid getting in the tax net through provisions of Sec. 28(via) of the Income Tax Act, the intention of developer to hold the constructed unit for generating income must be recorded in the beginning and the developer should record his work in progress as capital work in progress.
C. TDS to be paid at the time of Payment by Developer to Land Owner
In terms of Sec. 194-IC of the Income Tax Act, 1961 inserted vide Finance Act, 2017, developer is required to deduct an amount of TDS @10% on the payment made to the owner of land under Joint Development Agreement in cash.
*R & D Law Chambers is a firm providing Legal advisory and International and Domestic Tax Advisory services. To know more visit https://rdlawchambers.com/*The content of this article is intended to provide general information. No reader or user should act or refrain from acting on the basis of the information written above without first seeking legal advice from a qualified law practitioner.
Author: Ravish Bhatt, Managing Partner, R&D Law Chambers LLP Email – info@rdlawchambers.com