Business

Tax implications of agreement for joint property development

I HAVE entered into a joint development agreement by which I got flats in lieu of 50 per cent of land surrendered by me to the developer, who gets a registered power of attorney from me for the sale. I am not getting any cash except an amount as security deposit, which is to be returned on completion of the agreement. Is there any liability on mere conversion of part of my land to built-up property in the nature of a builder's agreement? If it is taxable, when does it become taxable?

Property development agreement is common these days. There is liability as there is exchange for part of the land parted with for the value of construction put up on the remaining land.

But there are no set guidelines as to the date of taxable event on which the income accrues to the owner or the manner of ascertainment of the capital gains in the hands of the owner, whether on completion of contract or on transfer of undivided interest to prospective flat owners before the completion of construction. There are no accounting standards or guidelines or any treatise in text books on accountancy on the subject. Even if there be any, it is not settled law, because this kind of business is of recent origin.

It is presumed that the reader is not engaged in real estate business. If it were a transaction by a dealer in real estate, such agreement would constitute a business agreement, so that the income will be computed according to the method of accounting adopted regularly by such a dealer, who is usually a developer himself. Developer's profit has to be taxed as business income.

Capital gains become taxable on the date of transfer. The date of transfer is the date on which the sale takes place. There is a wider definition of transfer under Sec. 2(47) of the Income-tax Act to cover even transfer of possession in pursuance of a written agreement of sale or any other arrangement by which the transferee has the right to enjoyment of the property. Though the developer is not acquiring the right in land for his own possession or enjoyment, there are a number of decisions in the context of pre-emptive purchase of property under Chapter XX-C (deleted with effect from June 30, 2002) in Ashok Leyland Finance Ltd. v Appropriate Authority (1998) 230 ITR 398 (Mad) and some other decisions treating a development agreement on a par with any agreement for sale, so that the date of handing over possession to the developer is sometimes wrongly understood as the date of transfer within the extended meaning of transfer inferring liability for capital gains tax as on that date.

But then, the possession by a developer as understood for the purpose of Chapter XX-C, may not be good enough to infer a sale, because the development agreement is not an agreement for sale simpliciter. It is essentially of executory character and not ordinarily capable of being the subject matter of a suit for specific performance.

Apart from the same, the developer is not an intending purchaser in his own right, since the development agreement is essentially a builder's agreement.

All the same, care should be taken in drafting the development agreement so that, pending completion of the development, the developer would only have a licence for right of entry for purposes of performing his obligations under the contract. As otherwise, there is scope for possible controversy as to the date of taxable event.

Even where it is possible to infer that income cannot arise till completion of the agreement, it will be doubtful whether liability can be postponed when part of the land being shares of undivided interest has also been registered for sale for prospective flat owners prior to completion, because liability cannot be postponed after a registered sale. Hence, the proportionate capital gains may well be liable on each registered sale with right to indexation of cost with reference to each such sale, the balance of capital gains being ascertained on the date of completion of the construction and delivery in discharge of the obligations of the developer under the agreement. But while this should be a fair method of ascertaining capital gains, there is no ruling that such a method would bind either the taxpayer or the Revenue.

Such issues relating to development agreement are raised from readers from time to time for answers in these columns. The readers are best advised to obtain competent professional advice even before entering into such agreements, instead of resorting to newspaper advice or from such other sources in view of the complexity of law and the heavy stakes that are usually involved in real property transactions.

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