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REAL ESTATE PROJECTS –
INTRODUCTION TO INCOME TAX
By
H Padamchand KhinchaB.Com, LLB, FCA
Chartered Accountant, Bangalore
&
Chythanya K.KB.Com, FCA, LLB
Advocate, Bangalore
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Real estate projects
Some legislations having a bearing:
Stamp Act
Transfer of Property Act
Indian Easements Act
Income Tax Act
Accounting standards
FEMA – FDI Guidelines
Subject demands multi disciplinary approach
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Discussion centres around
Characterization of asset
Characterization of income
Timing of income
Computation of income
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Business income v. Capital Gains
If charged as long term capital gains, concessional rate of tax under section 112 would apply
Further, deduction under section 54, 54EC and 54F would be available
If charged as short term capital gains, normal rate of tax would apply and no incentives are available
If charged as business income, normal rate of tax would apply and provisions of sections 54, 54EC, 54F and section 112 are not applicable
However, section 50C and section 2(47) don’t apply
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Business income v. Capital Gains
Tests for determination - Source
Draft Instructions of CBDT (2006)153 Taxman-St 9
CBDT Instruction No.1827 dated 31.08.1989
G.Venkata Swami Naidu & Co. v CIT (1959) 35 ITR 594
H. Mohammad & Co. v. CIT (1977) 177 ITR 637 Guj
Sarder Indra Singh & Sons v. CIT (1953) 24 ITR 415 SC
Karam Chand Thapar & Bros.V. CIT (1971) 83 ITR 899
CIT v. Rewashanker A Kothari (2006) 283 ITR 338 Guj
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Tests for determination – Courts Whether initial acquisition was with intention of dealing in
the item, or with a view to finding an investment
Does transaction, since inception, appear to be impressedwith character of a Commercial transaction entered into with aview to earn profit
Why, how & for what purpose sale was effectedsubsequently
How assessee dealt with subject-matter of transactionduring the time the asset was with the assessee
Has it been treated as stock-in-trade, or has it been shown inthe books of account and balance sheet as an investment.This inquiry, though relevant, is not conclusive
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Tests for determination – Courts• How assessee himself has returned income from such
activities and how Department has dealt with same in thecourse of preceding and succeeding assessments
This factor, though not conclusive, affords good & cogentevidence to judge the nature of transaction and is relevantto be considered in absence of any satisfactory explanation
• Whether partnership deed or MA authorizes such anactivity
• The most important test, is the volume, frequency,continuity and regularity of transactions of purchase andsale of the goods concerned
Where there is repetition and continuity, coupled with themagnitude of the transaction, an inference can be drawnthat the activity is in the nature of business
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Single transaction – does it
constitute a business
• Yes as per
- CIT Vs S P Balasubramaniam 250 ITR 127 (Mad)
- CIT Vs Sutlet Cotton Mills Supply Agency Ltd 100 ITR
706 (SC)
• Not necessarily as per
- Indian Hume Pipe Co Ltd Vs CIT 195 ITR 386 (Bom)
- CIT Vs Shashikumar Agarwal 195 ITR 767 (All)
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Conversion of capital asset into stock
in trade
• Such conversion is deemed as transfer–Sec 2(47)(iv)
• FMV on the date of conversion shall be deemed to befull value consideration for the purpose of section 48
• However, capital gains will be charged to tax in theprevious year in which such converted capital asset issold or otherwise transferred
• The time limit for investment under section 54EC etc ishowever with reference to date of deemed transfer andnot the date of actual sale. This position is mitigated byCircular No.791 of 2.6.2000
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Conversion of capital asset into
stock in trade
• FMV on conversion will be cost to business as per CITv. Bai Shirinbai K. Kooka [1962] 46 ITR 86
• Need for such conversion
- To overcome provisions of section 50C
- To possibly claim certain expenses particularly when theasset is held for not more than 36 months
- To claim the set off of past unabsorbed business loss
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Conversion of stock in trade into
capital asset
• Need for such change??
- To make use of brought forward capital loss
- To avail the concessional rate of tax applicable
to long term capital asset
• Practice is not recognised expressly in the Act
• Permissible if the circumstances justify
• Risk of courts treating the above as a
colourable device
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Conversion of stock in trade into
capital asset
• No tax upon such conversion in the absence ofdeeming provision - CIT v.Sir Kika Bhai Premchand[1953] 24 ITR 506 [SC]
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Conversion of stock in trade into
capital asset• Upon sale, chargeable to tax as capital gains as
nature of capital asset should be determined on thedate of transfer and not on the date of acquisition asper Nachiappan [M] v. CIT [1998] 230 ITR 98 Mad.
• For computing capital gains – actual cost should betaken and not the converted costs as per
- Ranchhodbhai Bhaijibhai Patel vs. CIT (1971) 81 ITR446 [Guj.]
- CIT vs. M. Ramaiah Reddy (1986) 158 ITR 611 (Kar)
- CIT vs. Vishwanath (1993) 201 ITR 920 (All)
- Keshavji Karsondas vs. CIT (1994) 207 ITR 737 (Bby)
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Capital asset – short term or
long term
Normal case :
Short term : Period of holding </= 36 months
Long term : Period of holding > 36 months
Special case : Circumstances listed in
section 49(1)
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Tax rates
Short term capital gains : Will be part of
common hotch pot and normal slab rate
will apply
Long term capital gains : Normal case –
20% flat
Business income : Will be part of
common hotch pot and normal slab rate
will apply
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Joint Development
The Partners :
– Developer
– Co developer
– Land owner
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Joint development – Income
characterization
a) In the hands of developer – Business income
b) In the hands of co- developers where there are
more than one developer– Business income
c) In the hands of land owners
- Capital gains where the land is held as capital
asset
- Business income where the land is held as
inventory
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Joint development – Timing for
developers and co-developers
a) Completed contract method
- Upon completion of the contract
- AS 7 ceases to recognize this method
- Judiciary has taken note of this method
- Costs are captured and reflected as work in progress
- However, period costs like interest may be debited on a yearto year basis K. Raheja (P) Ltd. (2007) 106 TTJ(Mumbai) 874
- In the year of completion, costs are debited and sales arecredited to P&L Account
b) Proportionate completion method
- On the basis of proportion completed
- AS 7 recognizes this method
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Joint development – Timing for Land owner
a) Where held as a capital asset
- In the year of transfer
- Method of accounting is not relevant
- Transfer is as per section 2(47)
- Applicability of section 53A of TP Act
b) Where held as a business asset
- In the year of sale
- Method of accounting, cash/accrual, will decide the year of tax
- Extended meaning of transfer as per section 2(47) is not applicable
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Joint Development – Issues for discussion
Whether joint development word is appropriate? Does it create an AOP
Amendment to section 53A of Transfer of Property Act -Relevance
Whether possession to developer tantamounts to a transfer under section 2(47)
Whether role of developer to be legally segregated into a contractor and a seller?
If transfer is completed on possession, whether charge could fail in view of impossibility of computation of gains
Feasibility of converting capital asset into stock in trade
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Contribution of land into firm
Contribution at cost / indexed cost
Contribution to be oral (and by intent) to a mitigate stamp duty incidence
After contribution, terms of partnership as orally agreed may be recorded
Revaluation of land thereafter
Changes in partners / their ratio to achieve desired objective
Stamp duty implications to be separately monitored
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Issues
Whether revaluation can be effected immediately after contribution
Whether revaluation is a taxable event
Whether settlement of retiring partner paying him in excess of capital contribution is a taxable event
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Conversion of firm into Company
Firm converted into Company under Part IX of Companies Act
Company to allot shares
Provisions of 47(xiii) to be complied with as a back-up plan
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Issues for discussion
Whether the Company can adopt the “stepped up” cost for computing gains on subsequent sale
Whether capital of partner before conversion but after revaluation could be split into capital and loan
Whether shares could be allotted only to the extent of capital, leaving the loan free for withdrawal
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Tax incentives
a) Infrastructure – sec 80IA(4)(i)
b) Industrial parks – sec 80IA(4)(iii)
c) Housing projects – sec 80IB(10)
d) SEZ development – sec 80IAB
e) WB’s aided housing project – sec 80HHBA
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IT BENEFITS to SEZ - SUMMARY
PERSON SECTION INCOME
Developer & Co-developer
80 IAB , 115 O Development Income
SEZ Authority 80 IAB, 115 O ..Do..
Infrastructure cap Fund/Company or Co-op society
10 (23G) Dividend, Interest and Long term capital gains
Entrepreneur 10 AA / 54 GA Business Income
Off shore banking unit (OBU)
80 LA, 197 A (1D) Interest
NR /NOR 10 (15) (viii) Interest On Deposit
IFSC 80 LA Interest
Non Resident 26(1)(f) of SEZ Act Security Transaction
Investor In Shares 115 (O) (6), 10(34) Dividend Income
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Issues
Completed contract method no longer being a recognised method as per AS, can proportionate completion method be imposed by the AO?
Where a project runs for several years and assessee has adopted project completion method and same was accepted by department, can AO impose percentage completion method for later years? No as per Bakshi Vikram P Ltd (2007) 158 TAXMAN ITAT (61) NEW DELHI & Vishal Infrastructure Ltd (2007) 104 ITD 537 Hyd.
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IssuesCan the AO disturb the book profits for thepurpose of section 115JB on the basis ofqualified accounts where completed contractmethod was adopted?
Is treating land as capital asset andconstruction as inventory and therebyaffording different treatment permissible?See Chandrika Tower’s in 275 ITR 173 (MP)
Taxation of retention money – Timing?
Adjustment of security deposit in case of pastcontract against current bill – Allowability?
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Issues – 44AD
Is sub contractor covered? Yes as per Manohar Ram Chandra Patil v. UOI 133 Taxman 792 (Ori.)
Is an interior decorator covered? No as per Sanjay Kataria (2004) TAXMAN ITAT 141 63 (Delhi)
Is addition u/s 69 etc permissible where section 44AD is applied? Yes as per Devisingh Solanki [2006] 99 TTJ [Jp] 890
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Issues – 44AD
Belated filing of audit report may entail penalty but there is no denial of benefit of section 44AD as per LEYLAND AUTOMOBILES (2007) 105 ITD 73 (COCHIN)
When taxed under this section, income from sale of scrap etc should not be taxed again as per MOHD. ASLAM [2006] 150 TAXMAN – ITAT 20 [JODH.] [2005] 94 TTJ [Jd] 282
FDR interest income does not qualify to be assessed under this section as per ALLIED CONSTRUCTION (2007) 105 ITD 1 (DELHI) (SB)
Presumed income is not book profit for the purpose of sec 40b as per Parul Toys (2007) 105 ITD 81(HYD.)