Taxation In Real Estate Wirc 20.11.2009

Paper 1 - Taxation in Real Estate

Residential Refresher Course,Umbergaon, 20 November 2009

CA Romesh S A Sankhe

CA Romesh S A Sankhe2

Contents

Indian real estate

Case study analysis

• Case study 1

• Case study 2

• Case study 3

• Case study 4

Other vital issues

Direct Taxes Code

Case studies on taxation of Real Estate_WIRC_20 Nov ember 2009


• Market expected to grow up to INR 50 billion, at a CAGR of 33% for 2005-10• Current shortage seen at about 20 million housing units

• Rising purchasing power - emergence of strong middle class with lifestyle aspirations

• Faster urbanization, set to reach 41% by 2010• Increase impact of IT/ITES and retail sector• Nuclear family and younger population

• 5 fold increase in office space over next 3 to 5 years• Shortage of quality commercial space• Hot destination for outsourcing• 80% of demand driven by IT/ITES• demand of over 200 million square feet for organised retail by 2010

• Demand of over 50,000 new hotel rooms in next 5 years• Increase in tourism and business travel• Hotel business expected to grow at 40% over the next 3 years

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Indian real estate - an exciting opportunity ahead


Real Estate …. a sector which no one can afford to i gnore !!!

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Case study analysis

CA Romesh S A SankheCase studies on taxation of Real Estate_WIRC_20 Nov ember 2009


Case study 1

Share of partnership whether ‘capital asset’ under section 2(14) ?

Share in a partnership firm is property and hence capital asset u/s 2(14), reliancemay be placed on following:

• V. Rangaswami Naidu v. CIT [1957] 31 ITR 711 (Chennai HC)• CIT v. Rajendra Babubhai Modi [1993] 200 ITR 98 (Gujarat HC)• CIT v. Bhanodaya Industries [2002] 253 ITR 350 (Andhra Pradesh HC)• Sree Narayana Chandrika Trust v. CIT [2003] 261 ITR 279 (SC) - this ruling

was in context of gift tax


When partner is retiring there is no transfer of share from one partner to another, there is reconstitution


Case study 1

Withdrawal of balance by retiring partner whether ‘transfe r’ under section2(47) ?

Two form of withdrawal are possible:(a) Outgoing partner relinquishes his share/interest in partnership in favor of the

continuing partner(b) Outgoing partner is withdrawing his amount due to him

In scenario (a) there is transfer of asset and hence capital gains tax, but no capital gains tax in scenario (b), reliance may be placed on following:

• CIT v. Tribhuvandas G Patel [1978] 115 ITR 95 (Mumbai HC), affirmed by Supreme Court in Tribhuvandas G Patel v. CIT [1999] 236 ITR 515

• ITO v. Smt Paru D Dave [2006] 303 ITR 469 (Mumbai ITAT)


No capital gains tax may be possible as retiring pa rtners are withdrawing their own balances


Case study 1

Withdrawal of balance by retiring partner whether ‘capital gains’ undersection 45(4) ?

Change in the partnership does not result into any change in ownership of the partnership firm on it’s assets, hence no capital gains to firm under section 45(4), reliance may be placed on following:

• James Anderson v. CIT [1960] 39 ITR 123 (SC)• CGT v. N.S. Getti Chettiar [1971] 82 ITR 599 (SC)• Addl. CIT v. Mohanbhai Pamabhai [1987] 165 ITR 166 (SC)• CIT v. R. Lingamallu Raghukumar [2001] 247 ITR 801 (SC)• CIT Vs Kunnamkulan Mill Board [2002] 125 Taxman 802 (Kerala HC)


Capital gains exposure possible, if retiring partne rs withdraws more thantheir credit balances


Case study 1

Whether the proposed arrangement can be construed as ‘tax av oidancedevice’ ?

As per Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 (SC), the arrangement may constitute as a ‘tax avoidance device’ if:

• the firm is not genuine, and • used as the devise to sell assets owned by partner’s by routing it through firm

The situation discussed in case study may not held as ‘tax avoidance device’, reliance may be placed on following:

• CIT Vs Kunnamkulan Mill Board [2002] 125 Taxman 802 (Kerala HC)• CIT v. A. N. Naik Associates and another and Rangavi Realtors and another

[2003] 265 ITR 346 (Mumbai HC)


Not every tax planning arrangement can be held as ‘tax avoida nce’


Case study 2

Whether the interest on loan borrowed utilised for repaymen t of partner’scurrent account balance is allowable as deduction ?

First, it is important to determine the characterization of firm’s taxable income i.e. is it ‘business income’ or ‘income from house property (“IFHP”)’ ?

• CIT vs. Shambhu Investment Pvt. Ltd. [2003] 263 ITR 143 (SC), states as under:

“If the main intention of the assessee is to let out the property or any portion thereof the income must be considered as rental income or income from property whereas if the primary object is to exploit the immovable property by way of complex commercial activities, in that event it must be held as business income”


In real estate business, characterization of income is vital for deductibility of expenditure


Case study 2


Incase of IFHP, interest paid is governed u/s 24(b), where interest is deductible if:“where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital”

It appears, that section 24(b) presupposes the relation of expenditure on property and the loan borrowed, the current capital account of partners may not construe the character of ‘loan’ or ‘borrowing’ hence the interest on borrowing may not be allowed as deduction u/s 24(b), reliance may be placed on following:

• CIT v. Four Fields (P) Ltd [1998] 231 ITR 262 (P&H HC)


Possibility of deduction though use of CBDT circula r 28 dated 28 August 1969, if current capital account classified as ‘loa n from partners’ ,


Case study 2


Incase of Business income, interest paid is governed u/s 36(1)(iii), where interest is deductible if capital borrowed it used for business, no condition like section 24(b)

Borrowed funds used by partner’s for withdrawal of their capital account balance may deem to be used for the business, provided the capital account has been utilized in business, reliance may be placed on following:

• CIT v. Gopikrishna Muralidhar [1963] 47 ITR 469 (AP HC)

Interest on funds used prior to acquisition of asset may be capitalized u/s 43 and thereafter revenue expenditure u/s 36(1)(iii), reliance may be placed on following:

• CIT v. Vardhman Polytex Ltd [2008] 167 Taxman 93 (P&H HC)


Nexus of partner’s capital fund utilization will have to be established before the revenue authorities


Case study 2

Whether the claim of deduction made through notes in the retu rn of incomeis sustainable, without revision of return u/s 139(5) ?

No, as there is no provision in the Act which enables the amendment in the return of income at the assessment stage without revised return, reliance may be placed on following:

• Goetze (India) Limited v. CIT [2006] 284 ITR 323 (SC)• Mittal Alloys & Steel v CIT [2008] 299 ITR 291 (P&H)• Punjab State Co-op S & M Fed. v DCIT [2008] 173 Taxman 15 (P&H)• California Software Co Ltd v ACIT [2008] 118 TTJ 842 (Chennai)• Sella Synergy (India) Ltd v ACIT [2008] 117 TTJ 110 (Chennai)• BRT Ltd v ITO (2007-TIOL-65-ITAT-Mum)

Possible , as per CBDT Circular 14/1955 dated 11 April 1955


A view of Goetze should prevail considering the ruli ng of M/s RatanMelting and Wires Industries [2008] 220 CTR 98 (SC)


Case study 3

Which is the better entity form of operation in real estate bu siness ?Let us compare the different form of entity with business objectives


Limited liability partnerships may prove to be a better option, however clarity on FDI norms is awaited

Business objectives PartnershipFirm

Private Limited Company

Limited Liability Partnership

Taxation of business income

30.90% 33.99% 30.90%

Minimum Alternative Tax Nil 16.995% Nil

Dividend Distribution Tax Nil 16.995% Nil

Exposure u/s 2(22)(e) Nil Yes Nil

Tax under India-Singapore DTAA

Nil Nil Nil

Liability Unlimited Limited limited


Case study 4

Various tax considerations under section 80IB(10) on ‘heav en on earth’ ?

• Positive considerations from Income tax perspective, are as under:• Phase I (building 1,2,3) and Phase II (building 4,5) will be treated as

‘different housing projects’ for income tax purposes;• Both projects got an initial approval before 31 March 2008, and hence

‘completion certificate’ should be obtained on or before 31 March 2012;• Size of land of Phase I and Phase II is 2.7 acres and 1.8 acres

respectively, complying with the prescribed minimum requirement;• As Phase II is complying with the other provisions of the section,

absence of CBDT approval for SRA will not have an negative impact


Eligible units has to satisfy all the prescribed conditions for the deductions, hence grey areas to be analyzed careful ly


Case study 4


• Grey considerations from Income tax perspective, are as under:• Whether terrace area will form part of residential units, resulting into non-

fulfillment of condition mentioned in sub clause (c) ?Arguably No , because;• Terrace can not be used for residential purposes, municipal corporations also

do not allow any construction on terrace,• Residential unit and terrace can exist separately, • Terrace is like garage or lobby which even though dedicated to a flat owner

but can not be used for residence,• Possibly separate agreement can be entered for allotment of terrace and

parking space


Specific mention in the agreement regarding terrace area and limited useis suggested, however revenue authorities may still raise objection


Case study 4


• Negative considerations from Income tax perspective, are as under:• Commercial area in phase I and II is 7,500 sq.ft. and 5,000 sq.ft.

respectively, which exceeding the maximum permissible limits;• Bulk selling of flats to companies and individuals, may attract

disqualifications under sub clause (e) and (f)

• Planning avenues from Income tax perspective, are as under:• Two flats can be allotted to the individual in two different projects; • It may not be commercially viable to restrict the commercial area to

maximum permissible limit or not executing the bulk deal


End of the day, business prudence and feasibility s hould be preferred in taking the decisions


Case study 4


• What if issues from Income tax perspective, are as under:• Unit was initially sold to a person, who subsequently sold it to an existing

resident of the same building without builders knowledge• Will sub clause (c), (e) and (f) will attract?

• Company bought the flat on the name of its director/employees, with a condition that the same should be sold back to them at a pre-determined value while termination of their relationship with the company• Will sub clause (e) will attract?

• What will constitute ‘built up area’ for residential and commercial units?


A lot will depend on the approach and methodology a dopted by revenue authorities


Case study 4

Various tax implications under section 80IB(10) on ‘heaven on earth’ ?

• When the housing project fails to comply with all the prescribed conditions, only related proportionate deduction could be disallowed, reliance may be placed on following :• ACIT v. Bengal Ambuja Housing Development Ltd. [2007] 39D BCAJ

546 (Kolkata ITAT)• Saroj Sales Organisation v. ITO [2008] 115 TTJ 485 (Mumbai ITAT)• Arun Excello Foundations Pvt. Ltd. v. ACIT [ 2007] 108 TTJ 71 (Chennai

ITAT )• ITO v. Air Developers [2008] ITA No.447/Nag/2007 (Nagpur ITAT)• DCIT v. Brigade Enterprises Pvt. Ltd. [2009] 28 SOT 7 (Bengaluru ITAT)• Brahma Associates v. JCIT [2009] 30 SOT 155 (Pune ITAT-SB) • DCIT v. Ansal Housing and Construction Ltd. [2009] 116 ITD 253 (Delhi

ITAT)


Computation of attributable profits and substantiat ion before revenue authorities will be crucial


Other vital issues

Conversion of housing units from ‘stock in trade’ into ‘inve stments’ andsubsequent sale thereafter ?

• No provision similar to section 45(2) with respect to conversion of stock in trade to capital asset, hence gains can be treated as capital gains and holding period is to be considered from the date of acquisition, reliance may be placed on following :• CIT v. Bright Star Investments (P) Ltd [2008] 24 SOT 288 (Mum ITAT)• Kalyani Exports & Investments (P) Ltd & Ors v. Dy CIT [2001] 78 ITD 95

(Pune ITAT)• However, in Splendor Construction (P) Ltd [2009] 27 SOT 39 (Delhi

ITAT), it was held period of holding should be considered from the date of conversion


The view adopted by Delhi ITAT in Splendor Construc tion seems to be a better view from legal perspective


Other vital issues

Whether a developer must be an owner of the land to claim the de duction ?

• No such provisions is stipulated in Section 80IB, hence if undertaking is developing and building the housing project, the deduction will be allowed u/s 80IB (10), reliance may be placed on following :• Radhe Developers v. ITO [2008] 23 SOT 420 (Allahabad ITAT-SB)• Insertion of explanation with retrospective effect, is only for denying

the benefit to the works contractors who does not undertake the entrepreneurial risk in the project

Whether a sub-developer can claim the deduction ?

• Yes, reliance may be placed on following :• Saroj Sales Organisation v. ITO [2008] 115 TTJ 485 (Mumbai ITAT)


Investment incentive deductions are available for e ntrepreneurial risk


Direct Taxes Code (DTC) - New era in Indian Taxation

DTC was released for public discussion on 12 August 2009 and proposed to be effective from 1 April, 2011, key proposals for ‘Real Estate’ sector are as under

• No exemption/deduction is proposed for real estate sector similar to Section 80IB(10) or to individual investor similar to Section 24(b) and 80C

• ‘Income from house property’ and ‘interest income’ would not be taxed as business income irrespective of its relation with business of assessee

• Corporate tax rate is 25%, with an effective tax rate of 34.78% considering DDT• Minimum Alternate Tax (MAT) to be computed at the gross value of assets

@2% with no MAT credit available in subsequent years• No deduction for borrowings attributed to assets

• Removal of distinctive tax treatment between business income and capital gains, business income deemed to include

• Gains from sale of business capital asset i.e. tangible as well as intangible assets including gains from slump sale

21 Case studies on taxation of Real Estate_WIRC_20 N ovember 2009

A lot of planning will have to be done for DTC

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Open house …

CA Romesh S A SankheCase studies on taxation of Real Estate_WIRC_20 Nov ember 2009

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The views expressed in this presentation are solely that of the speaker and do not constitute any kind of professional advice. These views or opinion expressed in this presentation should not be applied or used without a prior professional advice, as the review of the facts and existing judicial position is of utmost importance in the analysis of tax implications.

CA Romesh S A Sankhe(M) 9892 892504(E) [email protected]

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Taxation In Real Estate Wirc 20.11.2009