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India – Finance Act, 2013: Double Trouble On Certain Real Estate Transactions.

6 January, 2014

 

The Finance Act 2013 has amended the Income Tax  Act,  1961  (the  “Act“)  by introducing  new provisions  and amending  certain  existing provisions  which  may result  in  far  reaching consequences on the real estate sector in India, not only from a taxation perspective but may also have an impact on the sector as whole. The real estate sector has always been under the scanner of  the  Income  Tax  Department  of  India. Considering  the  absence  of  complete transparency  in  transactions  in  this  sector, builders and developers (collectively “Real Estate Developers“), brokerage firms and property  dealers  who  are  responsible  for consummating  or  facilitating  real  estate transactions have been under the scrutiny of the Income Tax Department time and again.

 

However,  with  the  introduction  of  Section 43CA  in,  and  amendment  made  to  Section 56(2)(vii)(b)  of,  the  Act,  the  Income  Tax Department  has  more  reasons  to  raise objections while scrutinising books of not only the Real Estate Developers and other persons dealing  in real estate business, but  also the investors and the acquirers of the immovable properties in India.

 

Section 43CA-Incidence Of Tax Under The Head Of “Profits And Gains From Business Or Profession

 

Section 43CA has been newly inserted in the Act  by  the  Finance  Act  2013  and  shall  be effective prospectively from April 1, 2014. This section  triggers  upon  transfer  of  an  asset (other  than  a  capital  asset),  being  land  or building or both, for a consideration which is less than  Stamp Value of such  asset.  Section 43CA  has  direct  implications  on  persons (including Real Estate Developers) who deal in  real estate (i.e. land or building or both) and for  whom such  land  or  building  is stock‐in‐trade  and  not  capital  asset.  However,  this section has its genesis in Section 50C of the Act, which is applicable in case of transfer of a capital asset, being land or building or both, but not stock‐in‐trade.

 

Section 50C-Incidence of Tax Under The Head Of “Capital Gains

 

For reasons stated above, prior to discussing Section  43CA  of the Act,  it  is  pertinent to give  a  brief  background  of  Section  50C  of the  Act  which  was  introduced  by  the Finance  Act,  2002  effective  from  April  1, 2003.

 

In terms of  Section 50C(1) of the Act,  if  a capital asset, being land or building or both, is transferred  for  a  consideration  (“Actual Sale  Consideration“)  that  is  less  than  the value adopted or assessed (“Stamp Value“) by the relevant stamp authority of the State, then for the purposes of computing capital gains under Section 48 of the Act, the Stamp Value  is  considered  to  be  the  total consideration received from transfer of such capital asset.

 

For  instance,  if  A  sells  a  flat  to  B  for Rs.90,00,000, being the actual consideration received for such sale by A but the Stamp Value  of which  is  Rs.1,00,00,000, then the sale  value  of  such  flat  shall  (in  terms  of Section 50C(1) of the Act, for the purpose of computing  capital  gains  of A  in respect  of such sale) be deemed to be Rs.1,00,00,000.

 

The above provision is popularly known as the  “Deeming  Fiction“.  The  difference between the  Stamp  Value  and the  Actual Sale  Consideration  is  deemed  to  be  a notional income arising in the hands of the transferor (read seller) of the capital asset  and  based  on  which  the  Stamp  Value (albeit  on  a  notional  basis)  is  considered for the purpose of computing capital gains of the transferor.  In  our  view,  the  legislators  have inserted this provision  in the Act  in the  year 2003 to  bring  about  greater transparency  in real  estate  transactions  and  also  to  plug  a loophole which may have been in vogue prior to 2003 in fixing the actual sale consideration for such transactions. 

 

[In  early  1980s,  w.e.f. July 1, 1982, the Act was modified and certain changes  were  incorporated  in  Chapter  XX‐A (then  colloquially  known  by  the  prescribed form  37EE),  which  Chapter  became  non‐applicable from October 1, 1986, when the Act introduced  Chapter  XX‐C  (then  colloquially known by the prescribed form 37‐I) and finally even this Chapter XX‐C became non‐applicable on and from July 1, 2002.]

 

The constitutional validity of Section 50C was challenged  in  K.R.  Palanisamy  and  Ors.  vs. Union  of  India  (UOI)  and  Ors. [2008]306ITR61(Mad).   However, the Hon’ble Madras  Court  upheld  the  validity  of  the provision  and  held that the  Section  50C  has been introduced by the Ministry of Finance to check the undervaluation of the capital asset thereby  evading  tax  payable  to  the Government and also to curtail black money.

 

Section 50C is applicable to transfer of capital assets only. The definition of the term “capital asset” under the Act specifically excludes any “stock‐in‐trade, consumable stores or raw materials  held  for  the  purposes  of  his business  or  profession“.  Although  the language  of  Section  50C  explicitly  covers within its purview transfer of capital assets only, the  Income  Tax Department  has,  on quite a few occasions, extended the ambit of this  Section  50C to transfer  of  land  or building by the Real Estate Developers and considered  the  difference  between  the Stamp  Value  and  the  Actual  Sale Consideration arising on such transfer as the “business  income”  of  Real  Estate Developers.

 

In  light  of  a recent  ITAT  (Mumbai  bench) ruling  in  Neelkamal  Realtors  and  Erectors India Private Limited vs the Deputy Commissioner of Income  Tax  [ITA  No.1143/Mum/2013]  and  a judgment  of  the  Allahabad  High  Court in Commissioner  of  Income  Tax  vs  Kan Constructions and Colinizers Pvt.  Ltd. [TS 252 HC‐2012(ALL)], it is now a settled position that Real  Estate  Developers  in  whose  books  an asset,  being  land  or  building,  is  reflected  as “stock‐in  trade“,  profits  arising  from  sale  of such assets will be liable to be taxed under the head  of  “Profits  and  Gains  from  Business  or Profession”  and  not  “Capital  Gains“.  In  view thereof,  Section  50C  cannot  be  made applicable  to  transfer  of  an  asset  which  is “stock‐in trade”.

 

Analysis Of Section 43CA

 

To  counter the  aforesaid settled position on applicability of Section 50C of the Act to Real Estate Developers and considering that  the  definitions  of  “capital  assets” under the Act specifically excludes stock‐in trade held for the purposes of business or profession,  Section  43CA  was  introduced by the Finance Act 2013 to cover within its ambit,  transactions  of  land  or  building which  are  held  as stock‐in  trade  by  the Real Estate Developers.

 

In terms of Section 43CA(1), on and from April 1, 2014, if  in  case of transfer of  an asset (other than a capital asset), being land  or  building  or  both,  the  Actual  Sale Consideration of such asset is less than the Stamp  Value,  then  the  Stamp  Value  shall deemed  to  be  the  total  consideration received  for  the  purpose  of  computing profits and gains arising from the transfer of such asset 

 

For instance, if a developer sells a flat to a buyer for Rs.90,00,000, the Stamp Value of which  flat  is  Rs.1,00,00,000,  then  for  the purpose  of  computing  business  income  of the developer under the head of “Profits and Gains from Business or Profession” under the Act, the Stamp Value is considered to be the total consideration received from transfer of such capital asset.

 

It  is  significant  to  note  that  the applicability  of  Section  43CA to transfers contemplated thereunder is prospective in nature  and will not be  applicable to real estate transactions consummated prior to April 1, 2014.

 

Section 56(2)(vii)(b)–Incidence Of Tax Under The Head Of “Income from Other Sources

 

Section  56(2)(vii)(b)  of the  Act  has  been amended by the Finance Act 2013. In view thereof, while earlier  Section 56(2)(vii)(b) covered within its ambit, gift of immovable property, the amended provision now also extends  to  acquisition  of  immovable property, which is for a consideration less than the Stamp Value of such immovable property  by  an  amount  exceeding Rs.50,000.

 

As a consequence of such amendment, the difference  between  the  Stamp  Value  of the property being acquired and the actual consideration  paid  for  purchase shall  be deemed  to  be  income  in  hands  of  the buyer and shall be subject to tax under the head of  “Income from other  Sources” for the purposes of Section 56 of the Act.

 

Section  56(2)(vii)(b)  is  applicable  only  if such buyer or transferee is an individual or HUF.

 

Going  by  the  earlier  illustration,  if  a developer  sells  a  flat  to  a  buyer  for Rs.90,00,000,  the  Stamp  Value  of  which flat  is  Rs.1,00,00,000,  the  differential amount  of  Rs.10,00,000 (to the  extent  it exceeds Rs.50,000, i.e. Rs.9,50,000) will be considered  as  deemed  income  in  the hands  of  the  buyer  under  Section 56(2)(vii)(b)  and  will  be  subject  to  tax under  the  head  of  “Income  from  Other Sources

 

Our View

 

1. Incidence of tax under Section 43CA will, from April 1, 2014 (Assessment Year 2014‐2015), arise in the hands of the Real Estate Developers or other persons dealing in real estate (who hold land or building in their books as stock‐in trade), upon transfer of land or building or both, on the difference between the Stamp Value and Actual Sale Consideration and shall be subject to tax under the head of “Profits and Gains from Business or Profession“;

 

2. No exception has been carved out to exclude genuine transactions consummated by the Real Estate Developers or other persons dealing in real estate. For instance, if a Real Estate Developer has, due to depressed market conditions or bulk booking by a proposed buyer (or group of buyers, all of whom are individuals), agreed to sell a residential flat at a price which is less than the Stamp Value of such flat, then on one hand the Real Estate Developer will be subject to tax on the notional income (being difference between the Stamp Value and actual sale price) in terms of Section 43CA and on the other hand the (individual/ HUF) buyer will be subject to tax on the notional income (being difference between the Stamp Value and actual purchase price as reduced by Rs.50,000) in terms of Section 56(2)(vii)(b);

 

3. The combined reading of these 2 sections could result dual tax implication on the same amount arising from the same transaction albeit in the hands of two different persons. For instance, if a developer sells a flat to an individual buyer for Rs.90,00,000, the Stamp Value of which flat is Rs.1,00,00,000, the differential amount of Rs.10,00,000 will be considered as deemed income (i) in the hands of the developer under Section 43CA, as well as (ii) in the hands of the buyer under Section 56(2)(vii)(b). In view thereof, at a rate of 30% (for the moment, not considering the surcharge charge) on the aforesaid deemed income, while the developer will be required to pay tax of Rs.3,00,000 (30% of Rs.10,00,000), the buyer too will be required to pay tax of Rs.2,85,000 (30% of Rs.9,50,000, being the excess of  Rs.10,00,000 over Rs.50,000). Interestingly, the Revenue stands to receive/ collect Rs.5,85,000 (plus surcharge) on a transaction, which would otherwise be genuine and on arms‐length basis, but the price being driven down due to market forces. Not to forget the additional stamp duty that the buyer will have to pay on the Stamp Value (which in the State of Maharashtra would be Rs.50,000 – being 5% on the differential amount of Rs.10,00,000). 

 

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For further information, please contact:

 

Prem Rajani, Partner, Rajani, Singhania & Partners

prem@rsplaw.in

 

Poorvi Sanjanwala, Partner, Rajani, Singhania & Partners

poorvi@rsplaw.in

 
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