Kolkata taxation of real estate development 17 dec 2011

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Kolkata taxation of real estate development 17 dec 2011

  1. 1. INCOME TAX ISSUES ON TRANSACTION OF REAL ESTATE Nihar Jambusaria nihar.jambusaria@ril.com jnihar@rediffmail.com j ih diff ilEIRC- Kolkata 17 Dec 2011 1
  2. 2. ROAD MAP OF THE CONTENTSAccounting Aspects of Forms of Real Estate Development Other Tax Issues Redevelopment development & Agreements & TaxRevenue Recognition Issues EIRC- Kolkata 17 Dec 2011 2
  3. 3. ACCOUNTING ASPECTSOF REAL ESTATEDEVELOPMENT &REVENUERECOGNITION EIRC- Kolkata 17 Dec 2011 3
  4. 4. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITION Guidance Applicable Tax Audit Note by ICAI methods Percentage Completion Method Project Completion Method Change of method of accounting EIRC- Kolkata 17 Dec 2011 4
  5. 5. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONGuidance NG id Note b ICAI by Guidance Note by ICAI AS 9 - Revenue AS 7 - Construction Recognition Contracts Conditions: Conditions: •Seller has transferred •When seller is obliged to significant risk and reward. perform substantial act after •No significant uncertainty transfer of risk and reward about consideration. b id i •Revenue should b recognized •R h ld be i d •Not unreasonable to on proportionate basis applying expect ultimate collection % of completion method in the manner explained in AS 7 EIRC- Kolkata 17 Dec 2011 5
  6. 6. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONApplicable methods of Accounting Illustration: Year 1 Total flats 50 flats Total flats sold 15 flats Selling price for 15 flats 15.00 Construction Expenses 7.50 Work completed 30% Year 2 Further flats sold 20 flats Selling price for 20 flats 25.00 Construction Expenses 13.50 Work completed 70% Year 3 Remaining flats sold 15 flats Selling price for 15 flats 19.00 Construction Expenses 9.00 Work completed 100% EIRC- Kolkata 17 Dec 2011 6
  7. 7. ACCOUNTING ASPECTS OF REAL ESTATE& REVENUE RECOGNITIONTreatment under Percentage Completion Method - Ill t tiT t t d P t C l ti M th d Illustration Year 1 Total flats 50 flats Total flats sold 15 flats Selling price for 15 flats 15.00 Construction E C i Expenses 7.50 7 50 Work completed 30% Profit & Loss Account (Year 1) INR INR To Construction expenses 7.50 By Income from operations (15*30%) 4.50 By Closing Stock (7.5*35/50) 5.25 To Gross Profit 2.25 Total 9.75 Total 9.75 EIRC- Kolkata 17 Dec 2011 7
  8. 8. ACCOUNTING ASPECTS OF REALESTATE & REVENUE RECOGNITIONTreatment under Percentage Completion Method - Illustration Year 2 Further flats sold 20 flats Selling price for 20 flats 25.00 Construction Expenses 13.50 Work completed 70% Profit & Loss Account (Year 2) INR INR To Opening Stock 5.25 By Income from operation 15*70% 10.50 To Construction 25*70% 17.50 Expenses 13.50 28.00 Less: Offered in Year 1 (4.50) 23.50 By Closing S k B Cl Stock (21*15/50) 6.30 To Gross Profit 11.05 TOTAL 29.80 TOTAL 29.80 EIRC- Kolkata 17 Dec 2011 8
  9. 9. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Percentage Completion Method - Illustration Year 3 Remaining flats sold 15 flats Selling price for 15 flats 19.00 Construction E C i Expenses 9.00 9 00 Work completed 100% Profit & Loss Account (Year 3) INR INR To Opening Stock 6.30 By Sale Year 1 15.00 To Construction 9.00 Year 2 25.00 Expenses Year 3 19.00 59.00 Less: L Offered in Year 1 & 2 (28.00) 31.00 By Gross Profit 15.70 TOTAL 31.00 TOTAL EIRC- Kolkata 17 Dec 2011 31.00 9
  10. 10. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONSummary of Year wise profit under Percentage Completion Method Profit P fit Rs. Rs In crores Year 1 2.25 Year 2 11.05 Year 3 15.70 TOTAL 29.00 EIRC- Kolkata 17 Dec 2011 10
  11. 11. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Project Completion Method - Illustration Profit & Loss Account INR INR Total Construction cost 30.00 Total Revenue 59.00 Profit 29.00 Total 59.00 Total 59.00 EIRC- Kolkata 17 Dec 2011 11
  12. 12. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Percentage Completion Method – Judicial Precedent CIT vs. Ad Advance C t ti C (P) Construction Co. Ltd. (2005) 275 ITR 30 (Guj) • It i h ld th t A is held that Assessee-contractor h i offered profits f t on t t having ff d fit for tax the basis of percentage completion method which is a standard accounting practice and has been constantly followed by the assessee in subsequent years, the same could not be rejected. EIRC- Kolkata 17 Dec 2011 12
  13. 13. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Project Completion Method – Judicial Precedent CIT vs. Bilahari Investments (P) Ltd. (2008) 299 ITR 1(SC) •It is held that Recognition/identification of income under the Act, is attainable by several methods of accounting. It may be noted that the same result could be attained by any one of the accounting methods. Completed contract is one such method. Similarly, percentage of completion is another such method. Prestige Estate Projects (P) Ltd. – 33 DTR 514 (Bang) •Assessee developer having regularly employed project completion method which is an accepted method of accounting, and the Central Government having not notified AS-7 u/s. 145(2), AO could not reject the accounts u/s. 145(3) on the ground that the assessee had not followed the percentage completion method EIRC- Kolkata 17 Dec 2011 13
  14. 14. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Project Completion Method – Judicial Precedent Nandi Housing (P) Ltd. NTD (2003) 80 TTJ (Bang.) 750 •The assessee projects were of a longer duration than one particular accounting year. The project may take a few years and actual sale may take place subsequently. The Project Completion method is a permissible method recognized by the ICAI. This is regularly employed by the assessee and the Department had not found any mistakes. The addition of 8% on WIP was totally uncalled for. H.M. Constructions (2003) 84 ITD 429 (Bang) •A Builder followed the Project Completion Method regularly. The AO attempted to adopt 8% of Contract receipts as the income. It was held that this is a recognized method recommended by the ICAI and if the Revenue attempts to tax the income on the basis of receipts, it could lead to absurd results because receipts may come earlier and the expenditure would have to be incurred over a period of time. It was held that Project Completion Method was correct . EIRC- Kolkata 17 Dec 2011 14
  15. 15. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Project Completion Method – Judicial Precedent Champion Construction Co 5 ITD 495 •The assessee contended that the profit should be taxed only on completion. The ITAT held that as the construction was completed and 80% of the flats had been sold, the income could be estimated in that year and that substantial completion was what was relevant. Dalmia Promoters Developers (P) Ltd. (2006) 281 ITR 346 (Del) •The issue in this case was whether interest income was to be held as incidental to the Real Estate business or whether it was to be taxable as Income from other Sources. The Judgement however refers to the fact that assessee followed project completion method of accounting. EIRC- Kolkata 17 Dec 2011 15
  16. 16. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTreatment under Project Completion Method – Judicial Precedent Certain other judgments where Project Completion Method has been accepted: • Shree Nirmal Commercial Ltd. 193 ITR 694 (Bom) ( ) • D.K. Enterprises – 39 ITD 394 (Bom) • WD Estate (P) Ltd. – 45 ITD 477 (Bom) • Shapoorji Pallonji & Co. (Rajkot)(P) Ltd. 49 ITD 479 (Bom) EIRC- Kolkata 17 Dec 2011 16
  17. 17. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONChange of Method of Accounting – Judicial Precedent Satish H Patel 93 TTJ 458 (Pune) H. • It is held that the assessee having changed his method of accounting from work-in- progress in original return to project completion method in revised return, project completion method also followed by assessee in subsequent year and same also accepted by revenue- assessee can change one system of accounting to another system before assessment is completed. completed EIRC- Kolkata 17 Dec 2011 17
  18. 18. ACCOUNTING ASPECTS OF REAL ESTATE &REVENUE RECOGNITIONTax Audit – Judicial Precedent Gopal Krishnan Builders [92 TTJ 215 (Luck)]) • Amount received as advance by builder following project completion method whether tax audit applicable and penalty under section 271B imposable • It is held that amounts received as advance by the assessee-builder from customers had an y element of profit and same were to be adjusted towards the cost of flats booked by each customer and thus, the amounts of advance have to be included in "gross receipts" for the purpose of s. 44AB; assessee being under obligation to get its accounts audited under s. 44AB. It cannot be contended that the assessee following project completion method would get the books of account audited in the last year and not in earlier years when he is debiting the expenses and other items and showing different types of receipts penalty under s. 271B was imposable for its failure to get the same done EIRC- Kolkata 17 Dec 2011 18
  19. 19. FORMS OF DEVELOPMENTAGREEMENTS & TAXISSUES EIRC- Kolkata 17 Dec 2011 19
  20. 20. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES Forms of Development Agreements: (C) Sharing of (D) Allotment of(A) Fixed Price (B) Sharing of Profits – AOP space in building Agreement Revenue issues to the Land-owner EIRC- Kolkata 17 Dec 2011 20
  21. 21. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES (A) Fixed Price Agreement • A Land Owner, enters into a development agreement to sell land for a fixed monetary consideration. Tax Perspective • Section 2(47)(v) of the I.Tax Act, 1961 states: Transfer in relation to capital asset includes – Any transaction involving the allowing of possession of any immovable property to be taken or retained in part performance of contract of the nature referred to in Sec. 53 A of the Transfer of Property Act, 1882 ….” • By entering into a “Development Agreement” and permitting construction to be commenced, the Owner would state that he had merely given a licence to the Developer to enter upon the property for the limited purposes of construction and had not handed over “possession” to the Developer. Hence, he would contend that no capital gains tax was leviable. EIRC- Kolkata 17 Dec 2011 21
  22. 22. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES Chaturbhuj Dwarkadas Kapadia vs. CIT 180 CTR Bom 107 •Transfer of property under a development agreement •Arrangements conferring privileges of ownership even without transfer of title fall under s. 2(47)(v) •In cases of development agreements, the year of chargeability of capital gains is the year in which the contract is executed •Substantial performance of the contract is not relevant •If the contract, read as a whole, indicates passing of or transferring of complete control over the property in p g g p p p y favour of the developer, then the date of the contract would be relevant to decide the year of chargeability •Under the terms of the agreement between the assessee and the developer a limited power of attorney was intended to be given to the developer to deal with the property •Hence, the date of contract was the relevant date of transfer under s. 2(47)(v) •Finding of the Tribunal that the transfer had taken place during the relevant asst yr is also vitiated by mistakes asst. yr. apparent on the face of the record. EIRC- Kolkata 17 Dec 2011 22
  23. 23. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES Conversion of Capital Asset into Stock- in-trade [Section 45(2)] • Section 45 --- • (2) “ Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him as, stock-in-trade of a business carried on by him shall be chargeable to income tax as his income of the previous year in income-tax which such stock-in-trade is sold or otherwise transferred by him and, for the purposes of section 48, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.” EIRC- Kolkata 17 Dec 2011 23
  24. 24. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES Shirinbai Kooka 46 ITR 86 (SC)• Process of conversion – • Get a Valuation Report of the land. • In the case of a Company, pass a resolution to convert the land and follow this up with a formal declaration or affidavit • The necessary entries must be passed in the books of account. EIRC- Kolkata 17 Dec 2011 24
  25. 25. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES Stock-in-trade : Certain issues •What is the date of sale or transfer in the case of stock-in-trade? •Is it the date on which the Land Owner entered into the Development Agreement? •Is it the date on which the Developer entered into an agreement to sell a particular flat? •Is it the dates on which the Developer receives installments of sale proceeds? •Is it the date on which the Developer hands over possession of a flat? p p •Is it the date on which the Developer conveys the building to the society? EIRC- Kolkata 17 Dec 2011 25
  26. 26. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES (B) Sharing of Revenue • The Owner enters into an agreement in which he is to get a share of top line. Since this consideration is not quantified at the initial stage of development, such a situation would normally result in the receipts by Owner, being treated as business receipts. If the land had been held until then as a Capital Asset, the Owner may convert the Capital Asset into Stock-in-Trade for clear classification and treatment of revenues. EIRC- Kolkata 17 Dec 2011 26
  27. 27. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES (C) Sharing of Profits • “Land Owner is to get a certain basic price and thereafter a share of profit” The AO may contend that this is an AOP • Option 1: • Formation of an AOP/LLP: • Introduction of land into the AOP/LLP at a mutually agreed price [u/s. 45(3)] • Division of profits between the parties. • Option 2: • C bi i Combination of profit sharing and sharing of revenue or other such b i so that the f fi h i d h i f h h basis h h parties are entitled to an independent share in the income. EIRC- Kolkata 17 Dec 2011 27
  28. 28. FORMS OF DEVELOPMENT AGREEMENTS &TAX ISSUES (D) Allocation of Area • The Owner enters into an agreement with the Developer under which the Developer is to carry on construction at the Developer’s cost. The Owner receives a certain percentage of area in return return. EIRC- Kolkata 17 Dec 2011 28
  29. 29. TAX ISSUES•FINANCE COST, INDIRECTCOST & COMPOUNDINGCHARGES•50C•PROPERTY VS. BUSINESSINCOME•80-IB(10) EIRC- Kolkata 17 Dec 2011 29
  30. 30. TAX ISSUESFinance Cost, Indirect Cost & Compounding Charges CIT vs. Lokhandwala Construction, (2003) 260 ITR 579 (Bom) •It is held that construction project undertaken by the assessee-builder constituted its stock-in-trade and the assessee was entitled to deduction under s. 36(1)(iii) in respect of interest on loan obtained for execution of said project. Wall street Constructions Ltd. & Anr. Vs. JCIT 2006 101 ITD 156 ( J (Mum) ( ) ) (SB) •It is held that the assessee following project-completion method of accounting, the interest identifiable with that project should be allowed only in the year when the project is completed and the income from that project is offered for taxation. The same cannot be deducted as period cost from year to year. True profits in such a case can be determined only when entire cost of the project, direct or indirect, including finance cost is added to the value of work-in progress EIRC- Kolkata 17 Dec 2011 30
  31. 31. TAX ISSUESFinance Cost, Indirect Cost & Compounding Charges JCIT vs. Raheja (P) Ltd. (2006) 102 ITD 414 (Mum.) • It is held that even though assessee was following competed contract method for returning its income, its claim of finance cost as a period cost in nature of interest was allowable in the year in which it was incurred or accrued, in accordance with AS – 7 issued by the ICAI. Income Tax Officer vs. Panchvati Developers [ p [115 TTJ 139 ( J (Mum)] )] • It is held that Assessee following project completion method, and advertisement expenses of the two projects being allocable to individual project, such advertisement expenses have to be capitalized as work – in – progress to be allowed deduction in the year of completion of project. EIRC- Kolkata 17 Dec 2011 31
  32. 32. TAX ISSUESFinance Cost, Indirect Cost & Compounding Charges Mamta Enterprises – [135 Taxman 393 (Karnataka.)] • In this case it was held in the order passed by a competent authority of Town Planning in unmistakable terms stated that he had permitted the payment of compounding charges by erring builders to regularize the infirmity in the building construction. There could not be any doubt that what had been done was to permit the assessee to compound the offence y p p committed by it putting up an unauthorized construction. • Explanation to Sec. 37(1) defines that any expenditure incurred for any purpose which is an offence or which is prohibited by law is not entitled to deduction. Hence compounding of the offence under Corporation Act cannot take away the rigour of explanation to sec 37 p y g p and the deduction is not available. EIRC- Kolkata 17 Dec 2011 32
  33. 33. TAX ISSUESSection 50C Applicable A li bl to •capital asset and not to business assets •CIT Vs. Thiruvengadam Investment Pvt Ltd 320 ITR 345 •Inderlok Hotels Pvt Ltd [4376/Mum/2008 ] Not applicable •in respect of transfer of tenancy rights •Kishori Sharad Gaitonde [ ITA No.1561/Mum/2009] Stamp duty •Stamp duty authority accepted consideration then no question of once again referring to DVO u/s 50C •Punjab P l J C P j b Poly Jute Corpn [120 ITD 233] EIRC- Kolkata 17 Dec 2011 33
  34. 34. TAX ISSUESSection 50C Does not apply to • cases in which the transfer property is not the subject matter of registration and the question of valuation for stamp duty purpose has not a reason p yp p • Navneet Kumar Thakkar [112 TTJ 76 ] Note : • Explanation to Sec.50C (2) is added w.e.f 1/10/2009 stating that the expression assessable means the price the stamp duty authority would have adopted or assessed if it were referred to such authority for the purpose of payment of stamp duty EIRC- Kolkata 17 Dec 2011 34
  35. 35. TAX ISSUESProperty V/s Business Income Shambhu Investment Private Ltd v/s CIT [263 ITR 143 (SC)] • In this case assessee was letting out furnished premises on monthly rent to various parties along with furniture, fixture, A.C., etc. for being used as “table space". Entire cost of property already recovered by way of interest free advance by assessee. Only intention was to let out a portion of premises to respective occupant. It was held that income derived from letting rightly held as income from property and not business income. PFH Mall & Retail Management Ltd v/s ITO [110 ITD 337(Kol)] • It was held that the fact that Apex court held that income earned by Shambhu Investment Pvt Ltd is assessable as property income has no relevance in the facts and circumstances of the present case because in that case the fact showed that the main intention was to earn rental income. That was why the entire cost of property was recovered from tenant by way of interest free advance. In the instant case the assessee has taken bank loan to finance his projects like any other business man. Every action of the present assessee appears to be the sole object of commercial exploitation of the premises CIT v/s Sarabhai Pvt Ltd [263 ITR 197(Guj)] • When property has been let out not only as property but with services which is complex letting, the income cannot be said to be derived from mere ownership of house property but may be assessable as income from business. EIRC- Kolkata 17 Dec 2011 35
  36. 36. TAX ISSUESSection 80-IB(10) – Some recent judicial precedents Bhrama Associates vs. JCIT (ITAT Pune Special Bench) ITA No. 1417/PN/06 •Where the local authority does not grant approvals to “housing projects” but instead grants approvals to “residential and residential cum commercial projects”, one will have to adopt the doctrine of purposive interpretation to draw a “lakshman rekha” and ensure that the basic character of the project continues to remain in harmony with the object of the tax incentive i.e. augmenting affordable dwelling units. Applying the said doctrine of purposive interpretation, cases where commercial built up area does not exceed 10% of the total area are eligible for the benefit as such projects are predominantly residential in nature •Cases where the commercial area is more than 10% will not be eligible for deduction unless it can be shown that income from the residential dwelling units can be worked out separately and even after excluding the commercial use of plot, the project satisfies all the requirements of section 80-IB (10) •On the question as to the extent to which commercial use in a “housing project” is permissible, the approval by the local authority of a project as a “housing project” is conclusive and no further enquiry is required EIRC- Kolkata 17 Dec 2011 36
  37. 37. TAX ISSUESSection 80-IB(10) – Some recent judicial precedents KZK Developers (2010) 130 TTJ 57 (Cuttack) (UO) • In this case the assessee entered in to an agreement with the lessee of a plot, on principal to principal basis for co- constructing a multi–storeyed residential complex whereby i was assigned the right to use, d l i li d id i l l h b it i d h i h develop, construct, sell or ll transfer the saleable area, it was not a contractor at all. Assessee had the right to select its own design, development plan and customers. Notwithstanding the fact that the approval for developing the housing project was given by the competent authority in favour of the co-venturer, the deduction under section 80IB(10) was still made available to the assessee G. V. Corporation (2010) 133 TTJ 178 (Mum.) (Trib) • Assessee undertaking engaged in development of housing projects could not be denied deduction under section 80IB, on the ground that it failed to fulfill all conditions of “industrial undertaking”, as prescribed by sub section (2) of section 80IB. Provisions of sec.80IB(2) h no application f claiming d d i u/s.80IB(10) and thus, the condition that the assessee h P ii f 80IB(2) has li i for l i i deduction / 80IB(10) d h h di i h h has to be an industrial undertaking does not apply for claiming deduction u/s.80IB(10) EIRC- Kolkata 17 Dec 2011 37
  38. 38. TAX ISSUESSection 80-IB(10) – Some recent judicial precedents Vandana Properties (2009) 31 SOT 392(Mum) •In this case the assessee was granted Commencement certificate for 4 Buildings and building 5 plan got approved on the same plot Since the commencement certificate was granted it could plot. granted, be said that the building 5 was a separate and independent housing project. Thus Housing project does not mean that there should be a group of buildings and that housing project would include construction of any building and thus the assessee can claim deduction u/s 80 IB(10) in respect of building 5 independently B.K Enterprise (2009) 125 TTJ 974 (Pune) •In this case the assessee developing a housing project and fulfilling all other requirements of section 80-IB(10) was allowed to adopt ‘percentage completion method’ to arrive at the eligible 80 IB(10) percentage method profits for claiming deduction under the said section. Deduction cannot be postponed to a later year; i.e., on completion of project. EIRC- Kolkata 17 Dec 2011 38
  39. 39. TAX ISSUESSection 80-IB(10) – Some recent notifications & instructions Slum rehabilitation scheme recognized u/s 80IB- Notification 67/2010 dated 3rd August, 2010 • Slum Rehabilitation was required to be notified to be eligible to the benefits of the deduction as stipulated under section 80IB(10) Hence according to 80IB(10). Hence, CBDT circular any scheme of Slum Rehabilitation would be eligible for claiming deduction under the said section of the Act provided all the other conditions are fulfilled Deduction in respect of undertakings of developing housing projects: Instruction No. 4/2009, dated 30th June, 2009 • Clarification regarding claiming of Section 80IB(10) if the assessee follows percentage completion method of accounting and offer proportionate profit on qualifying project on year on year basis EIRC- Kolkata 17 Dec 2011 39
  40. 40. THANK YOUEIRC- Kolkata 17 Dec 2011 40

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