Kolkata taxation of real estate development 17 dec 2011

INCOME TAX
ISSUES ON
TRANSACTION OF
REAL ESTATE

Nihar Jambusaria
nihar.jambusaria@ril.com
jnihar@rediffmail.com
j ih diff il

EIRC- Kolkata 17 Dec 2011 1

ROAD MAP OF THE CONTENTS

Accounting Aspects of Forms of
Real Estate Development
Other Tax Issues Redevelopment
development & Agreements & Tax
Revenue Recognition Issues


ACCOUNTING ASPECTS
OF REAL ESTATE
DEVELOPMENT &
REVENUE
RECOGNITION


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

REVENUE RECOGNITION
Guidance N
G 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

REVENUE RECOGNITION
Applicable 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
Work completed 70%
Year 3 Remaining flats sold 15 flats
Work completed 100%

ACCOUNTING ASPECTS OF REAL ESTATE
& REVENUE RECOGNITION
Treatment under Percentage Completion Method - Ill t ti
T t t d P t C l ti M th d Illustration
Year 1 Total flats 50 flats
Total flats sold 15 flats
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


ACCOUNTING ASPECTS OF REAL
ESTATE & REVENUE RECOGNITION
Treatment under Percentage Completion Method - Illustration
Year 2 Further flats sold 20 flats
Work completed 70%

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

REVENUE RECOGNITION
Treatment under Percentage Completion Method - Illustration

Year 3 Remaining flats sold 15 flats
Construction E
C i Expenses 9.00
9 00
Work completed 100%

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

REVENUE RECOGNITION
Summary 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


REVENUE RECOGNITION
Treatment 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


REVENUE RECOGNITION
Treatment 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.


REVENUE RECOGNITION
Treatment 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

REVENUE RECOGNITION
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 .

REVENUE RECOGNITION

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.


REVENUE RECOGNITION

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)


REVENUE RECOGNITION
Change 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


REVENUE RECOGNITION
Tax 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

FORMS OF DEVELOPMENT
AGREEMENTS & TAX
ISSUES


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


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.

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.


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.”

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.


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?


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.


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.


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.


TAX ISSUES

•FINANCE COST, INDIRECT
COST & COMPOUNDING
CHARGES
•50C
•PROPERTY VS. BUSINESS
INCOME
•80-IB(10)


TAX ISSUES
Finance 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


TAX ISSUES

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.


TAX ISSUES

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.


TAX ISSUES
Section 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]


TAX ISSUES
Section 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


TAX ISSUES
Property 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.


TAX ISSUES
Section 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

TAX ISSUES

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)


TAX ISSUES

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.


TAX ISSUES
Section 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


THANK
YOU

Kolkata taxation of real estate development 17 dec 2011

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Kolkata taxation of real estate development 17 dec 2011