Presentation on taxation of real estate made by me in RRC of WIRC in November 2009

1. Paper 1 - Taxation in Real Estate
Residential Refresher Course,
Umbergaon,
20 November 2009
CA Romesh S A Sankhe

2. 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
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3. Indian real estate - an exciting opportunity ahead
• 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
Real Estate …. a sector which no one can afford to ignore !!!
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4. Case study analysis
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5. 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), reliance
may 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
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6. Case study 1
Withdrawal of balance by retiring partner whether ‘transfer’ under section
2(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 partners are withdrawing
their own balances
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7. Case study 1
Withdrawal of balance by retiring partner whether ‘capital gains’ under
section 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 partners withdraws more than
their credit balances
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8. Case study 1
Whether the proposed arrangement can be construed as ‘tax avoidance
device’ ?
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 avoidance’
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9. Case study 2
Whether the interest on loan borrowed utilised for repayment of partner’s
current 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
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10. Case study 2
Whether the interest on loan borrowed utilised for repayment of partner’s
current account balance is allowable as deduction ?
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 circular 28 dated 28 August
1969, if current capital account classified as ‘loan from partners’,
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11. Case study 2
Whether the interest on loan borrowed utilised for repayment of partner’s
current account balance is allowable as deduction ?
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
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12. Case study 2
Whether the claim of deduction made through notes in the return of income
is 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 ruling of M/s Ratan
Melting and Wires Industries [2008] 220 CTR 98 (SC)
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13. Case study 3
Which is the better entity form of operation in real estate business ?
Let us compare the different form of entity with business objectives
Business objectives Partnership Private Limited Limited Liability
Firm Company Partnership
Taxation of business 30.90% 33.99% 30.90%
income
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 Nil Nil Nil
DTAA
Liability Unlimited Limited limited
Limited liability partnerships may prove to be a better option, however
clarity on FDI norms is awaited
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14. Case study 4
Various tax considerations under section 80IB(10) on ‘heaven 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 carefully
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15. Case study 4
Various tax considerations under section 80IB(10) on ‘heaven on earth’ ?
• 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 use
is suggested, however revenue authorities may still raise objection
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16. Case study 4
Various tax considerations under section 80IB(10) on ‘heaven on earth’ ?
• 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 should be preferred in
taking the decisions
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17. Case study 4
Various tax considerations under section 80IB(10) on ‘heaven on earth’ ?
• 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 adopted by revenue
authorities
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18. 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 substantiation before revenue
authorities will be crucial
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19. Other vital issues
Conversion of housing units from ‘stock in trade’ into ‘investments’ and
subsequent 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 Construction seems to be a
better view from legal perspective
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20. Other vital issues
Whether a developer must be an owner of the land to claim the deduction ?
• 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 entrepreneurial risk
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21. 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
A lot of planning will have to be done for DTC
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22. Open house …
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23. CA Romesh S A Sankhe
(M) 9892 892504
(E) romesh_sankhe@rediffmail.com
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.
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