All about capital gains taxation

T. Banusekar

This week, `Tax Talk' answers the elaborate query of a reader, Mr K. Pani, on the capital gains taxation arising out of joint development and transfer of a house property.

A, B, C and D are the co-owners of inherited property at Hyderabad owning 30,000 sq ft of land and a building being a residential house. They gave it for joint development in 1991. The documents executed are joint development agreement and unregistered power of attorney. The terms of joint development stipulate that the owners have to get 50 per cent of the super built up area aft er construction. The total super built up area expected was 60,000 sq ft and share of A, B, C and D was 30,000 sq ft in the form of four flats of 1,875 sq ft each. The builder, on signing the joint development agreement (mainly to compensate for the re-location of the families), paid a non-refundable deposit of Rs 40 lakh. The flats were supposed to be constructed and handed over within three years. The No Objection Certificate was applied in form 37-I for Rs 160 lakh as given below:

*Value of 30,000 sq ft

at Rs 400: Rs 120 lakh.

*Non-refundable deposit: Rs 40 lakh.

*Total consideration for 50 per cent share of undivided interest (UDI): Rs 160 lakh.

The appropriate authority granted the NOC in 1991 based on the Joint Development Agreement. The developer got the plan approved, wherein the approved super built up area came to 42,000 sq ft only.

The construction could be completed only in 2000. The developer progressively handed over the completed flats, before March 2000 and the balance was completed by July 2000. Ultimately, each of the co-owners got three flats of 1,750 sq ft each. None of the flats was sold, either by the developer or by the owners. It is likely the flats will be sold in 2000-01.

In this case, from the point of view of the owners of land:

Query 1: When does the capital gains tax arise? Is it at the time of signing the joint development agreement, at the time of receiving the constructed flats, or at the time of selling the flats?

Reply: The point where the capital gains is deemed to accrue will purely depend on the terms of agreement between the promoter and the land-owners. Where the agreement is of such nature that possession is given in part performance of a contract, the liability to capital gains tax will arise on the handing over of such possession to the builder.

If the possession is not transferred but deferred until the construction is completed, the liability to capital gains tax will arise in the year in which the construction is completed by the developer. This will be so, for in such a case the builder is given only a right to enter the premises for the purpose of construction, and the ownership will continue to remain with the land-owners.

Even in this case, capital gains will arise when the possession of the constructed area is given to the land-owners or when conveyance is registered, whichever is earlier. In any event the capital gain arising out of such joint development cannot be deferred until the time of selling the flats that are allotted to the landowners.

Query 2: If the capital gains tax liability is at the time of receiving the constructed flats, what is the basis of reckoning the value of flats (being the sale consideration)?

Reply: If the capital gains accrues at the time of receiving the constructed flats, the full value of consideration to be reckoned would be the cost of construction of flats actually allotted. That is, of the three flats to each co-owner ad-measuring 1,750 sq ft each. Though the reader has stated that the consideration in the form of built up area has been reduced, there is no indication that this reduction has been compensated in some other manner.

One would, therefore, presume that the consideration has been reduced by way of revised agreement by the developer and the land-owners. If this be the case, the Appropriate Authority would have to be re-approached for the NOC for revising the terms of agreement. Where, however, capital gain accrues at the time of the agreement between the land-owners and the builder, the full value of consideration would be the cost of construction of the flats originally agreed to be allotted, that is, four flats to each co-owner, measuring 1,875 sq ft each.

Query 3: Is exemption available under Section 54 since there was a house when the property was handed over to the builder or is it under Section 54F?

Reply: Section 54 provides for an exemption on the transfer of a long-term capital asset being a residential house subject to certain other conditions being satisfied. Section 54F provides for an exemption on the transfer of a long-term capital asset not being a residential house subject to satisfying certain other conditions.

In case of joint development agreements, a doubt oft en arises if the transfer is that of a residential house or only of land. As stated earlier, if capital gain accrues when possession is handed over to the builder, no dispute can arise and it can be said that the exemption would be available under Section 54. This would be so because the transfer would clearly be of the residential house.

However, if the capital gains accrues only when the construction is completed, the doubt could arise for the possession and if the transfer by the land-owners is only of land and not of the residential house. The land-owners would normally be registering only the undivided share of land in favour of nominees of the builder. However, in such a case also, it is a substance of the transaction that needs to be looked into and not its form. If this is done, then it can be easily said that the land-owners can claim exemption under Section 54.

Query 4: How do we compute the capital gains for some of the flats delivered before March 2000 and let out by this individual?

Reply: In the answer to the first query, it has already been stated that the gains may arise at the time of handing over of possession by the builder or when the conveyance is registered, whichever is earlier. If this be the case, in respect of the flats delivered before March 2000, the capital gains tax would arise in 1999-2000. The capital gains will have to be computed on a proportionate basis, by taking the proportionate cost of acquisition of the property. The proportion being arrived at on the basis of the consideration in the form of flats received to the total consideration receivable by way of flats.

Query 5: Will exemption be limited to one property under Section 54F or two, as amended from April 1, 2000?

Reply: The reader has misunderstood the amendment made to Section 54F by the Finance Act, 2000. Section 54F continues to allow exemption only in respect of one property. It is just that the law has been amended to provide that the exemption will be available, even if the assessee were the owner of one residential house other than the new asset. Though this question has been answered, as a matter of academic interest it may be noted that the columnist has stated that the exemption would be available under Section 54 and not under Section 54F.

Query 6: Can we have the option to invest in 54EA, 54EB or 54EC and got the tax exemption? If so, what is the investment to be made? Please note that we have only received flats, but do not have funds to invest, as we have not sold the flats.

Reply: The option to invest in specified assets for exemption under 54EA or 54EB (if the gains accrues before April 1, 2000) or 54EC (if the gains accrues on or aft er April 1, 2000) is available to the assessee. To get the exemption in full, the amount to be invested would be:

*In the case of Section 54EA -- the net consideration.

*In the case of 54EB or 54EC -- the capital gains.

The fact that the consideration is only in the form of flats is not material if the exemption is to be availed. The investment must be made within six months from the date of transfer. The assessee is, however, free to borrow the money or invest out of his other sources, and the exemption would still be available, though the investment is not made out of the consideration received from the transfer.

Query 7: When we sell the flats later, will the gains be long-term or short-term?

Reply: When the flats are sold later, a capital gain will arise. The gain would be short-term or long-term depending on the period of holding of the flats. If the flat was held for a period exceeding 36 months, the gain would be long-term or else short-term. If exemption under Section 54 has been claimed earlier in respect of the flats transferred, the capital gains earlier exempt would be reduced from the cost of acquisition of the flat, in arriving at the capital gains. This will apply only if the flat is transferred within three years of its acquisition.

Query 8: One of the co-owners, A, passed away, leaving a will that his share is to be shared equally by the children of the rest (B, C and D). The children are minors. What is the capital gains tax liability in the hands of legal heirs?

Reply: The capital gains tax liability in the hands of the legal heirs can be analysed in three different situations.

Situation 1: Where the capital gains liability has arisen to the deceased co-owner at the time of the agreement with the builder, there would be no capital gain tax liability in the hands of the legal heirs.

Situation 2: Where the capital gains tax liability is to arise on the handing over of possession by the builder, or on registering the conveyance, and where the co-owner has died aft er getting the flats, the capital gains tax liability would be that of the deceased co-owner. There would be no capital gains tax liability in the hands of the legal heirs.

Situation 3: Where the capital gains tax liability arises on the handing over of possession by the builder, or on registering the conveyance and where the co-owner dies before the liability arises in his hands, the heirs of the deceased would automatically become the co-owners along with B, C and D. The gains would be computed as though the property were co-owned by six persons -- B, C, D and three minor children.

It may be observed here that the income of a minor child is to be clubbed with that of the parent in accordance with section 64(1A). It may also be noted that the tax liability of the deceased may be recovered from the legal heirs (Section 159) if the deceased is liable to tax.

(The author is a Chennai-based practising chartered accountant. This column appears on the first and third Sundays of every month.)

Business Line invites queries on personal taxation issues to this column. They will be answered in the first Sunday's issue of Business Line every month. Queries may be addressed to Tax Talk, Business Line, Kasturi Buildings, 859, Anna Salai, Chennai 600 002, or by e-mail to vaidy@thehindu.co.in