The general economic slowdown has impacted the realty sector, but smart property investors, who raked in the moolah when the going was good,made use of the equity markets to reduce the tax they paid on those gains.
According to tax consultants, people who derive income from other sources, say a salaried employee, can and have in the past offset derivatives losses against short-term capital gains made in property transactions to reduce tax incidence on property gains. Gains from property are deemed short-term if they are held for less than three years.
Once a derivatives loss is offset against the gain, the balance short-term capital gain is clubbed with the salary income and taxed at the normal rate.
Tax experts like Sameer Gupta, director (financial services) Ernst & Young, point out that in the context of shares, Central Board of Direct Taxes (CBDT) issued a circular in June 2007 laying down the tests for distinction between shares held as stock in trade vis-a-vis those held as investment.
Some of these tests include the scale and frequency of the transactions, whether owned funds or borrowed funds were utilised for the transactions, the accounting treatment, the motive behind entering into the transactions, etc. The tests are indicative and not decisive, and need to be examined on a case to case basis, including their applicability to futures transactions, they add.
It may be argued that a gain or loss arising from an exchange-traded futures transaction (NSE/BSE F&O) is in the nature of a short-term capital gain or loss as a person buying or selling a futures contract is creating a right or interest (in buying/selling a specific number of shares on a net settlement basis) and that when this right/interest is transferred by way of squaring off the transaction, there is a capital gain or a loss, said E&Ys Gupta.
Other tax experts buttress this argument by pointing out that a capital asset in the Income Tax (IT) Act means property of any kind held by an assessee, whether or not connected with his business or profession.
Under Sec 2 (47) of the IT Act, a transfer in relation to a capital asset is defined as including the sale, exchange or relinquishment of the asset or extinguishment of any right therein or the compulsory acquisition thereof under any law. The word property used in Sec 2 (14) of the IT Act is a word of the widest amplitude and the definition has re-emphasised this by the use of words of any kind.
Thus any right which can be called property will be included in the definition of capital asset, said Tata Sons senior vice-president, finance FN Subedar, drawing attention to a Bombay HC decision in Tata Services versus Commissioner of IT case of 1979. The implication is that a derivatives contract entered into, and not held as stock in trade, is a capital asset and that when the futures contract is settled, the accrued gain or loss from the settlement of the contract is a capital gain or loss, he added.
Interestingly, while losses in derivatives can be genuine, as is likely to be the case over the past nine months which has seen the Sensex declining by 38%, investors can also buy losses in a structured deal with brokers in order to set off the derivatives loss against the short-term capital gain arising on sale of immovable property in the same financial year.
Share brokers say this, though illegal, is not an unknown market practice. They are also quick to point out that structured deals wherein one party buys a loss while the other books a gain is restricted to the unscrupulous variety of brokers and is not prevalent among reputed and big institutional and retail brokers.
Explaining the modus operandi of such transactions, a broker said this practice was prevalent in the case of Nifty futures. Say, investor A wants to buy a loss and investor B wants to book a profit. The broker punches in a buy and sell order respectively on two different terminals using As client code for both the transactions (buy and sell).
Depending on how the index moves, the transaction can be squared off on the same day and the client code changed when the transaction is reversed. For instance, if investor A has bought and the Nifty futures move down, the broker changes the client code for the sell transaction by replacing As client code with B's code.
At the end of the transactions, the broker is paid a commission by both parties to the deal.
Property developers like Orbit Corporation managing director Pujit Aggarwal say realty investors could make good profits even before construction is complete.
For example, an investor gives a downpayment of Rs 10 lakh for a one crore-worth property, construction of which will be complete in two years.
However, if the valuation of the property changes in six months to Rs 1.2 crore, the investor could sell it and make a cool profit of Rs 20 lakh on an investment of Rs 10 lakh. Mr Aggarwal said This mostly happens when realty market is on a high.