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Tax implications of development agreements
December, 03rd 2007

Construction of flats under a development agreement is now the order of the day in urban areas. Generally, the land owner grants a power of attorney to the developer authorising him to sell an undivided interest in the land to the prospective buyer of the flat. The developer constructs flats and completes the projects within the stipulated time. How is capital gains worked out in such transactions?

Contrary views

One of the first cases on this issue was the Ashok Leyland Finance (230 ITR 398) case. The Madras High Court ruled that notwithstanding the description of the document as a development agreement, the subject matter of the transfer being an undivided share in the land, and the consideration being partly in money and partly a thing which was not in existence (the thing being a flat which the transferee was required to construct), a development agreement should be treated as an agreement for sale. This was in the context of Chapter XXC of the Income-Tax Act, 1961.

A contrary view was taken in the R. Vijayalakshmi vs Appu Hotels Ltd (257 ITR 4 Madras) case, wherein it was held there was no transfer when possession is given to the builder for construction for a specified period under the development agreement.

However, the Bombay High Court, shedding more light on the scope of the development agreement, pointed out that a transaction which allows possession to be taken in part-performance of contract should be treated as giving rise to a transfer under Sections 2(47)(v) and (vi) of the Income-Tax Act,1961.

Capital gains would be taxable in the year in which such transactions are entered into, even if the transfer of the immovable property is not effective or complete under the general law. Under Section 2(47)(v), any transaction allowing possession to be taken over or retained in part-performance of the contract of the nature referred to in Section 53(A) of the Transfer of Property Act would come within the ambit of Section 2(47)(v) of the I-T Act.

Power of attorney

Now comes the ruling in the Jasbir Singh Sarkaria (2007 294 ITR 196 AAR) case. Here, the assessee had given an irrevocable general power of attorney to the developer to develop the plot and construct housing units for sale. This meant that possession was given when the power of attorney was utilised. The AAR (Authority of Advance Ruling) held that the general power of attorney (GPA) unequivocally granted to the developer a bundle of possessory rights, the acts of management, and control and supervision of the property explicitly mentioned.

The GPA was not a mere licence to enter the land for doing some preliminary acts in relation to the development work; the power of control of the land, which was an incidence of possession, was conferred to the developers under the GPA.

The irrevocable GPA must be regarded as a transaction which allowed possession to be taken in part performance of the contract of transfer. Possession need not necessarily be sole and exclusively. The transfer within the meaning of Section 2(47)(v) must be deemed to have taken place on the date of execution of the irrevocable GPA, and capital gains must be held to have arisen during that year.

Once it is held that the transaction of the nature referred to in Section 2(47)(v) has taken place on a particular date, the actual date of taking physical position need not be probed into. It is enough if the transferee has by virtue of the transaction a right to enter upon and exercise the acts of the possession effectively. For determining the date of transfer, possession given to the developer need not ripen into an exclusive one on payment of instalments in entirety. There is no warrant to postpone the accrual of capital gains to a point of time when the concurrent possession will become exclusive possession of the developer or transferee on payment of full consideration.

The AAR had examined the various clauses in the development agreement. The conclusion reached is to the effect that capital gains accrued when irrevocable GPA is granted by the owner of the land. Possession is generally given for construction purpose. The ruling implies that even without the construction being complete, there will be liability for capital gains tax for the land owners when they execute the irrevocable GPA. To safeguard the interests of the land owner, much care will have to be taken in drafting the development agreement. Critics have assailed the AAR decision as spelling hardship to landowners. Probably, the CBDT can come up with a detailed clarification on the implications of development agreements.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)
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