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Property deals, 'development agreements' chiefly among them, is one area where you need to know the tax implications well because the amounts involved can be quite large. I have often seen that property deals are not properly tax-planned and the results are not quite pleasant.
In this and in a few articles hereafter, I intend to discuss various tax implications of development agreements. We shall discuss these deals from two angles - the owner's and the developer's. Let us start with your being an owner and wanting to give your land for development.
Development, in relation to land, usually means where the property is handed over by the owner to a builder who will construct a building on it to be shared by the owner and builder in agreed proportions. Typically, you will enter into an agreement with a builder for development of your land with an understanding that he will hand over, say 50% of the built up area to you on completion of construction. You may, or may not, take some cash down, either as a refundable/adjustable amount or a part of the consideration.
In a straight sale, there is a simple cash consideration without much risk to the owner. On the other hand, in a development agreement you give your land to the builder without much cash consideration and expect him to build on it with his own resources. Thereafter, you share the building. You may or may not sell your part of the building, while the builder is most likely to do so.
What are the expectations when properties are given on development? Tax-wise two major issues are: capital gains and pre-emptive acquisition by the income tax department. Then you and the builder will want to ensure that the damage resulting from stamp duty and registration charges are minimised. These are, of course, besides the major issues like ensuring that you will actually get the consideration promised, and in time - but that is something we need not discuss here.
A question often asked is whether giving property on development will result in capital gains tax? I often wonder why this question should be asked so often, because the answer is quite clear: Yes. But since the question comes up so often, let us discuss why it is so.
Whenever you 'transfer' a capital asset there would result a capital gain or loss.
A capital asset is any property held by you except a few specified items like personal effects, stock in trade and rural agricultural lands. So, immovable property owned by you would be a capital asset.
Does giving property on development result in its transfer? For this, we should understand what is transfer under tax laws.
'Transfer' is a highly technical term in tax law and it is very necessary to understand what it means.
The original meaning of transfer was quite wide. The following were treated as cases of transfer:
- sale, exchange or relinquishment of an asset;
- extinguishment of rights in an asset;
- compulsory acquisition of an asset.
Note that transfer is not merely a sale of an asset. Even an exchange of an asset with another is transfer. Do you exchange your land with built up area? If so, there may be a transfer.
Even relinquishing - giving up - an asset to another is a transfer. Are you relinquishing your rights over your land in favour of the builder? If so, there may be a transfer.
Even if your rights in an asset are extinguished, there is a transfer.
But that was not enough for the taxman. The department found that taxpayers found ways and means of avoiding capital gains tax by artificially going outside the scope of the term 'transfer'. So, the meaning of the word 'transfer' was extended to include several other transactions that do not really mean transfer. So, the extended meaning includes the following:
- converting a capital asset into stock in trade;
- allowing possession of property in part performance of a contract;
- any transaction resulting in transferring, or enabling the enjoyment of immovable property. This may be by way of becoming a member or taking shares in a society, company etc or by way of any agreement or arrangement or in any other manner.
These clauses do extend the meaning of transfer really wide.
It is important that we understand what the last two clauses mean - you will know why as you read along.
Before we discuss the extended meaning of transfer, let us understand what property is - not immovable property, but property generally.
Property is basically a 'bundle of rights'. Each property that you think of - cash, land, house, shares, every asset - is really just a bundle of different rights. If you understand this simple concept, you will have understood quite a bit of law.
There may exist an asset with all rights associated with it, or without some of them. Understand this with an example.
You own a land absolutely, that is, you have all rights as an absolute owner of the land. Now, you enter into an agreement to sell it and take an advance. The agreement contains some terms and conditions.
After the agreement, you have transferred some rights in the land to another person. For instance, you have transferred the rights to sell the property to any person you desire. What you own is land without such rights, a smaller bundle of rights.
What your buyer owns is a part of your original bundle of rights - the right to buy the land from you.
Similarly, when you lease out your property to another person, you have given away temporarily your rights of occupation.
Once you understand that property is always a bundle of rights, you will appreciate much discussion in law relating to property.
We shall continue with this interesting subject in the next article
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