Taxation (Income Tax, LTCG, GST) impact of Redevelopment on Flat Owners

Updated: May 24

Redevelopment is a method of urban renewal that seeks to provide additional and better quality housing, make land available in the center of the city, eliminate urban decay and improve infrastructure. In the recent past there are two major reasons observed for the rapid surge in the number of redevelopment projects across India.

Under redevelopment schemes, societies plan to undertake redevelopment of existing building owned by them and for that purpose they enter into Development Agreements with Builders. Under Development Agreement, Builder will undertake construction on the plot of land, after demolishing existing building, and will give flats to existing members of the Society free of cost in proportion to the area of flats occupied by such members in the existing building along with some additional area in the new flat. Remaining Flats in the new building will be sold by the Builder to independent buyers at market price. So, what is the tax (GST & Income Tax) impact on existing Flat Owner?

GST Impact

Existing society members think that they must get flats free and they shall not be required to pay any money out of their pockets whether by way of GST, stamp duty or any other taxes. They expect Builder to pay all the taxes out of his share of sale to outsiders. Under these circumstances when existing members are told about additional GST on value of Development Rights, entire calculations about redevelopment start appearing unviable to those members, and also for developers.

An exchange of redevelopment rights on the land for newly constructed flats between the flat-owners and is ’barter’ and attracts Goods and Services Tax (GST).

While many people are of the opinion that transfer of Development Rights (DR) is akin to transfer of land and no GST should be applicable on it, the tax authorities have a different view on taxation of transfer of DR. The transfer of DR by the flat-owners to the developers prior to 1 April 2019 attracted liability to GST in the hands of the flat-owners. The tax on transfer of DR after 1 April 2019 by flat-owners to a developer is now required to be paid by the developer (who is registered under the Real Estate (Regulation and Development) Act, 2016). The responsibility to discharge GST on DR thus rests with the developer and the liability for residential projects that will arise will depend on the number of unsold flats at the time of issuance of OCs.

Under GST law, taxability of alternative accommodation charges or compensation for hardship or displacement has also been debatable. In one matter, the Maharashtra Advance Ruling Authority upheld levy of GST on such charges in the hands of the land-owner, since such amounts represent the consideration for agreeing to do an act of vacating the property, which is a taxable supply. Now, with the introduction of the underlying exemption of GST on DR, effective 1 April 2019, there is a prevailing view that compensation for displacement or hardship should not attract GST.

Prior to 1 April 2019, GST at 8% (after deduction of land) was applicable on construction of affordable housing projects and GST at 12% (after land deduction) was applicable on construction of regular housing projects.

The Government has recently introduced a new scheme of taxation under GST, which is applicable to all eligible projects commencing on or after 1 April 2019 and on-going projects (as on 31 March 2019) for which the developer has exercised an option to pay tax under the new scheme before 20 May 2019. Under the new scheme, i.e. after 1 April 2019, GST rates of 1% and 5% (after land deduction) have been prescribed for construction services for specific affordable housing projects and other residential housing projects, respectively.

Income Tax Impact

Whether existing Flat owner is liable to pay LTCG Tax?

As per Income Tax Department’s stand:

The act of a flat-owner handing over possession of a flat to the developer in exchange for a new flat comes under the purview of 'transfer' of a capital asset. Such a transfer attracts Capital Gains Tax. Consequently, the Capital Gains Tax liability is triggered in the year of the transfer by the flat-owner (without going into the implications of section 45(5A) of the Income-tax Act, 1961).

As per Section 54 of the Income Tax Act, 1961, if any residential property which was held for a period of more than 3 years is sold or given for redevelopment and the new flat is purchased or acquired within a period of 1 year before or 2 years after the sale or constructed within 3 years after the sale then capital gain arising on the transfer of the old flat will be exempt to tax u/s. 54 of the Income Tax Act, 1961 to the extent of the cost of such new flat. In the case of redevelopment, the new flat to be acquired is treated as constructed for the purpose of the Section 54. Thus, if the new flat is acquired by the owner within a period of 3 years from the surrender of the original flat then the capital gain arising from the sale of the original flat can be claimed to be exempted u/s. 54 of the Income Tax Act.

For computing capital gains on transfer of an old flat, the fair market value of the new flat (on the date of transfer, which is date of signing an agreement & handing over possession of old flat) in addition to the monetary compensation received could be regarded as the sale consideration. The indexed cost of acquisition (if the flat is acquired before 1 April 2001, then the cost of acquisition should be fair market value as on 1 April 2001) of the old flat is reduced from the sale consideration. Furthermore, the indexed cost of improvement incurred on the flat, if any, is reduced. The balance amount is the capital gains or loss on the transfer.

Caution: Income tax department has taken a stand that all redevelopment cases will be treated as “transfer” and would be covered for LTCG and LTCG taxes would be levied where possession is beyond 3 years (36 months). It is therefore essential that flat owners’ insist on possession within 36 months from the date they vacated old flat and handed over possession to Developer for Redevelopment. Members may like to add a clause in Development Agreement that if there is delay beyond 36 months, Developer has to reimburse LTCG Tax liability.

Taxing Head: Compensation received in lieu of flat given to developer under development agreement taxed as “capital gains” and not “income from other sources”.

What happens, if the Builder delays possession of new flat within 3 years?

The timing of receipt of the new property should not obstruct the claim of the relief mentioned above. Reliance should be placed on judicial precedents that have allowed a liberal interpretation of the benefits of the provision, even if the property is not in the possession of the home-owner within the prescribed timelines.

If the new flat is not acquired by the owner within a period of 3 years then the Assessing Officer at his discretion can disallow the same at any time during the assessment.

However, allotment of a flat or a house by a cooperative society, of which the old flat owner is the member, is also treated as construction of the house [Circular No. 672, dated 16-12-1993]. Further, in these cases, the assessee shall be entitled to claim exemption in respect of capital gains even though the construction is not completed within the statutory time limit. Courts have also applied the same analogy where the assessee made substantial payment within the prescribed time and thus acquired substantial domain over the property, although the builder failed to hand over the possession within the stipulated period. Hence, relying upon judgments, even if in the case of redevelopment, the new flat is acquired by the owner after a period of 3 years from the surrender of the old flat, an assessee can claim exemption u/s. 54. If, however, the new flat acquired to claim exemption u/s. 54 is sold within a period of three years from the date of purchase then the capital gain exemption claimed earlier would become taxable in the year the new flat is transferred.

Additional area in the hands of individual members

As per Section 54 of the Income Tax Act, 1961, if any residential property which was held for a period of more than 3 years is sold or given for redevelopment and the new flat is purchased or acquired within a period of 1 year before or 2 years after the sale or constructed within 3 years after the sale then capital gain arising on the transfer of the old flat will be exempt to tax u/s. 54 of the Income Tax Act, 1961 to the extent of the cost of such new flat. In the case of redevelopment, the new flat to be acquired is treated as constructed for the purpose of the Section 54. Thus, if the new flat is acquired by the owner within a period of 3 years from the surrender of the original flat then the capital gain arising from the sale of the original flat can be claimed to be exempted u/s. 54 of the Income Tax Act.

Thus the Receipt of extra carpet area over and above the existing area could be claimed as exemption u/s. 54 of the Income Tax Act, 1961. Further, under the definition of “Transfer” according to Sec 2(47) Income Tax Act, 1961, transfer, in relation to a capital asset, includes sale, exchange, or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law. An exchange involves the transfer of property by one person to another and reciprocally the transfer of property by that other to the first person. There must be a mutual transfer of ownership of one thing for the ownership of another. Hence, the acquisition of new flat would be considered as exchange and would be considered as transfer for the purpose of capital gain.

Argument could not be made that no cost is incurred by any member for the acquisition of the new flat and hence capital gain cannot be computed and the case does not fall within the ambit of Section 55(2). The member is forgoing his rights in the old flat. And hence, it would be considered as the cost of acquisition of the new flat.

Corpus Fund Received (Lump sum amount)

Corpus fund is a lump sum amount paid by the builder to the unit holder in form of hardship compensation. It is a well settled principal in Income Tax Law that the capital receipts are not liable to tax. So, the question arises as to whether this compensation received will be treated as Capital receipt or Revenue Receipt in the hands of the Unit Holder? There are many Judgments stating that such receipt would not be taxable in the hands of the flat owner and the amount received would be reduced from the cost of acquisition, whenever the occasion to compute the capital gain would arise in future upon sale of redeveloped flat arises. Hence, Corpus fund received is reduced from the cost at the time of computing capital gains (when redeveloped flat is eventually sold) and not taxed at the time of receipt from the Builder.

Cash compensation received upon surrender of entitled additional area, in part or in full, by an individual member

If the Individual member is surrendering a part of the existing area then the Individual member would be liable to pay Capital Gain Tax. The sale consideration would be calculated higher of amount received or fair market value as per Section 50C of the Income Tax Act. However, if the Individual member is surrendering a part of the additional area then the Individual member would not be liable to pay any income tax or capital gain tax on the same and Compensation received would be reduced from the cost at the time of computing capital gains (when redeveloped flat is eventually sold) and not taxed at the time of receipt from the Builder.

Monthly Rentals Received during the period of displacement

Monthly rentals are the amount paid by the builder during the displacement period for alternative accommodation to each and every unit holder. Courts have held that the rental compensation received would be allowed as deduction to the extant the same is paid for alternative accommodation and the balance would be taxable under the head Income from other sources.

Transportation, brokerage and Other Charges

Builders also provides (compensation) for the transportation, brokerage and other charges, to the flat owner for displacement. All such expenses and charges received would also be allowed as deduction to the extant the actual expenditure has been incurred for the same and the remaining amount would be chargeable to tax under the head Other Sources.

Society receiving amenities and facilities for the common use of its members and their families in Redeveloped Building

If the Society is receiving amenities and facilities for the common use of its members and their families then the same is not taxable in the hands of the Society or the Individual members as there is no cost of acquisition of the same. In deciding the case of JETHALAL D.MEHTA V. DY. CIT, Tribunal mainly relied upon Supreme Court decision in the case of CIT V. B.C.SRINVASA SHETTY 128 ITR 294 in which it was decided that if there is no cost no capital gain can be worked out hence amount received is to be treated as exempt receipt.

Corpus Money received by the Society from the Developer in lieu of surrender of part entitlement of FSI/Development Rights, such funds being invested by the Society to earn interest income to meet/subsidize the maintenance costs of its Redeveloped premises and property

If at the time of Redevelopment, the Society was in not in possession of unutilized FSI/Development Rights, then the Society would not be liable to pay any Capital Gain Tax on the receipt of the Corpus Money on surrender of a part of FSI/Development Rights.

However, if the Society has unutilized FSI/Development Rights in its possession at the time of Redevelopment, then the receipt of the Corpus Money on surrender of the part of FSI/Development Rights would be taxable in the hands of the Society.

Courts have interpreted that where the Society became entitled, by virtue of DCR to transfer development Rights (TDR) and the same was sold by it for a price to a builder, the question arose whether the transaction of sale receipt could be taxed. It was held that though the TDR was a Capital Asset, there being no ‘cost of acquisition’ for the same, the consideration could not be taxed.

The Society acquired the right to construct the additional floors by virtue of DCR which could not be available to the Society on expenditure of money and hence it was not a tradable commodity. However, suddenly by virtue of DCR the right was conferred by the Government to the Society. Such right exclusively belonged to the building owned by the society and it could not be transferred to any other building.

Similarly, similar right belonging to other societies could not be purchased by the Society for the purpose of constructing additional floors in its own building. Therefore, such right had no inherent quality of being available on expenditure of money and, therefore, cost of such asset could not be envisaged. Therefore, the right acquired by the assessee did not fall within the ambit of section 45 itself. The amended provisions of section 55(2) were also not applicable, since such right was not covered by any of the assets specified in section 55(2) (a).

Therefore, the Corpus received by the Society from the developer was not chargeable to tax under section 45.

Corpus Money received by the Society from the Developer and subsequently distributed to its members.

Whether such income, if taxable, shall be treated as Capital Gains or deemed to be income earned in the year of receipt.

Corpus fund is a lump sum amount paid by the builder via the Society to the unit holder is in form of hardship compensation. It is a well settled principal in Income Tax Law that the capital receipts are not liable to tax. So, the question arises as to whether this compensation received will be treated as Capital receipt or Revenue Receipt in the hands of the Unit Holder? There are many Judgments stating that such receipt would not be taxable in the hands of the flat owner and the amount received would be reduced from the cost of acquisition, whenever the occasion to compute the capital gain would arise in future upon sale of redeveloped flat arises. Hence, Corpus fund received is reduced from the cost at the time of computing capital gains (when redeveloped flat is eventually sold) and not taxed at the time of receipt from the Builder.

Liability of Income Tax on interest income arising from investment of such Corpus Money by the Society

If the Society receives interest income by investing the Corpus received from the Builders from a bank then the same will be dealt with as per Section 80P (2). Interest Earned by Investing Surplus Funds (including Corpus or General Reserve) would fall in to category of “Taxable” Income based on the judgment of Citizens Co Operative Society. This matter has seen many litigations but it would be wise to consider Interest Income as taxable in the hands of Society.

Liability of Income Tax, if any, on individual members for any asset other than immovable property that are sometimes included by Developers in the new premises on a complimentary basis

Property other than immovable property which are not attached to the walls of the flat and exceeds 50,000/- in value in totality are not treated as a part of the Flat and are thus taxable in the hands of the Individual Members in the year of receipt of such amenities u/s. 56(2) (vii) of the Income Tax Act, 1961, if property is covered under section.

Reimbursement of certain Expenses from Developer

Such expenses are Stamp Duty, Fees of Consultants (Architect, Lawyers, Chartered Accountants, etc.) cost of updating members and holding General Body meetings, Administrative Expenses towards the Redevelopment Process, etc. incurred/ to be incurred.

Any amount which is reimbursed by the Developer is not taxable either in the hands of the Society or the Individual Members, provided that the entire amount of reimbursement is spent on the expenses it is reimbursed for. Thus, if excess amount is reimbursed by the Developer than the amount which is actually spent for the purpose, than the excess amount would be taxable on the receipt of the same as Income from Other sources.

Liquidation & Disbursement of Existing Sinking Fund

Sinking Fund is to be used on the property itself either for the purpose of development or major or structural Repairs. However, if the Registrar gives permission then the Sinking Fund could be distributed amongst the Individual Members which again has a number of restrictions in MCS Act, itself. This distribution of Sinking Fund after the permission of the Registrar would not be taxable in the hands of the Individual Members as it is a Capital Receipt.

TDS on payment by Builders to flat owners such as Corpus Money, Allowances, Compensations, Reimbursement of Fees of Consultants and other Expenses, Rent for Temporary Alternative Accommodation and Deposits or any other form of receipt in the hands of the Society/ its individual members.

As per the Income Tax Act, 1961, no TDS is to be deducted on the amount reimbursed by the Developer to the Society or the Individual Members or on other items such as Corpus Money, Allowances, Compensations, Reimbursement of Fees of Consultants and other Expenses, Rent for Temporary Alternative Accommodation and Deposits or any other form of receipt as Section 194 has not contemplated this.

Responsibility/ Liability towards stamp duty

Responsibility/Liability of the Society/its individual members towards Stamp Duty, if any, in transition from surrender of existing premises to the Developer to the occupation and registration of the Redeveloped premises

Normally, in the cases of Redevelopment, the Stamp Duty and the Registration Charges on surrender of the existing premises to the Developer for the purpose of Redevelopment would be paid by the Developer. Whereas, when the Individual Members receives the Redeveloped Premises from the Developer, he is liable to pay Stamp Duty and Registration Charges on the same. The Stamp Duty payable would be on the cost of construction of the present area of the Premises and on the market value for the extra area received as per the Ready Reckoner Value.

Restructuring of Society post Redevelopment

Post Redevelopment, existing members would continue to be member with Share Capital of Rs.500 (10 shares of Rs.50/- each) and new members has to contribute similar amount plus admission fees of Rs.100/- each to become member of Society. Existing Society will continue as Land title is still in the name Society in government records and there is no need to form new Society. Prior to restructuring, the Society, would have distributed its funds amongst old members with the permission of Registrar and thus both set of members begin on the same footing.

Conclusions

Tax litigation in respect to Redevelopment is an emerging area and the matter has not reached finality at Supreme Court, which can take decades and until then there is hanging sword on Society & members as regards Capital Gain taxes and Corpus. For this, it is advisable to consult experts like Advocates, Solicitors, Chartered Accountants and get suitable advise including modifying the agreements or taking precaution in drafting the agreement so as to cover themselves.



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