Tax Insights
from India Tax & Regulatory Services
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Mumbai bench of Tribunal holds that transfer of development rights not taxable as capital gains, as
conditions attached to the transfer not fulfilled
June 8, 2020
In brief
Recently, the Mumbai bench of the Income-tax Appellate Tribunal (Tribunal)1 dismissed the Revenue’s appeal on the “transfer of development rights” to a joint venture (JV). Such transfer was held as not taxable owing to non-fulfilment of the obligations under the JV agreement, which was linked to disbursement of the agreed value. Although the receipt of part of the agreed value was upfront, it was conditional/ performance linked. Since the taxpayer was unable to fulfil its performance obligations, it was not obligated to recognise such receipt as income and pay tax thereon, under section 45 of the Income-tax Act, 1961 (the Act).
In detail
Facts
• The taxpayer, set up as a company, is a builder and developer. Through the unanimous resolution of members of six cooperative societies formed by certain slum dwellers, the taxpayer had obtained the
development rights to redevelop these properties.
• The taxpayer subsequently executed a JV agreement with an Indian real estate company (R Co.) in connection with the redevelopment of the property. As per the JV agreement, the taxpayer was to receive an amount
1
ITA No. 3251/ Mum/ 2018
on account of “development rights” from the JV and the transaction was to be funded entirely by R Co., being the other participant in the JV.
• Under this JV agreement, the taxpayer was to, inter alia, perform various obligations, including help in procuring and furnishing documents [e.g. Letter of Intent (LOI)/ Intimation of Approval (IOA)] to be filed before the Slum
Rehabilitation Authority (SRA), help in procuring resignation and NOC from architects in favour of the architect appointed by R Co.
•
The agreement provided the following paymentmilestone for the
consideration agreed to be paid to the taxpayer for
“development rights”:
- 16% of the total agreed consideration to be paid upfront at the time of entering into the JV agreement.
Subsequently, a Deed of Modification was executed to add a condition that the above payment was to be treated as an advance until at least 25% of the slum dwellers occupying the property vacate the premises. In case of non-
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fulfilment of this obligation by the taxpayer within five years, the entire money will have to be refunded to R Co. The taxpayer received this amount and accounted it as advance in its financial statements.
- 42% of the total agreed consideration was to be paid on obtaining the IOA and commencement certificate by the JV. The taxpayer did not receive this tranche.
- 42% of the total agreed consideration was to be paid upon all the slum dwellers vacating and shifting to alternate temporary transit accommodation. This tranche too was not received by the taxpayer.
• The assessment was originally completed at nil income.
Subsequently, the assessment was reopened by the Tax Officer (TO) on the basis of information received from the investigation wing of the income-tax department.
- The TO sought to tax the entire consideration amount in the relevant previous year, treating it as transfer under section 53A of the Transfer of Property Act, 1872.
- The TO emphasised that considering the taxpayer followed the mercantile method of accounting, the accrual of income does not depend on the receipt of income, and therefore, the income was earned when the transfer was complete,
2 Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC)
3
E D Sassoon & Co Limited v. CT [1954]
26 ITR 27 (SC)
i.e., in the relevant previous year.
• The Revenue also considered the Deed of Modification (which linked the conditions to the upfront payment by R Co.
to the taxpayer), which was submitted by the taxpayer during the end of the
assessment proceedings as an afterthought, and a colourable device fabricated for the purpose of tax evasion.
Key issue before the Tribunal Whether the agreed consideration had accrued to the taxpayer upon
“transfer of development rights,”
and thereby, whether the taxpayer was liable to offer this amount for taxation as income from capital gains?
Tribunal’s ruling
While holding that the income has not accrued to the taxpayer in the year of appeal, the Tribunal made the following key
observations:
• The payment received/ to be received by the taxpayer cannot be read in isolation to the obligations under the JV arrangement. The JV agreement is a composite agreement, and irrespective of whether the modifications are examined, all the terms of the JV agreement were to be read in conjunction with each other.
• When a taxpayer has an obligation to perform
something and does not fulfil those obligations nor does it seem to be in a position to perform such obligations, it cannot be said that a partial payment can be treated as
4 ACIT v. Mahindra Holiday Resorts Private Limited [2010] 3 ITR(T) 600 (Chennai)
5 CIT v. Shoorji Ballabhdas & Co [1962]
46 ITR 144 (SC)
income in the hands of the taxpayer.
• The Tribunal placed reliance on various judgements and made the following
observations:
- The Supreme Court’s decision2 highlights the
“Principle of conservatism,”
i.e., anticipated losses are to be accounted for, but anticipated profits are not accounted for until these profits arise.
- The Supreme Court’s decision3 highlights that until the obligations for the performance of which an amount is received, such receipt cannot have the character of income in the hands of the person who is still to perform such obligations.
- The Tribunal’s ruling4 highlights that even under the mercantile method of accounting, the relevant point of time is not the actual receipt of income but the point of time when the right to receive that income, in income character, is crystallised.
- Referring to the Supreme Court’s decision,5 which stated that “If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about
‘hypothetical income,’
which does not
materialise.” The Tribunal observed that, when obligations of the taxpayer are not yet performed, there cannot be any occasion to bring the consideration for
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performance of such obligations to tax.
• With regard to the Deed of Modification, the Tribunal observed that in any case, the TO cannot disregard the supplementary, or
modification—whichever way one terms it—agreement, only because the result is clear and unambiguous negation of tax liability in the hands of the taxpayer.
The takeaways
This is a welcome decision, in which the Tribunal has provided relaxation to a builder
and developer, transferring their
“development rights” to another JV partner, from taxability under section 45(1) of the Act when the obligations under the JV
agreement remain to be performed.
The Tribunal made some key observations, including on income accrual and the taxability of advance payments, which are subject to performance-linked conditions. The Tribunal has commented that even if the taxpayer has adopted the
mercantile method of accounting, it cannot be forced to account for a mere receipt of money as
income, if such receipt is subject to the performance of certain obligations.
The point of taxation is not the actual receipt but the point of time when the right to receive that income crystallises. The Tribunal observed that a receipt could not have the character of income in the hands of the person who is still to perform the
obligations for which an amount is received.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
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