How Budget can affect tax on redevelopment

Budget 2017 has proposed changes in the tax laws that have significant impact on the taxation of the redevelopment process that is on in full swing in Mumbai. Currently, there is little clarity about the tax department’s view on the tax impact of redevelopment process. 

Let’s take a simplified representation of the redevelopment process to consider the various tax issues currently plaguing the redevelopment process:

The society decides to go in for redevelopment after it is approved by the members in a specific manner. The society appoints a developer and enters into an agreement with the developer for the redevelopment on pre-agreed terms and conditions. 

The redevelopment agreement is entered into by the society on behalf of its members as well as on its own behalf. In some cases, each individual member enters into an agreement with the developer instead of the society entering into an agreement with the developer.  

The developer pays consideration to the members or the society or to both. This consideration is paid at various points of time and for various reasons such as hardship compensation, compensation for displacement or rent payable by the owners, compensation for moving charges incurred by members, etc. 

The developer provides new flats to the member within a defined time frame as may be defined in the permanent alternative arrangement agreement that is entered into between the developer, member and the society. 

Today, there is plenty of confusion regarding the department’s view on the taxability of this arrangement. First, the department tries to tax both the Society and the members on each of these elements. The value of the new flats are also a matter of litigation. The year in which these amounts can be taxed is also under dispute. Of course, tax payers argue that none of the amounts are taxable because the compensation is in the nature of capital receipt and there is no cost of acquisition for the additional FSI that leads to the redevelopment in the first place. In short, it wont be wrong to say that where there is a redevelopment there is a tax dispute. 

The new Section 45(5A) proposed in the Budget does bring about some clarity but may end up creating much more litigation unless some things are clarified before it is finally enacted as law. 

The new section brings light to the year of taxation. The taxability will be in the year in which the completion certificate is issued. The sale consideration in respect of the new flat is also clarified as the stamp- duty valuation of the new flat as on the completion certificate date. It seems to imply that the members will be taxed but there are many grey areas especially where the members have not entered into individual agreements with the developer.

A new provision for deduction of tax at 10% of the cash consideration has also been proposed. 

The new section adds a lot of confusion especially because consequential amendments in other related provisions have not been made. For example, members claim exemption for the capital gains arising from the handing over of the old flat and obtaining the new flat under Section 54 thus paying no capital gains tax at all in respect of the value of the new flat. Essentially, the capital gains is payable by the members, if at all, on the cash consideration received by them. 

This is now jeopardised. It is unlikely that the finance minister wants to tax the members in respect of the transfer of the old flat despite it being effectively exchanged for a more expensive new flat. Members can also claim exemption for the taxable cash consideration by investing in capital gain bonds. Now, the cash consideration will be taxable in the year of completion but the wordings of capital gain bonds exemption Section (54EC) requires the investment to be made within six months of transfer of the old house. Again, tax will be deducted in the year of payment of cash consideration but taxability of the amount will be in the year of completion. 

It is good that the finance minister has turned his attention to an area that can generate good revenue for the government which is currently mired in litigation. The only request is to do a thorough job so that all major litigation areas can be resolved.

Harsh Roongta is a CA and Sebi-registered investment advisor. Send your queries to personalfinance@dnaindia.net or tweet them to @AskHarshdna