Understanding Redevelopment and likely Income Tax by A N Shanbhag

We have received the following query from one our valued readers. The answer is very interesting and is of general interest.

Query — Recently, our society went for redevelopment as the buildings had become very old. As per the development agreement, the society agreed for the developer to demolish existing buildings, load the TDR available with him, construct new flats, allot existing members new flats free of cost and sell additional flats in the open market.

 The developer in return agreed to give each member a new flat with higher carpet area, to pay each member a sum of ` Rs 36,00,000 as hardship compensation, payable in three equal installments over a period of 3 years and Rs 50,000 per month as rent compensation along with Rs 85,000 as shifting charges to a new premises. I have shifted to alternate place and am paying the rent from my pocket.

There have been two different views on these amounts received. One view is that these amounts are non-taxable as these are capital receipts. We were told that there are number of Mumbai tribunal rulings to this effect, but there are no clear-cut guidelines. The other view is that, one needs to compute capital gains in the case of such transactions and avail capital gains tax exemption u/s 54. I seek your help on how I should file my returns, particularly in respect of the amount of Rs 36 lakh which will be received in installments.

Our Reaction — The old flat is a sale (or transfer) to the builder for a consideration. In the normal parlance, a sale consists of simultaneous transfer of cash and an asset between two parties. In your case, you have received some cash and a right to possess a new flat sometime in near future. The value of this right cannot be quantified at this particular juncture. It will get crystallized when and only when the new flat comes into your possession. It is this aspect that is causing confusion and needs examination under a microscope.

The various amounts paid by the builder (other than the Rs 36 lakh) are definitely towards reimbursement you have incurred for surrendering your old flat to the builder and shifting to a new accommodation. Therefore these are not taxable. These expenses need not have been incurred by you had you continued to occupy your old flat which was owned by you. Reimbursement of expenses is not income and income tax is leviable only on income and capital gains; nothing else.

However, if you have saved any money by spending less amounts for shifting or paying rent, the balance amount becomes taxable. As a corollary, if you have spent higher amount, you can claim it as deduction.

The contentious issue is related only with the Rs 12 lakh/year paid to you by the builder. It is our considered opinion that this is a capital receipt and therefore, not eligible to any tax. Let us examine the logic behind our opinion which has also been endorsed by the tribunal in certain cases.

We strongly feel that the builder has bought your flat for  Rs 96 lakh. He sells the new flats, contemplated to be constructed and handed over to the buyer, including you, for a price of Rs60 lakh. At the first glance, it appears that this is a losing proposition, but a second glance makes you realise that his profit comes out of the flats he sells to persons who were not members of the housing society.  He is collecting  Rs 60 lakh in 3 installments of  Rs 20 lakh from everyone, including you. He owes you Rs 36 lakh (= 96 – 60), which, he is returning to you also in 3 installments. Therefore, you are getting Rs 12 lakh per installment. Consequently, the amount of Rs 12 lakh paid to you is capital receipt. This being non-taxable, you may declare this receipt in your returns as and when you receive the amount.

You may also depend upon the decision of Mumbai Income Tax Appellate Tribunal — Jethalal D Mehta v Dy CIT (2005) 2SOT422 and several others which announced that since the ‘hardship allowance’ has no cost of acquisition, it is not exigible to tax. This decision was based upon the famous SC decision in the case of CIT v B.C.Srinivasa Shetty 128ITR294 in which it was decided that where there is no cost of acquisition, there is no capital gain.

What if the Department disagrees with this view and desires to consider this amount taxable as capital gains? This amount can be considered to be subtraction from the cost of acquisition of the new flat or addition to the cost of acquisition. In both the cases, the amount of capital gains remains the same. In any case, whatever be the amount arrived at, it is exempt u/s 54.

There is yet one more important aspect we wish to deal with regarding your own computation of capital gains which turns out to be negative and therefore, you have ignored it. Kindly note that Sec. 71 allows such loss to be carried forward for 8 subsequent years and set off against capital gains, if any, earned during this period of 8 years. Consequently, it matters very little whether you treat this amount as capital receipts or capital gains. Bothe the approaches lead to the same destination.

Surely, the builder must have booked some flats to persons who were not members of your co-operative housing society. This value (market value) can be taken as your cost of acquisition, if and when you sell this new flat.

Incidentally, very recently, we came across a similar case where the developer had handed over a flat which was less by 30 square feet in size than what was contracted for. The developer agreed to pay a penalty for his mistake. We took the view that notionally, the purchaser had sold 30 sq square feet to the builder and therefore this amount received from the builder is chargeable to short-term capital gains. We are mentioning this situation to save you from approaching us once again in case you face similar situation.

To Sum

You have earned capital gains tax during the current year but are not liable to pay any tax since you are claiming exemption u/s 54. Normally, the value of redeveloped flats is so high that you will end up paying no tax. However, in the unlikely event of the value of the new flat happens to be lower than your indexed cost (less Rs. 36 lakh), you will have to pay tax on the difference at the rate applicable on long-term capital gains at the rate applicable to you, depending upon the tax zone you belong to.

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