Taxability of Joint Development Agreements in India - analysis of Section 45(5A) of Income Tax Act, 1961 (‘the Act’)

Introduction to JDA

Under a typical JDA, a land owner provides his land and enters into an agreement with the developer for developing and constructing a real estate project at the costs incurred by developer. Thus, the land is provided by the owner of the land, and the developer incurs the cost/expenses of the development and construction of a property on the land provided by the owner. The developer also assumes the responsibility of obtaining necessary approvals, undertaking legal formalities, marketing the project, selling and registering the properties in the name of the buyers etc. In return, the owner may either receive a lump sum consideration or a certain share in the constructed property or a percentage of the revenue from the sale of such constructed property. The mode of consideration would purely depend on the commercial arrangement agreed upon between the parties. A JDA is a win-win for both the land owner and the developer. The land owner may not necessarily have the adequate resources to undertake a construction project, and the developer with the resources may not have a land to build upon. Thus, such JDAs ensure that the resources of land owners and developers are pooled together and create value for both parties.

Taxability of income arising from JDAs in India

The taxability of incomes arising in the hands of the owner and the developer in a JDA is discussed in the ensuing paragraphs.

Taxability in the hands of the owner of the land or building
JDA necessarily leads to the transfer of a capital asset by the owner of the land or building, and hence, capital gain taxation would become relevant. However, multiple questions could arise in such a case, for instance, when is the owner liable to pay the tax, i.e., the timing of payment? Whether mere entering/signing of a JDA would trigger the taxable event and lead to taxability in the hands of the owner? What is the amount of consideration which would be subject to tax etc. The computation of capital gain is a highly litigated subject matter, with the tax offices generally challenging the taxable event/point of taxation and determination of the taxable amount in the hands of the landowner. This discussion on taxability can further be categorised as the tax on JDAs entered till March 31, 2017, and JDAs entered after that.

Taxability of JDAs entered till March 31, 2017 (AY 2017-18):
Up till March 31, 2017, the capital gain arising in the hands of the owner was governed by section 45(1) of the Act, i.e., it was taxable in the year in which the transfer of capital assets took place. The definition of 'transfer' under the Act, interalia, includes any arrangement or transaction wherein the rights are handed over on execution of part performance of a contract. Such transfers are similar to the transfers which are referred to in section 53A of the Transfer of Property Act, 1882, even though the legal right has not been transferred. By virtue of this, mere execution of JDA between the owner and the developer triggered the tax liability under the head capital gains. Such gains were taxable in the hands of the owner in the year in which the JDA was entered into, and the possession of the immovable property was handed over to the developer.

It is to be noted that under a JDA, the owner would generally receive the consideration only in the future, once the project has been completed, which could take as long as 2-3 years. Therefore, the existing mechanism of taxation posed serious challenges to the owner, as he was expected to pay the capital gain tax at the time of entering into a JDA, while in reality, he never received any consideration at that point in time. The owner had to pay the taxes from his pocket in the absence of any real consideration, which caused a genuine hardship. Not just this, to add to the woes of the land owners, the tax offices typically invoked section 50D of the Act, which provided that the fair market value of the project, including land, as on the date of transfer, would be the deemed consideration for such transfer of capital asset. A fundamental flaw in such assumed/deemed consideration was that it completely disregarded that the projects under such JDAs generally take time to complete and are subject to fluctuation risks. Therefore, the fair market value as on the date of execution of JDA would never give an accurate picture and hence, cannot be justified. This provision of the Act, which existed till March 31, 2017, was unclear and led to several litigations.

Taxability of JDAs entered on or after April 01, 2017 (AY 2018-19 onwards):
In order to ease the genuine hardships faced by the owners, Finance Act, 2017 introduced section 45(5A) of the Act. As per this new provision, capital gains arising to individuals and HUF, by entering into a prescribed agreement for the development of a project, would be taxable in the year in which the designated authorities issue a certificate of completion for the whole or part of the project. In other words, this provision aims to defer the payment of capital gain taxes to that year in which a part or whole of the project is completed, as supported by a certificate. The owners would no longer be required to discharge the tax at the time of entering into a JDA, as was the case in the erstwhile provisions. Further, the provisions also explicitly laid down the consideration which would be subject to the tax, i.e. the stamp duty value (‘SDV’) of the land or building or both, pertaining to the owner’s share in the project, on the date of issue of said certificate, plus the consideration received in cash, if any, by the owner.

However, in a scenario where the owner transfers his share of the project before the said certificate is issued, the capital gains shall be taxable in the year in which the transfer takes place and the new provision under section 45(5A) would not be applicable. Consequently, the normal provisions under section 45, before the insertion of subsection 5A would only be applicable.

Thus, the key takeaways and certain nuances of the new section 45(5A) can be summarised as follows -

1. This section is applicable only to JDAs entered on or after April 01, 2017;
2. The section is applicable only where the JDA / specified agreement is registered;
3. Only individuals and HUFs, who are owners, can avail these beneficial provisions;
4. The owner treats the land or building as a capital asset and not as stock in trade;
5. For the purpose of consideration, the stamp duty as on the date of issue of the certificate is to be considered, and not as on the date of the transfer;
6. The owner should not transfer his share in the project before the completion of the project;
7. The section is not applicable where the entire consideration is received only in monetary terms/cash.

Let’s now understand the taxability by way of a simple illustration -

Taxability in the hands of the developer
In the developer’s case, the income arising from the sale of the completed project would be in the nature of business income. The property would constitute stock in trade for the developer. The sale proceeds received from the buyers of the developed project would be the income, and the expenditure incurred on the development of the project would be the cost.
Separately, section 194-IC was introduced by the Finance Act, 2017, which cast a liability on the developer in a JDA to deducted taxes by way of TDS on the monetary consideration paid to the land owner, in addition to the share in the project. The rate of tax on such payment would be 10% and 20%, where the PAN of the owner is not available. Further, the tax is deductible at the time of credit of such sum to the account of the owner or payment of the cash, whichever is earlier.