Capital Gain Tax on Sale of Under-construction Flats

Introduction

In today’s time and error and specially in metros people have steadily started moving their residence to flats instead of row houses for the reason that flats are usually more affordable than individual row houses and also provide a sense of security as they are being accompanied by other occupants of flats of the very same society/project. This trend of moving towards flat system has also led to emergence of large builders and developers who specialize in building world class projects. This industry being a very capital intensive, builders also prefer to receive upfront payment to minimize their financial costs and also to ensure that their flats are sold at the earliest. To incentivise such upfront payment builders usually offer these amenities at a discounted price which has also leads to making it a very wonderful investment option for some.

Therefore, the sale of under construction flats is seen as a popular investment option in India. This is because under construction flats are usually sold at a lower price than ready-to-move-in flats. Additionally, the prices of under construction flats tend to appreciate over time, making them a good investment for those looking to make a profit. However, there are some risks associated with investing in under construction flats. One of the biggest risks is that the project may not be completed on time or at all. Additionally, the developer may default on the project, leaving investors with nothing.

Surge in purchase and sale of such under construction flats or properties have sparked a debate on its taxation under the Income Tax Act as there are multiple views of different experts on this issue. The issue might relate to the fact that what is being sold is neither a land or building and might be a right to obtain a particular land or building and therefore the period of holding might change accordingly. Further since the builder’s issue allotment letters at a different date and enter into an agreement for sale at a later date this also creates a confusion as to which date should be taken into consideration for the purpose of determining period of holding of the capital asset sold.

Legal provisions for determining whether the Capital Asset being sols is a Long Term Asset or a Short Term Asset-

Section 2(29AA)-

(29AA) “long-term capital asset” means a capital asset which is not a short-term capital asset ;

Section 2(42A)-

(42A) “short-term capital asset” means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer :

Provided also that in the case of a share of a company (not being a share listed in a recognised stock exchange in India) or an immovable property, being land or building or both, the provisions of this clause shall have effect as if for the words “thirty-six months”, the words “twenty-four months” had been substituted.

Analysis-

Now understand the case at hand with the help of an example. Let us say a person named Mr. Hanuman has been allotted a flat in an upcoming residential real estate project to be developed by a builder called M/s Ram Builders wide an allotment letter dated 1st January 2021. Now Mr. Hanuman wants to sell the flat which is still not completed and is under construction to Mr Krishna on 31st of March 2023. Important question that arises whether this transaction shall be considered long term or a short term one. This determination is very essential for the reason that short term capital gains are taxed as per the slab rate applicable to the person whereas long term capital gains get taxed at 20% and also the benefits of indexation are available only in cases of long term capital gain. Further the benefits of exemption under section 54 or 54F or section 54EC are also available only against gains of Long-Term nature.

The provisions for long-term and short-term capital assets are different for capital asset being land or building than from the rest of the herd. While for capital asset being land or building has a holding period of mere 2 years to qualify as a long-term capital asset, other assets would require a holding period of 3 years to qualify as a long-term capital asset. In our instant case since vide Allotment letter right to obtain has been provided in the to be constructed residential project it cannot be said that the capital asset being transferred is a land or building. For this very reason the nature of asset that Mr. Hanuman received is not a land or building but a right to obtain a land or building and therefore for it to be considered a long-term asset period of three years is required.

Further since the asset is not being considered as land or building the benefits of section 54 and section 54EC shall not be allowed even if the same is sold after a period of three years as what is being sold is neither a residential house property nor can it be called land or building. The only other option available to a person selling an under construction flats is to a wail exemption under section 54F.

Judicial Decisions for determining date from which period of holding is to be calculated-

The point of argument and debate between the taxpayer and the department on the issue of period of holding is whether the period of holding shall commence from the date an allotment letter has been issued to the taxpayer or from the date on which an Agreement of Sale has been entered into or from the date of actual receiving of possession of the flat.

The case in which holding period is considered as date of possession, there arises no point to argue. However, the argument arises when the holding period is considered as date of allotment. This involves considering judgements as pointed below, for better clarity and there are conflicting views related to the same:-

PCIT Vs. Vembu Vaidyanathan (Bombay High Court) [2019] 172 TAXLOK.COM (IT) 247 (BOM) – The assessee argued that the residential unit in question was acquired on the date on which the allotment letter was issued by the builder which was on 31st December, 2004. The Assessing Officer however contended that the transfer of the asset in favour of the assessee would be complete only on the date of agreement which was executed on 17th May, 2008.

Entire issue was clarified by the CBDT in its two circulars dated 15th October, 1986 and 16th December, 1993. In terms of such clarifications, the date of allotment would be the date on which the purchaser of a residential unit can be stated to have acquired the property.

In that view of the matter, CIT appeals of the Tribunal correctly held that the assessee had acquired the property in question on 31st December, 2004 on which the allotment letter was issued.

Then, the Bombay High Court, held in January 2019 that the date of allotment would be treated as the date of acquisition. The ITAT reiterated the same principles.

ACIT Vs Keyur Hemant Shah (ITAT Mumbai) [2019] 173 TAXLOK.COM (IT) 342 (ITAT-MUMBAI) – In the present case, Mumbai-based Keyur Hemant Shah had sold on April 4, 2012 a duplex apartment with 4 car parkings in a Cooperative Society in Mumbai for Rs. 12 crore, the assessee’s share being 50% in the same. After adjusting the indexed cost of acquisition, LTCG worked out to be Rs 288.73 lakh, and after claiming deduction u/s 54F for Rs 109.40 lakh against the same, the assessee (Shah) offered the balance LTCG of Rs 179.33 lakh to tax. The income tax officer, however, said that the very flat was purchased by Shah via a Registered Agreement for Sale on March 25, 2010 and his holding period was less than 36 months (before FY 2017-18 / AY 2018-19) from this date. That led the AO to treat the resultant gains as short term (STCG).

Shah, however, defended the same by submitting that the said flat was purchased via the allotment letter dated February 26, 2008 and substantial payment of Rs 185.50 lakh was already made by July 24, 2008. Thus, the holding period, as counted from the date of allotment letter, was more than 36 months and, therefore, the resultant gains should be considered as long-term capital gains.

Keeping all these things in view, the Mumbai bench of ITAT observed that the date of allotment will be treated as the date of acquisition.

Vinod Kumar Jain Vs CIT [2010] 122 TAXLOK.COM (IT) 477 (P&H) – In this judgement, the Punjab and Haryana High Court held that for flats allotted by the Delhi Development Authority (DDA), the holding period should be counted from the date of allotment letter. The Central Board of Direct Taxes (CBDT) also issued a circular (No. 471, dated 15th October 1986), where it has clarified that for flats under self-financing schemes of the DDA, the holding period shall begin from date of the allotment letter.

From the above reading it is crystal clear that the period of holding shall commence from the date an allotment letter has been issued. This provides a much needed and necessary relief in calculating the period of holding and also provides the benefit of lower taxation and an option to avail exemption by making specified investments in construction or purchase of property.