An analysis of Section 45(5A) of the Income Tax Act

Introduction & Brief History

Section 45 of the Income Tax Act, 1961 ('Act') is the charging section of the income chargeable under the head 'Capital Gains'. In the ordinary course, a transaction is subject to capital gain in the year of transfer of the capital asset. In the case of the Joint Development Agreement ('JDA') or Specified Agreement ('SA') where the capital asset being land, building, or both have been transferred to the developer, such transaction is taxable in the year of transfer. There was a significant time gap between the year in which the transfer took place and the year in which the consideration is received. Thereby, the owner of the capital asset faced difficulties in payment of taxes.

To minimise the hardship to the assessees, the amendment was bought up to insert section 45(5A) in the Act.

• Analysis of the main provision of Section 45(5A) of the Act

• Applicability: The section applies to the assessee being an individual or HUF on the transfer of the capital asset being land or building or both. The residential status of the assessee has no bearing on the section therefore, the section is applicable on both residents as well as non-residents transferors.

It is a prerequisite condition that the transfer should take place. If in a transaction, transfer of the capital asset is not regarded as transfer, section 45(5A) shall not apply.

Issue 1: Whether transfer of interest such as leasehold rights, tenancy rights, etc. in the capital asset being land or building or both will suffice for the applicability? No, in case of transfer of an interest in capital asset being land or building or both, this section does not apply.

Issue 2: If a capital asset is co-owned by an individual and a corporate entity, can the provision to this section apply? There are divergent views on this issue. It would be prudent to apply this section proportionately to the share of individual assessee in the capital asset.

• Specified Agreement: To transfer the capital asset being land or building or both by the owner of such an asset to the developer, it is mandatory to enter into a specified agreement. The agreement must be registered with the state authorities. By way of such agreement, the owner of the capital asset, being land or building or both, agree to allow other person to develop a real estate project on such land or building or both.

• Year of Taxability: The capital gain shall be chargeable to tax as income of the previous year in which the certificate of completion has been issued by the competent authority.

Issue 3: If the certificate of completion has been issued for part of the project when will be the tax incidence of the capital gains? The answer to the question depends on the facts of the case. If the development has been carried out in separate phases, then the proportionate capital gain shall be taxable in the year of issue of part completion certificate. Otherwise, the whole of the capital gain shall be taxable in the year of the issue of part completion certificate.

Issue 4: If the competent authority issues the completion certificate at a much later date when capital gain be taxable? Since the competent authority is the government organisation, the assessee may face instances where the stamp duty value has upward revalued between the date of filing application for issuance of completion certificate and the actual date of issue of completion certificate. In such cases, the assessee can offer the capital gains to tax in the year of filing full/complete application for issuance of completion certificate.

Issue 5: Some of the states don't issue completion certificate, instead issue occupancy certificate, will the provisions of section 45(5A) of the Act defer the taxability to an indefinite period? No, instead of the year of issuance of the completion certificate, year of issuance of occupancy certificate shall be the year of taxability of capital gains.

• Year of Transfer: The provisions of section 45(5A) of the Act only deals with the year of taxability and the full value of consideration. For the purpose of year of transfer, recourse to section 2(47) shall be made.

• Full value of consideration: The full value of consideration, of the capital asset being land or building or both, transferred for the purpose of entering into JDA, shall be stamp duty value on the date of issue of completion certificate of the incoming developed capital asset along with the consideration received in cash (if any).

Issue 6: Can an arrangement be made where 90% of the consideration constitute cash component? The language used by the statute is 'the consideration received in cash, if any'. The reasonable construction of the provisions and the intention of the legislature states that the consideration received in cash is ancillary to the stamp duty value of the incoming developed capital asset. Therefore, it can be opined that the cash component should not exceed the stamp duty value of the incoming developed capital asset.

• Benefit of Indexation: The benefit of indexation is available in case of transfer of the long-term capital asset, except capital asset being bonds or debentures (with exceptions). The benefit of indexation is available up to the year of transfer.

Issue 7: Since there is a difference in the year of computing full value of consideration and the year up to which the benefit of indexation is available, isn't that would create hardship to the assessee? Ideally, the benefit of indexation is available up to the year of transfer. There are several instances under the Act wherein the year of transfer differs from the year of taxability. In most of the instances, the year for computing the full value of consideration and the year for the benefit of indexation of cost of capital asset, is the same i,e., the year of transfer. Under the provisions of section 45(5A) of the Act, the inflation during the period between year of transfer and year of taxability is ignored, leading to the genuine hardship to the assessee.

• Analysis of the proviso to section 45(5A) of the Act

The proviso to section 45(5A) of the Act provides that the benefits of this section will not be available in case the assessee transfer his share in the project before the issuance of completion certificate. In this case, the capital gains will be deemed to be the income of the previous year in which the assessee transfer its share in the project.

Issue 8: In a case where part of the share in the project is transferred before the issuance of the completion certificate, will the proviso apply? In such a case, the proviso shall apply and the benefits of this section shall not be applicable.

Issue 9: How the full value of consideration of the original asset will be determined, wherein the proviso is applicable? The full value of consideration shall be determined by comparing actual consideration with stamp duty value. If actual consideration is indeterminable, the fair market value of the original asset shall be the full value of consideration.