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Finance bill 2014 has proposed to enhance the area of section 51, Forfeiture of advance money received in process of transferring a capital asset. The modification will elevate tax collection and is therefore to the benefit of the Revenue Department. It also helps them to receive tax at an early stage.

Scope widened by Finance bill:

Finance bill 2014 has expanded the outlook of the Section 51 of Income Tax Act 1961, through the medium of Section 56(2) (ix) of the said section which is quoted below:

In section 51 of the Income-tax Act, the following proviso shall be inserted with effect from the 1st day of April, 2015, namely:—

“Provided that where any sum of money, received as an advance or otherwise in the course of negotiations for transfer of a capital asset, has been included in the total income of the assessee for any previous year in accordance with the provisions of clause (ix) of sub-section (2) of section 56,then, such sum shall not be deducted from the cost for which the asset was acquired or the written down value or the fair market value, as the case may be, in computing the cost of acquisition.”.

Consequently, in section 56 of the Income-tax Act, in sub-section (2), after clause (viii), the following clause shall be inserted with effect from the 1st day of April, 2015, namely:—

“(ix) any sum of money received as an advance or otherwise in the course of negotiations for transfer of a capital asset, if,––

(a) such sum is forfeited; and
(b) the negotiations do not result in transfer of such capital asset.”.

For the purpose of this section Capital Asset will be taken as defined in section 2(14).

Date of Applicability:

These amendments will take effect from assessment year commencing on the 1st day of April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

ANALYZING THE EXISTING PROVISION WITH NEW PROVISION

Existing Provision:

As per Section 51 of the Income Tax Act, 1961, if the owner of an asset has received advance money or other money by forfeiting the said amount relating to the asset, this amount will be deducted from the;

a. the written down value in case of depreciable assets, or

b. the cost of acquisition of the asset, or

c. the fair market value of the asset that will be taken as cost of acquisition as on 01.04.1981, if the asset was purchased before 01.04.1981 as the case may be, in computing the cost of acquisition.

Here, other money received includes

a. any earnest money received for guaranteeing the performance of the contract and not forming part of sales consideration.

b. any advance amount received under an agreement to sell & subsequently purchaser failed to pay balance amount as per agreement.

Brief Illustration

As per old provision:

An Agreement for Sale of property on 29.11.2014 for a total consideration of Rs.70,00,000/- to be paid on or before 5.3.2015 and, towards earnest money, an amount of Rs.4,00,000/- was paid on 29.11.2014 and another Rs.3,00,000/-on 30.11.2014, that means, altogether Rs.7,00,000/- was paid, being 10% of the total sale consideration. The purchaser, however, could not pay the balance amount of Rs.63,00,000/- before 5.3.2015, consequently, the sale deed could not be executed. Seller, therefore, did not return the earnest money to the purchaser. The same property was purchased by the assesse in Sept,2010 for Rs.50,00,000/-. Compute taxable income for assessment year 2015-16.

Answer:

In the present case, 10% of advance money forfeited will be reduced from the cost of acquisition i.e. Rs.50,00,000/- which in turns reduce the cost of acquisition to Rs.43,00,000/-

New Proposal:

Where any capital asset was on any previous occasion, the subject matter of negotiation for its transfer and any advance money or other money received is Forfeited by the assessee, then the amount so forfeited shall be taxable as Income from other sources under sec-56(2)(ix).

Here, other money received includes

a. any earnest money received for guaranteeing the performance of the contract and not forming part of sales consideration.

b. any advance amount received under an agreement to sell & subsequently   purchaser failed to pay balance amount as per agreement.

Illustration with same facts –

As per new provision:

An Agreement for Sale of property on 29.11.2014 for a total consideration of Rs.70,00,000/- to be paid on or before 5.3.2015 and, towards earnest money, an amount of Rs.4,00,000/- was paid on 29.11.2014 and another Rs.3,00,000/-on 30.11.2014, that means, altogether Rs.7,00,000/- was paid, being 10% of the total sale consideration. The purchaser, however, could not pay the balance amount of Rs.63,00,000/- before 5.3.2015, consequently, the sale deed could not be executed. Seller, therefore, did not return the earnest money to the purchaser. The same property was purchased by the assesse in Sept, 2010 for Rs.50,00,000/-. Compute taxable income for assessment year 2015-16.

Answer:

In the present case, 10% of advance money forfeited i.e. Rs.7,00,000/- will be taxable as income from other source under section-56(2)(ix) for the assessment year 2015-16.

Tax impact on buyer:

i. Forfeiture of earnest money by the vendor if due to default on the part of vendee, will not amount to relinquishment of a right in that asset. Therefore the amount forfeited will not be allowed as a capital loss under the head capital gains as uprooted in CIT vs. Sterling Investment Corporation Ltd (1980) 123 ITR 441.

ii. However, if the seller fails to honor the deal and pays the buyer double the compensation, this will be treated as capital gain because it amounts to relinquishment of a right by the buyer.

iii. Does advance money for the purchase of a commercial property be treated as business expenditure incurred by the buyer?

iv. No, the amount cannot be claimed as revenue expenditure. In CIT vs. Jaipur Mineral Develop Syndicate (1995) 216 ITR 469 (Raj), it was held that if the payment is made for the purpose of acquiring a capital asset, the amount lost upon forfeiture will not be considered as revenue loss though the amount may not have the same consequence or character in the hands of the recipient or beneficiary. 

Tax impact on seller:

The seller must know that this is a one-way street. If he rescind the deal and paid the buyer Rs 2 lakh as compensation, it would be treated as a capital loss and not added to the purchase price of the property. Seller can claim tax benefit on this only if he was in the business of sale and purchase of the property. In such a case, the loss due to forfeiture would be treated as a revenue loss.

Whereas, in case the buyer defaults and the earnest money is forfeited, then it will be taxable as income from other source.  

Effect of Amendment:

The case of Travancore Rubber & Tea Co. Ltd. v. C.I.T [2000} 243 ITR158 {SUPREME COURT} is quashed by finance act 2014 with effect from assessment year 2015-16 & onwards. 

In which it was held that, the advance money forfeited, by the seller of capital asset, shall be reduced from the cost of the assets and if the advance money forfeited, exceeds the cost of acquisition then the excess shall be a Capital Receipt not taxable.

But, the same has now been annulled by the finance act 2014; the amount forfeited would be taxed as income from other source under section- 56, and subsequently no question arise for capital receipt not taxable.

For Instance: Mr. X purchased an asset on 01.01.2004 for Rs.5, 00,000. He entered in to an agreement to sell the asset on 31.07.2014 and received Rs. 7,50,000 as earnest money. The sale did not materialize and he forfeited Rs. 7,50,000 on 15.08.2014.
 

Now as per section 51, the forfeited amount on capital asset will be taxed as income from other source. Here the above mentioned case was nullified by the amendment made in finance act 2014.

The excess amount of money forfeited over and above the cost of acquisition which is capital Receipt not being taxed as upheld in judgment supreme court in Travancore Rubber & Tea Co. Ltd. v. C.I.T [2000}   is now taxable in the Financial year of receipt of money of advance which pertains to forfeited amount.

Where in case the cost of acquisition of asset is more than the forfeited amount of money, then the said amount is taxable in the year of receipt of forfeited money under the head income from other source as against existing provision which leads to delay in taxation of forfeited amount, as the same is taxable in the year of sale of capital asset.

Conclusion:-

In case the advance money received in course of negotiation for transfer of capital asset but the negotiations does not results in the transfer of such capital asset, accordingly the amount is forfeited, then as per amendment by finance act 2014 it would be chargeable to tax as income from other sources under section 56(2) (ix) in the income of receiver of advance money.

Corresponding amendment to section 51 has been done so that such advance is not deducted from acquisition cost/ FMV/WDV as the case may be.

Written By: Riddhi Vasistha

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