Treatment of non refundable earnest money received

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Querist : Anonymous

Querist : Anonymous (Querist)

01 April 2013 I want to know about the tax treatment of the Non-refundable Earnest money received by the land owner from the land developer after execution of the land collaboration agreement & the flats/township is expected to be completed in 2015 end. Is it a capital gain to be deposited in the capital gain account or is there any restrictions on its Utilization. How can it be dealt with & what are the consequences if it is utilized in contradiction with the law. please suggest me with your superb advice?

Also suggest me any book regarding this?

C A S.S.Agarwal, M.Com.,LL.B,

C A S.S.Agarwal, M.Com.,LL.B, (Expert)
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23 May 2013 The moment you have signed a development agreement the provisions of Capital Gains will come into force and non refundable EM is to be treated as part of the consideration. You have calculate CG tax as the case may be LTCG or STCG and accordingly you have to pay the tax. Now, if the builder gives you the flats then you can take the help of Section 54F but to the extant of how many flat?

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Querist : Anonymous

Querist : Anonymous (Querist)

23 May 2013 But Sir how can we calculate the capital gain as the sale consideration is not defined and the purchase consideration is also not clear as it was an ancestral property.

Isn't it a capital receipt therefore not taxable.

There is not a clear way to calculate the capital gain.

The whole tax issue will come into picture after the flats are alloted and put on sale after that.?

Aashok Kumar Sharma

Aashok Kumar Sharma (Expert)
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02 August 2025 Here’s a detailed breakdown of the **treatment of non-refundable earnest money (EM) received by a landowner under a land collaboration agreement**, from the income tax and accounting perspectives:

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### 1. **Nature of Non-Refundable Earnest Money**

* The **non-refundable earnest money** is part of the consideration for transfer of rights in the land.
* On execution of the development agreement, the landowner’s rights over the land are effectively transferred to the developer for future construction.
* This amount is **considered as capital receipt** and treated as part of **sale consideration** for capital gains computation.

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### 2. **Capital Gains Tax Implications**

* As per Income Tax Act, capital gains tax provisions **apply from the date of agreement**, even if the actual allotment of flats happens later.
* The **non-refundable earnest money forms part of the sale consideration**.
* **Capital Gain = Sale consideration (including earnest money) – Cost of acquisition (or WDV in case of depreciable asset).**
* If the property is ancestral and the cost of acquisition is unclear:

* You can claim **cost of acquisition as per section 49(1)** which allows use of the cost to the previous owner (ancestor) or fair market value as of 1 April 1981 (indexation benefits for long term).
* **If the agreement fixes sale price later, then capital gain will be computed on that basis.**
* Until possession or allotment of flats, the EM is taxable as capital gains (LTCG or STCG depending on holding period).

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### 3. **Capital Gain Account Scheme (CGAS)**

* If you intend to **claim exemption under Section 54/54F** (reinvestment in residential property or capital assets), then the capital gains amount (including EM) should be deposited into a **Capital Gain Account Scheme** before filing the income tax return.
* This allows you to claim exemption by investing in specified assets within the prescribed time.

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### 4. **Utilization of Capital Gain Account**

* The capital gain amount deposited in the CGAS **must be utilized strictly as per the provisions of the Income Tax Act**.
* Typically, it should be used to purchase or construct new residential property within the stipulated time frame.
* **Misuse or utilization for any other purpose can lead to withdrawal being treated as income and taxed accordingly.**

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### 5. **Accounting Treatment**

* The earnest money received should be recorded as **capital receipt** and disclosed appropriately.
* It should not be treated as revenue income or advance rent but as consideration towards transfer of asset.
* On allotment of flats, corresponding entries should reflect the exchange of assets.

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### 6. **Summary / Key Points**

| Aspect | Treatment |
| ------------------------------- | ------------------------------------------------------ |
| Nature of EM | Part of sale consideration |
| Taxability | Capital gains on EM amount on execution of agreement |
| Cost of acquisition (ancestral) | Use ancestral cost or FMV as of 01-04-1981 |
| Deposit of capital gains | In Capital Gain Account Scheme if claiming exemption |
| Utilization restrictions | Must be used as per IT Act for capital gains exemption |
| Consequences of misuse | Amount treated as income and taxed |

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### Suggested Books / References:

* **“Income Tax Act with Notes”** by Dr. Vinod K. Singhania & Dr. Kapil Singhania — detailed chapters on capital gains and exemptions.
* **“Taxmann’s Income Tax Law”** – for updated interpretations and case laws.
* **“Capital Gains Tax Guide”** by Taxmann or professional guides on property taxation.
* Consult **CBDT circulars and rulings** for case-specific clarifications.

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If you want, I can help draft the **journal entries** or a stepwise **capital gains computation** for your case too. Would you like that?

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