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Redevelopment compensation is not taxed

By Tinesh Bhasin
September 12, 2016 17:17 IST
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Cooperative societies get more tax benefits as compared to individual house owners.

Members of cooperative housing societies, going in for redevelopment, can stop worrying about the tax on the compensation developers pay them.

A recent judgment of the Mumbai Income Tax Appellate Tribunal (ITAT) clarifies how the different components of compensation should be taxed.

Property redevelopment is widespread in Mumbai. Developers are increasingly eyeing old housing societies in other big cities such as Delhi and Pune. Experts say the judgment can be used as a reference by house owners to plan their taxes.

“The judgment favours home owners and reinforces that compensation should not be taxed. The observations made in this landmark judgment also balance the expectations of home owners and the income tax (I-T) department,” says Arvind Rao, founder of Arvind Rao & Associates.

Housing societies: Hemal Mehta, partner at Deloitte Haskins & Sells, explains that when a society goes for redevelopment, a developer typically pays its members a fixed rent that takes care of accommodation until the project is completed and the owners also receive shifting charges, a small one-time payout.

With this, the realtor also creates a corpus fund for existing members, which takes care of the sudden increase in maintenance and other charges, post redevelopment. As the facilities in a project increase, so do the maintenance costs. In many cases, the corpus fund is distributed among the members. 

Rent and shifting charges: The rent that developers pay is an actual expenditure that the flat owner incurs while staying at an alternative accommodation and so it does not attract tax.

However, if the compensation for rent paid by the developer is more than the actual rent incurred by the assessee, the difference will be subjected to tax. Say, a developer pays an annual rent compensation of Rs 3 lakh.

But, the home owner stays at a house where he pays annual rent of Rs 2.4 lakh. The Rs 60,000 difference will be added to the home owner’s income and taxed according to the applicable slab. Shifting charges are tax-free.

Corpus fund: Taxation of this component has been the biggest bone of contention between I-T officials and assessees.

“The I-T department has been sending notices to members of societies that distributed the corpus fund,” says Neeraj Agarwala, partner at Nangia & Co. Assessing officers considered it a share of the profit that the developer earned and asked for relevant tax on it. But, the ITAT ruled this was paid for hardship caused to the assessee because of his house undergoing redevelopment and, therefore, should not be taxed. 

For taxation purposes, this money is considered to have reduced the cost of acquisition of the flat, and needs to be adjusted when the house is sold. This means the seller will end up paying higher taxes when he sells the house.

Say, an individual had bought a flat for Rs 30 lakh, which undergoes redevelopment. He receives Rs 50 lakh from the corpus fund, and after construction, sells the house for Rs 1.5 crore. The gain, difference between buying and selling price, is Rs 1.2 crore. But, I-T laws allow the owner to arrive at the real cost of acquisition after taking inflation into consideration. Say, this indexed cost of acquisition comes to Rs 60 lakh. The capital gains, therefore, come to Rs 90 lakh (Rs 1.5 crore less Rs 60 lakh).

According to the ruling of the ITAT, the hardship allowance should be deducted from the indexed cost (Rs 60 lakh less Rs 50 lakh) of the property to arrive at the gains. The cost of acquisition of the property will, therefore, reduce by only Rs 10 lakh, and capital gains will be calculated on Rs 1.4 lakh. 

Not a housing society? “The taxation of other properties depends on the structure of the agreements that developers have with owners,” says Kuldip Kumar, partner and leader (personal tax), PwC.

In a standalone property like a bungalow, for example, the two parties execute a joint development agreement.

Here, the taxation will depend on the character of the asset in the hands of the owner. If the owner is in the business of letting out properties and shows it as stock in trade while filing returns, any kind of compensation will be treated as business income.

If not, the compensation (be it house/s, cash, mix of both or share in profit) will be taxable in the hands of the owner as capital gains.

In the case of properties that come under the Rent Control Act, the tenants transfer tenancy rights.

This means, they are willing leave the property. “In such cases, compensation of any kind is treated as a capital receipt and the receiver needs to pay capital gains tax it,” Agarwala says.

Relief for taxpayers

  • An I-T officer demanded tax from an assessee on a corpus fund of Rs 22 lakh and rent of Rs 8.56 lakh received as compensation after his society went for redevelopment
  • The officer contested the corpus fund is a share in developer’s profits
  • The tribunal ruled the nature of payment in the hands of payer (developer) could not determine the nature in the hands of recipient (assessee).
  • The money was paid for hardship caused to assessee on redevelopment and, hence, was not taxable
  • The corpus fund reduces the cost of acquisition and, therefore, will be taken into account while computing capital gains on transfer

Photograph: Reuters

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