SEPTEMBER 02, 2022

Dr Shrikant Kamat, Executive Director & CA Bhavin Shah, Partner,Bhuta Shah & Co. LLP

A lot has already been written and read on typical tax implications and tax issues arising from execution of a Joint Development Agreement (JDA) by a land owner with a developer or a builder. Even so, two issues - firstly, the applicability of Goods & Services Tax (GST) on the constructed saleable area or units by the developer to the land owner and secondly, the issue whether the landowner, not being an individual or a Hindu Undivided Family (HUF), is liable to capital gain tax immediately on execution of the JDA, have continued to rile tax experts, legal luminaries and real estate honchos into debating amongst themselves and with Tax Authorities. In this article, we would like to bring to the fore some deeper legal aspects associated with a JDA that may offer a glimmer of hope to the land owner son putting up a robust challenge to the taxability and on the time when the tax liability would devolve, if it has to, eventually.

GST on landowner's share of fully constructed units

In the recent Bhavani Developers Ruling - 2022-TIOL-101-AAR-GST, the Authority for Advance Ruling (AAR) has stated that "Section 2(31) of CGST Act 2017 defines "Consideration", in relation to the supply of goods or services or both, as any payment made or to be made, whether in money or otherwise. Since the applicant (Bhavani Developers) received the consideration in the form of development rights which is other than money, it qualifies to be "consideration", holds the said Ruling. Therefore, it states that the supply (of constructed units by the applicant) to the land owner is in the form of barter and the consideration is in the form of development rights and is in the course of furtherance of business. Hence the activity squarely falls under 'Supply "under CGST Act, 2017", states the said AAR. In a nutshell, the Authority stated that, "the applicant, a registered person, is supplying the construction service of building/civil structure to supplier of the development rights (the land owner) against consideration in the form of transfer of development rights."The Authority further clarified that "if the land owner further supplies such apartment to the buyers before issuance of completion certificate, he shall be liable to pay CGST & SGST on such supplies. However, the land owner shall be eligible for input tax credit of the taxes charged from him by developer."

In other words, as per this Ruling, since the Developer has received full consideration in the form of the rights under the JDA on its execution he is liable to discharge the GST liability in full also immediately on execution of the JDA, on the market value of the apartments/units to be handed over to the landowner in future if the land owner has to avail the ITC of such GST charged for payment of outward GST on the units sold by him to independent buyers at a later date.

What is the Controversy?

The interesting question of law that arises here is this: If the flats were constructed by the Developer for the land owner and hence if he has charged GST for "Construction Services" supplied to the land owner as per Notification No. 6/2019 dated 29.03.2019, is it legally tenable to hold that the land owner too shall charge GST to the ultimate buyers of his share of units for provision of "Construction Services" to these buyers. In other words, can the same service of construction of units be provided twice, once by the builder to the land owner and again by the land owner to his buyer and thereby taxed twice? This issue has not been dealt with in detail by any of the Advance Rulings issued thus far. In their defence, the Authorities may argue that in the first leg, the construction service is provided by the Developer to the land owner while in the second leg, the construction service is provided by the land owner to the ultimate buyer. So the service is not being provided by the same person or received by the same person and hence it can be taxed for both the legs. But does the construction service really get provided twice?

What does the current law state?

Section 7 defines the expression 'supply' which is the backbone of the entire framework of the GST Act. It is pertinent to note that the levy is on supply of goods or/and services. Section 7(IA) of the Act is a deeming provision by virtue of which certain activities or transactions are deemed to be either supply of goods or supply of services. These are more elaborately specified in Schedule II to the Act. At entry no. 5(b) of this instant Schedule the following is specified as a deemed supply of service:

"(5)(b) The following shall be treated as supply of services, namely -

Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration has been received after issuance of completion certificate, where required by the competent authority or after its first occupation, whichever is earlier."

A plain reading of this said entry reveals that the activity of construction that is deemed to be a service is intended for sale to a buyer. Given this clear language of law, the intent to deem construction by the Builder/Developer for the land owner as a service exigible to GST warrants questioning. A position can indeed be taken that had the law makers intended to bring this leg of the transaction of construction under the ambit of the levy, the deeming provision would have stated the same in as many words. However, such intent is conspicuously absent by virtue of the specific omission of the words "or the land owner promoter" after the words "to a buyer". Hence, it cannot be presumed that service of construction also includes service provided to the landowner. In fact, until the buyer is identified and a consequent Agreement with him is entered into either by the land owner or the Developer, no service can be said to have been provided.

In the words of Lord Wenslydale, "no subject is to be taxed without clear words for that purpose." In this regard, the salutary rule of interpretation laid down by the Hon. Supreme Court of India as early as in 1957 ¹ states that "If the Revenue satisfies the Court that the case falls strictly withing the four corners of the provisions of law, the subject can be taxed, otherwise, no tax can be imposed by inference or analogy or by trying to probe into the intentions of the legislature and by considering what was the substance of the matter."

It is also pertinent to note that Section 148 of the Act mentions about certain classes of persons that may be notified by the Central Government on the recommendations of the GST Council and the special procedure to be followed by such persons including those with regard to registration, furnishing of returns, payment of tax and administration of such persons. Nowhere does the Section 148 mention about charging a certain class of person with GST levy. Therefore, Section 148 merely enables prescription of a special procedure for a certain class of persons.

A notification (Notification No. 6/2019 - Central Tax (Rate) dated 29.03.2019) has been issued in this connection, under the impugned Section 148 and an attempt is made by Revenue thereunder to fasten GST liability on the Developer, so far as the supply of construction service by him against the consideration in the form of development rights or FSI is concerned. In other words, it is the impugned notification, a delegated legislation, which creates the GST liability on the Developer when the actual charging section or the deeming provision nowhere mentions any liability on the Developer for the units constructed for the land owner at the time of handing over these units to the land owner.

Can the Mohit Minerals decision help?

The recent SC decision in Mohit Minerals case ² may throw some light on this question and may offer hope to the beleaguered land owner. In that case, the challenge by the Tax Payer, to the GST levy on overseas ocean freight, was two fold - firstly, that the levy cannot be created on the basis of the delegated legislation (the Notification that imposed liability under reverse charge on the importer) and secondly, if service of overseas ocean freight has been manifested in the value of imported goods and taxed as a composite supply, the same service cannot again be made exigible to GST on the ground that there was a separate contract between the freight service provider and the importer which needs to be subjected to the GST levy. While the Apex Court rejected the Taxpayer (importer)'s first argument about delegated legislation, it upheld their contention regarding taxing the same service under two different aspects manifested in two separate contracts, one for supply of goods and another for supply of ocean freight service and thereby discarded the GST levy on overseas ocean freight

In the instant case too, while there is some similarity with the fact pattern of the Mohit Minerals (supra) case as regards imposition of the GST levy by way of a Notification (No. 6/2019) and existence of two distinct agreements, viz - the JDA between the Builder and the land owner and the Agreement for Sale between the land owner/builder and the ultimate buyer, the case as regards delegated legislation appears to be on a stronger footing for the land owner to contend that levy cannot be fastened by virtue of Notification No. 6/2019 which has been issued under Section 148 that is enacted merely to prescribe the class of persons and the procedure to be followed by such persons while the actual Entry No. 5(b) to Schedule II read with Section 7(IA) nowhere mentions the levy on the construction of units handed over to the land owner by the developer.

The Capital Gains Conundrum in Income Tax

Section 45(5A) of the Income Tax Act provides for taxability of capital gains arising to the land owner being Individual or HUF, in case of transfer of land or building or both to the developer under a JDA which is in the nature of 'specified agreement'. As per this section, Capital Gains shall be chargeable as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority. The said section in effect defers the charge ability of the capital gain till the completion of the project

Some of the key points dealt with under Section 45(5A) of the Act are -

- The provisions of Section 45(5A) of the Act are applicable only to an Individual or HUF. In case of assesses like Partnership, AOP, LLP, Companies etc. the issues arising as regards point of taxation in case of JDA still remain unresolved.

- The 'specified agreement' is a registered JDA in which one party is the owner of a land or building or both and another develops the real estate project on such land or building and consideration is payable in the form of a share in the developed land or building. Thus, the Section applies only to development agreement which are in the nature of area sharing agreement and not in the nature of revenue sharing agreement as per the definition of term "Specified Agreement" as provided in explanation (ii) of the Section 45(5A) of the Act.

- The land owner is required to pay tax on receipt of completion certificate irrespective of whether the property is sold or not. In case, if the property is not sold for a very long time then the land owner may end up paying tax on income not earned / received.

- The provisions of Section 45(5A) of the Act provide for deferment of capital gains tax till the issue of completion certificate by the Competent Authority, whereas the transfer of the Developer's share in land occurs on the date of executing the Specified Agreement. As the "transfer" takes place on the date of execution of the Specified Agreement, whether the time limit stipulated for taking deductions under sections 54EC/54/54F of the Act would commence from the date of entering into the Specified Agreement or date of issue of the completion certificate by the Competent Authority.

- One another aspect which needs to be considered is whether indexation will be given up to the date of Specified Agreement or to the date of completion certificate for the purposes of computing capital gains.

- Further, provisions of section 45(5A) of the Act provide that capital gains shall be chargeable as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the Competent Authority. It has been observed that in some cases, the certificate of completion of the project is issued after a considerable lapse of time from the actual completion and occupation of the project. In such cases, the question arises whether the liability to capital gains does not arise till such time that the completion certificate is issued by the Competent Authority. Further, it would be interesting to see as to what stand the Income Tax authorities would take in cases where no completion certificate is issued by the Competent Authority even after considerable time delays.

In the context of the provision under Section 45(5A) discussed above, it would be worthwhile to examine whether this provision is discriminatory to the extent that it creates a favourable position in law in respect of an exclusive class of persons (an individual assessee and a HUF assessee) to the detriment of other class of persons. On the subject, whether a taxing provision is discriminatory, contravenes Article 14 of the Constitution of India and hence liable to be struck down, a wide number of decisions have already explained the position in law established over the years by the Apex Court. It was held by their Lordships in  V. Venugopala Ravi Varma Rajah vs. Union of India, (1969) - 2002-TIOL-2546-SC-IT-LB at p.54 that, "Equal protection clause of the Constitution does not enjoin equal protection of the law as abstract propositions. Laws being the expression of legislative will intended to solve problems or to achieve definite objectives by specific remedies, absolute equality or uniformity of treatment is impossible of achievement. Again, tax laws are aimed at dealing with complex problem of infinite variety necessitating adjustment of several disparate elements. The courts accordingly admit, subject to adherence to the fundamental principles of the doctrine of equality a larger play to legislative discretion in the matter of classification. The power to classify may be exercised so as to adjust the system of taxation in all proper and reasonable ways; the legislature may select person, properties, transactions and objects, and apply different methods and even rates for tax if the legislature does so reasonably. Protection of the equality clause does not predicate a mathematically precise or logically complete or symmetrical classification: it is not a condition of the guarantee of equal protection that all transactions, properties, objects or persons of the same genus must be effected by it or none at all. If the classification is rational the legislature is free to choose objects of taxation, impose different rates, exempt classes of property from taxation, subject different classes of property to tax in different ways and adopt different modes of assessment. A taxing statute may contravene Article14 of the Constitution if it seeks to impose on the same class of property, persons, transactions or occupations similarly situate incidence of taxation, which leads to obvious inequality. A taxing statute is not, therefore, exposed to attack on the ground of discrimination merely because different rates of taxation are prescribed for different categories of persons, transactions, occupations or objects."

Also, in the case of  R.K. Garg v. Union of India  (1981) - 2002-TIOL-1706-SC-IT-CB the Apex Court held that, "every legislation, particularly in economic matters, is essentially empiric and it is based on experimentation. There may be possibilities of abuse but on that account alone it cannot be struck down as invalid. These can be set right by the legislature by passing amendments. The Court must, therefore, adjudge the constitutionality of such legislation by the generality of its provisions. Laws relating to economic activities should be viewed with greater latitude than laws touching civil rights such as freedom of speech, religion, etc. Moreover, there is a presumption in favour of the constitutionality of a statute and the burden is upon him who attacks it to show that there has been a clear transgression of the constitutional principles. The legislature understands and correctly appreciates the needs of its own people, its laws are directed to problems made manifest by experience and its discrimination is based on adequate grounds. There may be cases where the legislation can be condemned as arbitrary or irrational, hence, violative of  Article 14.  But the test in every case would be whether the provisions of the Act are arbitrary and irrational having regard to all the facts and circumstances of the case ."

In order to understand what could have been the basis adopted by the law makers to extend this provision only to individual and HUF assessees, the note on Income Tax clauses of the Finance Bill 2017 were also examined but there is not much mentioned over there too. The only basis one could assume to be behind insertion of this specific sub-section 5A in Section 45 could be that Individuals and HUF assessees could face more financial hardships as a result of cash outflow on account of capital gain tax payment if made immediately on signing of the JDA instead of in the year of receipt of the certificate of completion. However, there is no specific data or information that could authoritatively hold that other class of persons such as Companies, Partnership Firms, AOPs, etc. do not face financial hardships or face lesser financial hardships if capital gains are recorded in the year of execution of the JDA. Hence, a view could be taken that the benefit extended by sub-section 5A of Section 45 is discriminatory and violative of Article 14 of the Constitution.

With the insertion of section 45(5A) of the Act, the legislature has tried to address the issued faced by the taxpayer as regards the point of taxation of Capital Gains in the hands of the land owner. However, by restricting the benefit only to Individuals and HUFs, certain gaps/ issues still remain to be resolved as regards taxation of capital gains arising from the JDA for the landowner. One hopes that these should get settled through clarificatory amendments in the near future.

Conclusion

Delays in project completion, uncertainties in raising funds for the project and current burden of taxes and compliances have already taken a toll on India's Real Estate Sector. If tax provisions such as the provision under the GST Act and the Income Tax Act discussed above can be amended and interpreted in a way that is logical and reasonable and also offers some leeway to the land owner in managing his cash outflows, will certainly be welcomed and embraced whole heartedly by the fraternity. It is high time that the GST Council as well as the Parliament re-examines the current provisions discussed above and initiates amendments that could pave the way for a flourishing real estate industry.

[The views expressed are strictly personal.]

¹ AV Fernandez Vs. State of Kerala; - 2002-TIOL-436-SC-CT-CB

² Union of India Vs. Mohit Minerals Pvt.Ltd; 2022-TIOL-49-SC-GST-LB