JULY 13, 2009

Govt seeks to retrospectively withdraw tax breaks for realty developers

By S Sivakumar, CA

WITH the initial euphoria (or the lack of it) created by the Budget having settled down, it is time for serious business in terms of an in-depth analysis of the Budget provisions.

I am shocked to see a lot of income tax issues impacting the Realty Sector in a very big way, especially in terms of the draconian retrospective amendments to Section 80-IA and 80-IB of the Income tax Act.

++ As is known, Section 80-IB deals with 100% exemption of eligible housing projects approved on or before March 31, 2007, while Section 80-IA provides exemption in respect of profits to Developers from new industrial parks, Special Economic Zones, specified infrastructural projects, etc. These two Sections provide very major tax benefits for the Realty Developers and Builders. In the initial years of these Sections, many of us had interpreted the Sections to mean that the tax exemption would be available to both the Developers as well as the Contractors who execute the construction contracts. The reasons are not far to seek. After all, this is an exemption provision aimed at giving tax sops the residential realty sector as an encouragement to get into new housing projects.

++ For reasons best known to itself, the Income tax Department would seem to be paranoid with this Section, in terms of the extension of the tax exemption benefit to the contractors, on the basis of an illusory belief that there is a double benefit in as much as, both the Developers and the Contractors were claiming the benefits. As a trained Accountant, I know for sure that it is impossible for a double benefit to be extended in respect of the same profits, as what the Developer claims is only his profits, which have been arrived at after deducting the profits of the Contractor as the bills of the Contractor are booked as expenses in the Developer’s Books.

++ The Finance Bill has proposed to include the following Explanations in Sections 80-IA and 80-IB, respectively, with retrospective effect from Financial Year 2000-01:

In Section 80-IA

"Proposed Explanation.—For the removal of doubts, it is hereby declared that nothing contained in this section shall apply in relation to a business referred to in sub-section (4) which is in the nature of a works contract awarded by any person (including the Central or State Government) and executed by the undertaking or enterprise referred to in sub-section (1).".

In Section 80-IB

"Proposed Explanation.—For the removal of doubts, it is hereby declared that nothing contained in this sub-section shall apply to any undertaking which executes the housing project as a works contract awarded by any person (including the Central or State Government).".

In terms of Section 80-IA, the above referred proposed Explanation will replace the existing Explanation, which reads as under, while under Section 80-IB, it would be a new insertion:

Existing Explanation.—For the removal of doubts, it is hereby declared that nothing contained in this section shall apply to a person who executes a works contract entered into with the undertaking or enterprise, as the case may be.

++ The existing Explanation, reproduced above, in Section 80-IA related to industrial parks, etc. was introduced through Finance Act, 2007, with retrospective effect from Financial Year 2000-01, and is clearly meant to deny the benefit of the exemption to contractors, who undertake the work for the Developers.

++ Now, not content with denying the tax benefits to the Contractors, the Government, by proposing draconian retrospective amendments, is seeking to deny the exemptions to the Developers themselves, as the new Explanations talk of ‘works contractors’ not being eligible to claim the benefits under Sections 80-IA and 80-IB. Most unfortunately, the term ‘works contract’ does not seem to have been defined under the Income tax Act and the Income tax Department is bound to interpret this term in a wide manner, so as to deny the tax benefits under Sections 80-IA and 80-IB, to Developers and Builders. Incidentally, the contracts entered into by Developers and Builders are treated as works contracts both for VAT as well as Service Tax purposes.

++ Some of my friends in the Realty Sector have seem to have unshakeable belief that the intention of the Government is not to deny the benefit to the Developers but only to the Contractors. I am not able to understand as to how this honourable intent has not got reflected in the proposed Explanations. The very fact that the Government is seeking the replace the existing Explanation under Section 80-IA which denies the tax benefit to Contractors, with a new Explanation, taking effect retrospectively with effect from Financial Year 2000-01, is proof of the fact that the Government is looking at beyond the Contractors.

The Housing Realty Sector is bound to get affected more, as compared to the Commercial Realty Sector, vis-a-vis these draconian proposals, as most of the contracts entered into by the Housing Developers can be treated as works contracts.

The tragedy for the housing sector does not end here, Sir.

++ The Government is also proposing the introduce the following amendments, fortunately, with prospective effect from April 1, 2010 to deny the tax benefit under Section 80-IB to residential projects in which more than one residential unit in the housing project is allotted to any person not being an individual and in cases where a residential unit in the housing project is allotted to a person being an individual, no other residential unit in such housing project is allotted to any of the following persons, namely:—

(i) the spouse or the minor children of such individual,

(ii) the Hindu undivided family in which such individual is the karta,

(iii) any person representing such individual, the spouse or the minor children of such individual or the Hindu undivided family in which such individual is the karta;"

I am amazed at the imagination of draftman here. How does it matter if some of the flats are bought by a corporate, for instance and why should the tax exemption be denied to the Developer on this count.

++ As regards the proposed amendments related to allotment of flats to spouses, etc., it is really crazy. Perhaps, the Government felt that the Housing Developers were circumventing the rules related to the maximum built up areas specified in Section 80-IB by allotting flats in the names of the spouses, etc. The dangerous word that is used here is ‘allotted’. Does it refer to the date of entering into the agreement or is the date of the actual allotment of the flats, which would mean the date of registration? If it were to be the latter, many Developers would lose the benefits of Section 80-IB, for sure, as it is common for families to book more than one flat, especially in cities like Bangalore, where both the husband and work for software companies. Despite that the tax exemption has been withdrawn for housing projects approved on or after April 1, 2007,  many of these projects are still running given the fact that Developers have four years to complete the projects, as per Section 89-IB.

Before parting ...

++ Some Tribunals including the Bombay Tribunal [in Patel Engineering Ltd vs. DCIT] have taken a view that the benefit under Section 80-IA cannot be denied to Contractors. These decisions resulted in the Government retrospectively amending Section 80-IA, so as to deny the tax benefit to Contractors.  But, now, even Section 80-IB is getting amended. The issue now is that, the denial of the tax exemption could get extended to the Developers and Builders also, considering the fact that, all works contracts are being denied the tax benefits.

++ If the non-renewal of the benefits under Section 80-IB came as a dampener for the Realty Sector, the new proposal, worded as it is, has come out of the blue, to haunt the sector, which is already down. If the intention indeed, of the Government, is to deny the tax benefits to the Contractors, the Explanation can be suitably worded to the existing one, in Section 80-IA, which leaves nobody with a doubt that the denial is for the Contractors and not for the Developers.

++ Despite Tribunal decisions, the Income tax Department has been denying the benefit under Section 80-IB for the whole project, even when the violation (for example, in the case of the built up area exceeding limit prescribed) is only in respect of a few units. Viewed in this perspective, the proposed amendment denying the exemption vis-a-vis allotment of flats to non-individuals and to members of the same family, is likely to be misused by the Department.

++ Not much discussion seems to have gone into these draconian retrospective amendments. The Realty Sector should rise from its slumber and lobby with the Government to ensure that, at least, the Developers are not denied the tax breaks under Sections 80-IA and 80-IB. The Explanations, as they are proposed, are bound to be used by the Income tax Department to deny the tax benefits for Developers and Builders, despite that the intention of the Government might be to deny the benefits only to the Contractors.

(The author is Director of S3 Solutions)