Domestic Transfer Pricing in India : An Analysis

Domestic Transfer Pricing in India

After the grand success of International Transfer pricing, through which huge transfer pricing orders slapped on companies with cross-border operations in the financial year 2011-12, Hon’ble Finance Minister has cast his net wider and deeper for the next one by including “Specified Domestic Transactions” in the purview of Transfer Pricing (TP). Out of 100+ amendments in the Finance Act 2012 by overruling 100+ case decisions, the provisions related to Domestic Transfer Pricing seems to be the one which had been brought in the statute after considering instructions / suggestions of the Supreme Court (SC). The other reason for implementing the same may be hidden in the statistics.

Origin of Domestic Transfer Pricing (DTP) law in India:

While dealing with the issue that, whether the assessee company and its service provider are related companies in terms of Section 40A(2), Hon’ble SC in CIT vs. GlaxoSmithKline Asia (p) Ltd. (SLP 18121/2007) had observed “The larger issue is whether Transfer Pricing Regulations should be limited to cross-border transactions or whether the Transfer Pricing Regulations to be extended to domestic transactions. In domestic transactions, the under-invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature, except in two circumstances having tax arbitrage such as where one of the related entities is (i) loss making or (ii) liable to pay tax at a lower rate and the profits are shifted to such entity. The CBDT should examine whether Transfer Pricing Regulations can be applied to domestic transactions between related parties u/s 40A(2) by making amendments to the Act.  The AO can be empowered to make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties and can apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing Regulations.”

SC further mentioned “Though the Court normally does not make recommendations or suggestions, in order to reduce litigation occurring in complicated matters, the question of extending Transfer Pricing regulations to domestic transactions require expeditious consideration by the Ministry of Finance and the CBDT may also consider issuing appropriate instructions in that regard.”  

These remarks of the SC has laid the foundation for Domestic Transfer Pricing (DTP) law in India. The same is also acknowledged in the memorandum explaining the Finance Bill 2012.   

Interesting Statistics of Transfer Pricing (TP) regime in India:

For understanding the magnitude of the topic, it is important to refer interesting statistics of TP regime in India. TP provisions were introduced in India by the Finance Act 2001 (w.e.f. AY 2002-03) and 8 TP assessments i.e. assessment of AY 2002-03 to AY 2009-10 had been concluded. As per the available data, aggregate adjustments of INR 1,70,000 crores (USD 32 billion, approximately) had been made by the TPO’s in these eight years, out of which apx adjustments of INR 45,000 crores & INR 70,000 crores had been made in last 2 assessment years i.e. in A.Y. 2008-09 & A.Y. 2009-10. (Source: Business standard/ The Hindu-Business Line/ The Financial Express).

Interestingly AY 2008-09 was one of the best years in terms of outbound Mergers & Acquisition (M & A) deals in India. According to Bloomberg data, Indian companies had acquired assets abroad worth USD 20 billion in 302 deals. When I go through the statistics above,  I wonder  whether the record Transfer Pricing Adjustments were only an aggressive move on the part of an over enthusiastic department or justified in the wake of global norms? However, various Tribunal / High court orders pronounced in last couple of years have given the answer wherein the magnitude of these adjustments has been significantly reduced.

Category of Transactions covered under Domestic Transfer Pricing net:

As per the newly-inserted section 92BA of the IT Act, “Specified Domestic Transaction” in case of an assessee means any of the following transactions (the aggregate of which exceeds INR 5 crore in previous year and which is not an international transaction), namely:—

(1) any expenditure incurred between related parties referred to in section 40A(2)(b);

(2) any transaction referred to in section 80A;

(3) any transfer of goods or services referred to in  section 80-IA(8);

(4) any business transacted between the assessee and other person as referred to in section 80-IA(10);

(5) any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which section 80-IA(8) or section 80-IA(10) are applicable; or

(6) any other transaction as may be prescribed,

If a transaction is an International Transaction, then the same will not be a Specified Domestic Transaction.

Aggregate of Transactions should exceed INR 5 crore:

TP provisions will not be applicable, if aggregate of transactions entered during the year does not exceeds INR 5 crore.

For e.g. - Rent payment of INR 2.5 crore has been made to a sister concern and a remuneration of INR 1.5 crore paid to Managing Director. In this case the aggregate of transaction is below INR 5 crore; hence TP provisions will not be applicable. Suppose Rent of INR 4 crore is paid to sister concern and MD’s Remuneration is INR 1.5 crore. Here the aggregate value of transactions will exceed INR 5 crore and both transactions will become Specified Domestic Transaction.

As per Section 92(2A), any allowance for an expenditure or interest or allocation of any cost or expenses or any income in relation to the Specified Domestic Transaction shall be computed having regard to the Arm’s Length Price. In the succeeding paras, different categories of transactions have been dealt in detail:

1.    Any ‘Expenditure’ incurred between related parties referred to in section 40A(2)(b)

Section 40A overrides the other provisions of IT Act related to computation of income under “Profit & Gains of Business or Profession”.  As per sub section (2), any expenditure by way of payment to the persons [mentioned in sub clause (b)], is liable to be disallowed in computing business profit to the extent such expenditure is considered to be excessive or unreasonable having regard to fair market value of goods, services, facilities etc. For e.g. expenditure on purchase of goods, procurement of services, interest payments, purchase of tangible and intangible property, Director’s Remuneration, Commission, Sitting fees etc.

However, no disallowance shall be made if the transaction (Specified Domestic Transaction) has been made at arm’s length price. Sub clause (b) of sub section (2) covers the various situations mentioned below wherein the two persons are related parties.  

Illustration:

Payments by ABC Ltd to the following persons will be covered under this clause, if the relationship exists at any time during the previous year, where:   

F Any company in which ABC Ltd has 20% or more voting rights,

F A company, XYZ Ltd, has 20% or more voting power in ABC Ltd,

F A company in which above-mentioned XYZ Ltd has 20% or more voting power,

F Any company of which a director has 20% or more voting rights in ABC Ltd,

F Any company in which a director of ABC Ltd has 20% or more voting rights,

F Any Director of ABC Ltd or XYZ Ltd and his/her  relative,

F Any Individual having 20% or more voting rights in ABC Ltd or any relative of such individual

Further, related party also includes a company having the same parent company. 

Now, transactions between (i) ABC Ltd – XYZ Ltd, (ii) ABC Ltd – PQR Ltd & (iii) XYZ Ltd – PQR & (iv) ABC Ltd – AAA Ltd., will fall under the mischief of section 40A (2). However, any transaction between ABC Ltd – BBB Ltd & AAA Ltd – BBB Ltd will not come under 40A(2).  

This clause covers only the “Expenditure” and not the income. Hence, it will not cover the cases when any person receives any income which is less than ALP. For e.g. - ABC Ltd gives an interest-free loan to its sister concern. The notional interest is not covered in this section and hence no addition can be made in the hands of the ABC Ltd.  

Area of Uncertainty / clarification required:

a) Benchmarking requirement for Remuneration / other payments to Director / Chairman / KMP:

In case of a company, specified person as per sub clause (b) includes directors, key management personnel and their relatives. It will be very difficult for the companies / groups to benchmark the payment made to their directors / chairman. For e.g. - It will be a tough task for Reliance Group to justify the payments made to Mr. Ambani, as it is not possible to find a comparable instance and one cannot compare the above payment with those made by business groups, like the ones owned by the Tatas or Birlas, to their key management personnel.   

Delhi High Court in a recent Judgement (CIT vs. India Thermit Corporation – ITA/350/2011) held that when commission paid to the Managing Director/Director was in accordance with the provisions of the Companies Act 1956; AO cannot make any disallowance on this account. Inspite of the same, this issue is litigation prone.   

b) Payment for Expenditure made to Sister Concern / corresponding adjustments:

For e.g. -  ABC Steel Ltd has paid rent of INR 6 crore to sister concern ABC Housing Ltd in F.Y. 2012-13. TPO disallows 50% of the rent payment by stating that it is unreasonable or excessive and accordingly allows a deduction of INR 3 crore only to ABC Steel Ltd. There are no corresponding provisions in the act to adjust the income of ABC Housing Ltd i.e. inspite of disallowance, ABC Housing Ltd will be assessed at an income of INR 6 crore. This will result to double taxation.

c)  Whether Depreciation will be covered?

Can depreciation be treated as expenditure for the purpose of this section? For e.g. - A Ltd purchases certain fixed assets from its sister concern Z Ltd for INR 1 crore, the ALP of which is INR 50 Lakh. Whether AO can disallow depreciation on INR 50 lakh, as the payment made for purchase of capital asset is not covered under section 40A (2)?  

2.    Any transaction referred to in section 80A;

Section 80A (6) refers to internal transactions between various units / undertakings of the assessee in respect of goods or services. This clause covers any transactions of goods or services and hence this transaction will be applicable to income as well as expenditure.

3.    Transactions of Tax Holiday undertakings

a)      Any transfer of goods or services referred to in  section 80-IA(8) 

b)      Any business transacted between the assessee and other person as referred to in section 80-IA(10)

c)       Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which section 80-IA(8) or  section 80-IA(10) are applicable;

It is a common practice among corporates, enjoying tax holiday period, to park excess profits in tax-exempt units / businesses. To curb this loophole, given clauses has inserted in the DTP law. Now TPO is empowered to make adjustments if it appears that ‘more than ordinary profits' are earned by tax exempt businesses/units owing to its ‘close connection' with transacting parties.

Section 80IA (8):

Section 80IA-(8) deals with the internal transactions with more than one undertaking / units of the assessee, out of which one or more undertaking is enjoying the tax holiday. Normally units enjoying tax holiday, charge more than the market value for goods or services used by non-eligible units. Due to this practise, there is no effect on the health of the tax holiday unit as there are no taxes at all and the non-eligible unit gets higher deduction from taxable income. As per Section 80IA-(8), if the internal transfer of goods or services is not at market value, then profits or gains of transacting units shall be computed, as if, transfer, in either case, had been made at market value of such goods or services. Onus is on the taxpayer to prove that the internal transfer is at ALP.

Section 80IA (10):

As per this clause, when due to close connection between assessee and ‘any other person’ or for any other reason, the eligible business of the assessee produces ‘more than the ordinary profit’, then for the purpose of deduction under this section, profit of the eligible business shall be determined by taking ALP of the transaction. Primary onus is on the taxpayer to prove that the internal transfer is at ALP. However, the department has to prove that the transaction is not at ALP.

Section 10AA: As per this section, profits of the units located in SEZ, engaged in the manufacturing of any article or thing or providing any services, is exempt subject to conditions.    

Non Allocation of Indirect Costs / Services to Tax Holiday Units:

Many a times indirect expenses / head office expenses / administrative expenses have not been charged to the undertaking enjoying tax holiday, due to which more than ordinary profits arises to the tax-holiday undertaking.

Illustration:                                                                                                                                      

 ABC Sugar Co Ltd., engaged the manufacturing of Sugar, is having three divisions- Sugar, Power & Chemical. Power produced by power division is captively consumed in the sugar and chemical division. In case of any shortfall in power generation, the same is purchased from the State Electricity Board (SEB). By-product of the sugar division is used in chemical division for producing ethanol. Profits of the power division are exempt u/s 80-IA.

INR 5 / unit have been charged by Power Division to sugar & chemical divisions for consumption of electricity. However, SEB rate for industrial undertakings are INR 4/ unit. Due to this pricing, the profit of the power division, which is enjoying a tax holiday, gets inflated by INR 1/ unit. Further, taxable profits of sugar and chemical divisions get reduced due to overcharging by the power division.

There are certain administrative/ indirect expenditure which have been incurred by ABC Sugar Co Ltd. As per prudent accounting norms, entire expenditure should be allocated to the three divisions in a proper ratio. However, ABC Sugar Co Ltd had not allocated the indirect expenditures in the Power division, due to which profits of power division gets inflated and profits of Sugar & chemical division gets reduced. Domestic Transfer Pricing law is introduced to curb similar types of transactions.    

4.    Any other Transactions as may be prescribed: 

Board (CBDT) had been given the power to notify any other transaction, which they feel it necessary, to include in the definition of “Specified Domestic Transaction.” 

Area of Uncertainty / clarification required:

a)      ‘Close Connection’ not defined

By applying arm's length principle, an imprecise concept of ‘more than ordinary profits' has suddenly started appearing. Section 80-IA(10) talks about ‘close connection’ between the assessee and the other person. However, the term has not been defined, which may lead to litigation. 

b)      ‘Corresponding Adjustments’

Normally DTAA provides that where any upward adjustment has been made in the hands of one entity, say an Indian Company, with respect to transaction with another company, say a British Company, then the corresponding downward adjustments should be made in the hands of the British Company. This eliminates the double taxation. No corresponding provisions are incorporated in DTP law.

c)       ‘Indian Company having Domestic / International Transaction’ :

What happens when an Indian company is having both international transactions as well as domestic transactions? Whether the specified domestic transactions are required to be reported in the following scenarios:

a)       When the value of aggregate of international transactions and specified domestic transactions is less than INR 5 crore.

b)       When the value of aggregate of international transactions and specified domestic transactions is more than INR 5 crore, but value of specified domestic transactions is less than INR 5 crore.

What if, when the value of International transactions as well as value of Specified Domestic Transaction will be INR 3 crore each? Is the assessee required to report the same or to take an accountant’s report for the same?  As per plain language of the IT Act, if the aggregate value of the Specified Domestic Transaction does not exceed INR 5 crore, then DTP law will not be applicable. A clarification may be required on this issue.

Domestic Transfer Pricing (DTP) law is not applicable, if original tax liability reduces: 

Section 92(3) provides that TP provisions will not applicable when it has the effect of reducing the income chargeable for tax or enhancing the original losses. Hence, for expenditure recorded in the books for ‘less than ALP’ or income recorded in the books for more than ALP, will be out of purview of DTP. The situation may be reversed when tax holiday unit will come in picture.

For e.g. – If an internal transfer from a tax holiday unit to a non-tax holiday unit has been made at INR 1,00,000 for which ALP is INR 200,000, then the provisions of DTP as well as TP will not be applicable and ALP will not substitute the original recorded transaction. If ALP of INR 200,000 will substitute the original price then it will result into additional exemption to tax holiday unit as well as additional deduction of expenditure to non tax holiday unit, which is not the intention of the statute.     

Computation of Arm’s Length Price(ALP):

As per Section 92C, the Arm’s Length Price in relation to “Specified Domestic Transaction” shall be calculated by the any of the following methods, being the ‘most appropriate method’, namely

a)       Comparable uncontrolled price method;

b)       Resale Price Method;

c)       Cost Plus Method;

d)       Profit Split Method;

e)       Transactional Net margin method;

f)        Such other method as prescribed by the board i.e. Any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the facts.     

As per Rule 10C of the Income Tax Rules, most appropriate method shall be the method which is best suited to the facts and circumstances of each particular transaction and provides the most reasonable measure of the transaction. Following factors should be taken into account while choosing the most appropriate method namely: 

                       I.            the nature and class of the international transaction;

                      II.            the class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises;

                    III.            the availability, coverage and reliability of data necessary for application of the method;

                    IV.            the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions;

                     V.            the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions;

                      VI.          the nature, extent and reliability of assumptions required to be made in application of a method.

If more than 1 price is determined by the most appropriate method, the ALP shall be taken to be arithmetical mean of such prices.

Further as per notification no 30/2013 dated 15.04.2013, Actual transaction price of Specified Domestic Transaction shall be deemed to be at Arm’s Length, if the variation between the ALP so determined and the actual transaction price does not exceed 3% of the actual transaction price (1% in case of whole sale trade)  

Documentation / Compliances:

As per section 92D, every person who has entered into Specified Domestic Transaction shall keep and maintain such information and documents in respect thereof, as prescribed in Rule 10D of the Income Tax Rules.

As per Section 92E, the assessee has to take an accountant’s report, in Form 3CEB, duly signed and verified as per the provisions of the Act. The Transfer Pricing Audit Report is required to file electronically on or before the due date of filing of Income Tax Return i.e. on or before 30^th November of the respective assessment year.    

Penalty Provisions for Non- compliances:

Penal provisions for non compliance are now made very harsh by the Board. Earlier there was no penalty when any transaction escapes from the Auditor’s Report in Form 3CEB. Section 271AA has been amended w.e.f. 01-07-2012 to give the power to the AO to impose penalty @ 2% of the value of transaction, if assessee fails to report any transaction or fails to maintain required information or furnishes incorrect information. Thus, even if one forgets to disclose a transaction of INR 5 crore, which is the minimum threshold for reporting, the penalty is INR 10 lakh.

This penalty is in addition to penalty of INR 1 lakh prescribed u/s 271BA for non- furnishing of Auditors report u/s 92E.

Preventive Measures:

TPO will apply all lessons learnt from the assessments of international transaction over the past 10 years, while finalising assessments of Specified Domestic Transactions. Now they know the exact issues which require special attention. Questions will be raised on routing of transactions through multiple entities, and adjustment entries. Companies, who have the specified domestic transitions exceeding INR 5 crore, should be advised to validate their present business model and pricing methodology from a transfer pricing perspective, which will enable them to take corrective action, if any. A good understanding of the business of the assessee is a must for every consultant dealing with the Transfer Pricing issues.

Conclusion:  

Domestic Transfer pricing will not be limited to large groups. Many mid-sized groups, partnership firms, HUFs and even individuals in smaller cities will now have to adhere to the TP laws. This will lead to an increase in the administrative and compliance burden for the taxpayer in respect of such transactions. Certain expenses, transfer of goods and services between related parties, extraordinary profits and profits earned by SEZs / tax holiday units will now be liable for scrutiny by TPO’s. While the Advance Pricing Agreement (APA) regime has been introduced with respect to international transactions, the same benefit has not been extended for domestic transactions.

One can pray that the extension of transfer pricing provisions to Specified Domestic Transactions will not create the same level of havoc as prevalent in current Transfer Pricing assessments. It would be pertinent for the Government to bring out a clarification on all such issues so that domestic transfer pricing provisions can achieve the purpose for which they were introduced.

By CA. Bikash Bogi

(Partner)

SBR & CO. Chartered Accountants

bikashbogi.blogspot.com , info@sbrca.in, www.sbrca.in

DEEMING FICTION FOR REAL ESTATE : IS IT BEYOND REALITY

“Roti, Kapda aur Makan”, are 3 basic needs of a common man, out of which buying a Makan is one of the common dreams of every Indian. Time and again various representations have been made to the government to regularize the Real Estate Sector to make it affordable for the common people.

So far as Income Tax Regulations are concerned, since last two decades, which is also the period of major economic growth of the country, Finance Ministers had given due weightage to systemize the taxing provisions, specially related to Real Estate Sector.

Why Real Estate Sector is Special?

Before moving into the topic, an interesting question pops up in my mind, regarding reason for affection of the taxing authorities with the Real Estate Sector and the answer may be hidden in the given statistics. 

Real estate sector in India has come a long way by becoming one of the fastest growing markets in the world. The growth of the industry is attributed mainly to large population base, rising income level and rapid urbanization. Currently, the Indian Real Estate Market has a market size of approx USD 70 billion [INR 3.8 lakh crore] and is expected to touch the market size of USD 180 billion [INR 10 lakh crore] by the year 2020. The Real Estate sector contributes approx 5% of the national GDP. As per the recent global survey, India Ranked 20^th among the top 20 Real Estate Investment markets globally with investment volume of USD 3.5 billion [INR 19000 crore] recorded in FY 2012-13 alone. Further, there is a huge demand – supply mismatch in the Indian Real Estate industry. As per an estimate Indian cities have faced a shortage of approx 15 - 20 million residential units by the end of FY 2012-13.

It is a known fact that number of property transactions in India is not recorded as per their actual market price. Due to these reasons, the taxing authorities are now giving “much needed special attention” to the Real Estate Industry”

Introduction of Deeming Fiction in Real Estate :

One of the most controversial provisions, which had a huge impact on the taxation of Real Estate Transactions, was the introduction of concept of “Deeming Fiction” through Section 50C.

Section 50C was introduced by the Finance Act 2002 with lots of hue and cry by the Industry. As per this section, when immovable property, being land or building or both held as Capital Asset, is transferred, at the value which is less than value adopted, assessed or assessable for the purpose of stamp duty, then the stamp duty value will be taken as Deemed Sale Consideration for computing capital gains.

Deeming Fiction is constitutionally valid:

The constitutional validity of Section 50C was challenged in the Madras High Court [Palaniamy vs. UOI 306 ITR 61] on the ground that an income based upon the guidelines (stamp duty value) is fanciful and imaginary and that the provision lacked legislative competence. It was also contended that the provision is discriminatory as between those assessee in whose case stamp duty value was more or less than actual consideration. The arbitrary manner in which the stamp duty value was fixed by the state authorities is evident from the variation in values within the same area under common guidelines. It was claimed that the procedure to challenge the guidelines before the state authorities, was unworkable and placed an undue burden on the taxpayer.   

High Court found that any arbitrary result on application of Section 50C against the taxpayer can be avoided by the protection offered by resources to remedies available in the section itself. The court was also not inclined to accept that the guidelines valuation was an arbitrary yardstick. They are fixed after following the prescribed procedure under the Stamp Act and they are also justifiable. Accordingly, Constitutional validity of the section 50C had been upheld by the High Court.   

Amendments made by Finance Act 2013 (Introduction of Section 43CA):

After a gap of 4 years, Mr. P Chidambaram had taken the charge of Finance Ministry in August 2012. Prevalent tax loopholes were in his mind while presenting the Finance Bill 2013. In his budget speech Mr. Chidambaram had said “Some tax avoidance arrangements have come to notice, and I propose to plug the loopholes”.  

Before jumping into the fine print of the Amendment, it will be interesting to take a look on a few judicial pronouncements (now overruled), which was a major cause for amendment of so called avoidance arrangements:

a)      Indralok Hotels (p) Ltd. (122 TTJ 145) Mumbai

In this case, the assessee company, a real estate developer, had sold two residential flats for a consideration of INR 60 lakh & INR 40 lakh respectively. The Stamp duty of these flats was INR 78 lakh and INR 72 lakh. The Assessing Officer (AO), in the scrutiny proceedings, by applying the provisions of section 50C, had taken stamp duty value of these two flats i.e. INR 150 lakh as deemed sale consideration instead of actual sale consideration i.e. INR 100 Lakh and added the differential amount as Deemed Business Income. The matter ultimately travelled to ITAT.

Hon’ble ITAT held that section 50C w.r.t. concept of deemed sale consideration shall be applicable only for transfer of ‘Capital Assets’ for calculating capital gains. In the given case the residential flats are shown as ‘Stock in Trade’ and income thereof is taxable under Business Income and accordingly deleted the addition made by the AO.    

b)      Kan Construction & colonizers (p) Ltd. (70 DTR 169) Allahabad HC:

Assessee Company, a Real Estate Developer, had some plot of land which was shown as stock in trade. During the previous year assessee sold some plot of land for a consideration of INR 80 lakh and offered the income under Business Head. The AO had treated the said plot of land as capital assets and thereby applying the provisions of section 50C, had taken stamp duty value as sale consideration for calculating capital gains. Appellate authorities had deleted the addition made by the AO, against the department preferred an appeal before High Court. 

Hon’ble High Court held that if the asset is held as stock in trade, the profits and gains from the sales is liable to be taxed as profits and gains from business and not as capital gains. Section 50C has no application where transfer of immovable property is on account of sale of stock.

c)    CIT vs. Mukesh & Kishore 33 Taxmann.com 87 (Gujarat HC):

In this case the assessee had sold a plot of land, which was held by them as stock in trade. The Stamp duty value of the land was 2.2 times more than the stamp duty value. AO had made the assessment based on  stamp duty value. Matter ultimately travelled to High Court. High Court had held that as the land was held as stock in trade & the profit is taxable under business head, section 50C will not be applicable as the same was applicable only in case of transfer of capital assets.    

Amendment made by the Finance Act 2013 to counter [overrule / nullify] the above judgments, as is clear from the Memorandum Explaining the Finance Bill 2013 read as under:

 “Currently, when a capital asset, being immovable property, is transferred for a consideration which is less than the value adopted, assessed or assessable by any authority of a State Government for the purpose of payment of stamp duty in respect of such transfer, then such value (stamp duty value) is taken as full value of consideration under section 50C of the Income-tax Act. These provisions do not apply to transfer of immovable property, held by the transferor as stock-in-trade.

It is proposed to provide by inserting a new section 43CA that where the consideration for the transfer of an asset (other than capital asset), being land or building or both, is less than the stamp duty value, the value so adopted or assessed or assessable shall be deemed to be the full value of the consideration for the purposes of computing income under the head “Profits and gains of business or profession”.”

Presently when a capital asset (other than stock in trade) is sold for a consideration, which is lower than the stamp duty value, then the stamp duty value is considered as deemed sale consideration for the purpose of computing capital gains. From the definition of capital assets, as given in section 2(14), ‘Stock in Trade’ is specifically excluded.

Finance Act 2013, vide insertion of section 43CA, has adopted concept of deemed sales consideration being stamp duty value, on the transactions of land or building or both, held as ‘stock in trade’, transferred by builders / real estate developers. Sub section (1) says that where the consideration for transfer of an asset (other than capital asset), being land or building or both, is less than the stamp duty value, then the stamp duty value shall be the deemed sale consideration for calculating income under the head “Profits & gains of business or profession”.  Sub section (2) states that for calculating stamp duty value under this section, provisions of sub section (2) & (3) of section 50C will be applicable. Sub section (3) states that where the date of sale agreement (for fixing final consideration) and the Registration date are not the same, then the value may be taken as value for payment of stamp duty, on the date of the agreement, provided the seller has received, on or before the agreement date, full or partial consideration from the buyer, other than cash. This Section is introduced w.e.f. 1 April 2013 and will apply to all transactions effected on or after this date.

Amendments made by Finance Act 2013 in Section 56(2)(vii):

Earlier, when any immovable property is received by an individual or HUF without consideration, the stamp duty value of which exceeds INR 50,000, then the stamp duty value is chargeable to tax in the hands of the individual or HUF as Income from Other Sources.

Earlier Immovable received for Inadequate Consideration was not covered in the section, which is now taken into consideration by the Amendment. Memorandum explaining finance bill 2013 clears the intention of the statute, which reads as under:  

The existing provision does not cover a situation where the immovable property has been received by an individual or HUF for inadequate consideration. It is proposed to amend the provisions of clause (vii) of sub-section (2) of section 56 so as to provide that where any immovable property is received for a consideration which is less than the stamp duty value of the property by an amount exceeding fifty thousand rupees, the stamp duty value of such property as exceeds such consideration, shall be chargeable to tax in the hands of the individual or HUF as income from other sources.

 Considering the fact that there may be a time gap between the date of agreement and the date of registration, it is proposed to provide that where the date of the agreement fixing the amount of consideration for the transfer of the immovable property and the date of registration are not the same, the stamp duty value may be taken as on the date of the agreement, instead of that on the date of registration. This exception shall, however, apply only in a case where the amount of consideration, or a part thereof, has been paid by any mode other than cash on or before the date of the agreement fixing the amount of consideration for the transfer of such immovable property.

As per the amended provision, immovable property received for a consideration, by an Individual or HUF, which is less than the stamp duty value by INR 50,000; then the difference between the stamp duty value and such consideration, shall be taxed as income from other sources in the hands of recipient individual or HUF.

Areas of Concern / Controversial Issues:

a)      Now deeming fiction will be applicable even if the land / building is not registered with the concerned Government authorities as the transfer takes place on the basis of the mere agreement for sale. 

b)      The deeming fiction will make an adverse impact on genuine real estate transactions. Many a times the assessee is required to sell the property for a price much lower than the stamp duty value due to certain urgencies. There is no provision in the act to cover situations like distress sale.

Recently Chennai ITAT in case of ACIT vs. MIL Industries Ltd [33 Taxmann.com 120] had held that misfortunes happened to the assessee or difficulties faced by the assessee or matters of distress sale etc. shall not be considered for exclusion of application of section 50C and stamp duty value only shall be taken for calculating capital gains.

c)       Law has not provided any tolerance band for non applicability of deeming fiction. Kolkata ITAT in a recent Judgement of Heilgers Development & Constructions co. (p) ltd vs. DCIT [32 Taxmann.com 147] had held that even if there is a marginal difference between the actual sale consideration and the stamp duty value due to gap between the agreement date and the registration date, then also the stamp duty value will be taken for calculating capital gains.

d)      The Amendment will lead to Double Taxation in certain cases. For e.g. If a property sold by Real Estate Developer (say for INR 40 lakh) is less than the stamp duty value (say INR 50 lakh), then INR 10 lakh will be taxed as business income in the hands of developers.

Consequently, buyer is getting property for INR 40 lakh, which is less by INR 10 lakh from stamp duty value and accordingly INR 10 lakh will be taxed in the hands of buyer u/s 56(2)(vii) as income from other sources.

e)      Normally there is a time gap [3 – 5 years or more] between the launch of a particular project and completion of the project. Real Estate Developers sell the product throughout the construction period and receive the payment progressively. As per section 43CA stamp duty value [if it is higher] shall be considered as deemed sale consideration. The sale consideration, accordingly, will vary drastically and financials of the company will not reflect the true position of its profitability.

f)       There will be an uphill task for Real Estate Developers to prepare their books of accounts by considering the new provision. Normally Real Estate Developers are following either percentage completion method or project completion method for accounting of revenue. In case of project completion method, income is offered for taxation only when the project is completed. In case of percentage completion method, the income is offered based on % completion of the project. Once the income is calculated on the basis of stamp duty value, can they defer the income by applying percentage completion method? There is no clarity on the same.

In case of transaction below stamp duty value, are they required to record the transaction at stamp duty value or on actual value? If they record the transaction at actual value then for income tax purpose they have to prepare a separate set of accounts incorporating deeming values.  

In metro cities, Real Estate Developers are selling the flats / inventory on basis of letter of allotment [mainly in cases where the buyer is purely an investor]. The agreement for sale and final registration is done only after possession or at the time of subsequent sale. As per section 43CA, it will result into a higher profitability in the hands of the Developers as well as Investors. 

g)      No corresponding amendment has been proposed in section 50C where there is a time gap between the agreement date and the registration date.

h)      Consider a situation where assessee had earlier converted the land [held as capital assets] into stock in trade and the sale is made after 1 April 2013. As per the new provision the assessee has to calculate the business profit based on stamp duty value, which will impact the taxability. Similar kind of situation will be faced by assessee who had converted the properties / flats purchased before the introduction of section 43CA as stock in trade. They have to pay much higher tax on the final profit.

i)        The Stamp duty value as on the date of the agreement shall be taken for calculating profit, only if the amount of consideration or part thereof [other than cash] has been received on or before the date of agreement of sale. There is an ambiguity regarding the taxability of certain individual buyers who had already booked their flats and are waiting for completion of the construction so they can get the registration and possession. Further ‘part consideration’ has not been defined which leads to confusion.

For e.g. Mr. A had bought a flat which is under construction and registration is pending. Possession of the flat will be given by 30 Sept 2013. As per agreement for sale dated 1 Jan 2011, the consideration for sale is INR 75 lakh; however the stamp duty value at the time of registration is INR 2 crore. Till 1 Jan 2011, the assessee had paid an amount of INR 5 lakh to the developer and further INR 40 lakh had been paid till 31 Mar 2013. As per the plain language of the section, the stamp duty value as on 1 Jan 2011 shall be taken as deemed sale consideration as the assessee had made part payment. The said interpretation is highly litigation prone.

j)        The word “other than cash” may be interpreted in a different manner. Any payment by way of book entry can be considered as valid payment under this section. Further payment through bearer cheque can be a sufficient compliance. Clarification on these issues is necessary to prevent dispute.

k)      Let’s take the case of transfer of business undertaking on slump sale basis, where no separate consideration is paid for land or building. Can deeming fiction be invoked? Prima facie the answer is no due to non identifiable consideration for land or building. However, the same may be disputed by the department.

l)        In case of contribution of stock in trade in to the partnership business, provisions of section 43CA may not be invoked as the consideration for transfer is indeterminable. The same principle is given by SC in Sunil Siddharthbhai vs. CIT 156 ITR 509. It will be interesting to see that how the department will take up this issue.        

m)    Can transfer of leasehold rights will be covered under the mischief of the deeming fiction. As per plain language of the section, it is clear that it will be applicable only in case of transfer of assets being land or building or both. Kolkata ITAT in DCIT vs. Tejinder Singh [ITA/1459/Kol/2011] had held that section 50C does not apply to transfer of tenancy / leasehold rights. Still the issue is litigation prone.

n)    Is the deeming fiction applicable on the Transferable Development Rights (TDR) ? Mumbai ITAT in ITO vs. Prem Ratan Gupta had held that section 50C does not apply to transfer of FSI and TDR. However after the introduction of 43CA, the issue may be subject to litigation.     

Can assessee challenge the Stamp duty value?

In case of transactions covered u/s 50C & 43CA, statute provides an option to the assessee to challenge the stamp duty value as deemed sale consideration and ask for a reference to the Departmental Valuation Officer [DVO]. When requested, the AO is duty bound to make a reference to DVO. In case the value adopted by the DVO is higher then the stamp duty value then the Stamp duty value will be the full value of consideration. A question arises here is whether the AO is duty bound to wait for the report of the DVO? The answer is no. In case of time barring assessments, they generally pass the order without waiting for DVO’s report.  

In case of transaction covered u/s 56(2)(vii), assessee cannot challenge the stamp duty value.  This will cause great hardships to the assessees. 

Conclusion:

The intention of the statute for introduction of the concept of deeming fiction is that the people dealing in Real Estate should report the transaction honestly. After the introduction of Section 50C, the said object had been achieved to a certain extent. However, many a times, due to unavoidable circumstances, genuine transactions fall under the purview of this section. Law has not provided any safeguard to the genuine assessees.  Extension of Deeming concept on Real Estate Developers has made their life more difficult for common man. Real Estate Developers may pass on the cost of additional Tax / compliance burden on to the buyers. VAT, Service Tax, Stamp Duty & now this Deemed tax, is effectively pinching the common man for buying his dream home. 

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The information contained in this write up has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. It cannot be relied upon to cover specific situations and one should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. SBR & CO. or its partners do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.