Understanding Section 45(5A) of the Income Tax Act

Introduction

Section 45(5A) of the Income Tax Act, 1961, was introduced by the Finance Act of 2017, addressing a major challenge faced by individuals and Hindu Undivided Families (HUFs) involved in Joint Development Agreements (JDAs) for immovable properties. Prior to its introduction, owners had to pay capital gains tax at the time of transferring the property rights, even though they had not received any financial consideration yet. Section 45(5A) aimed to ease this tax burden by deferring capital gains taxation to the year in which the project is completed, as certified by competent authorities.

What is Section 45(5A)?

Section 45(5A) primarily applies to JDAs between property owners and developers. Under such agreements, owners transfer the development rights of their land or property to a developer, who, in return, either gives the owner constructed units or pays a portion of the profit from the project. Earlier, tax liabilities were triggered the moment the property was handed over to the developer, leading to hardship for owners who often hadn’t received any tangible benefit at that point.

With the introduction of Section 45(5A), the capital gains tax is deferred until the project is completed, as evidenced by a certificate from a competent authority. This provision applies to JDAs entered into on or after April 1, 2017.

Scope and Application

• Applicable to Individuals and HUFs: Section 45(5A) is only applicable to individuals and HUFs who own immovable properties. Other entities such as companies, firms, or associations do not benefit from this provision.
• Registered JDAs: The section only applies if the JDA or development agreement is duly registered. Unregistered agreements do not qualify for the deferral of tax under this section.
• Capital Asset: The land or building must be treated as a capital asset in the owner’s hands and not stock-in-trade. This is particularly important for landowners who are not developers by profession.
• Consideration: The tax will be computed based on the Stamp Duty Value (SDV) of the owner’s share of the property, as assessed on the date of the project’s completion certificate. Additionally, any cash consideration received by the owner will also be included in the computation.
• Holding Period: If the property has been held by the owner for more than 24 months before the transfer, it qualifies as a long-term capital asset, attracting long-term capital gains tax, which offers indexation benefits.

Important Conditions for Section 45(5A)

• Stamp Duty Value as Consideration: When calculating capital gains, the stamp duty value on the date of the project’s completion certificate is considered, along with any cash consideration. This ensures that tax liability is calculated based on the fair market value of the asset at the time of completion.
• No Transfer Before Completion: If the owner transfers their share of the project before receiving the completion certificate, the benefits of Section 45(5A) cease to apply, and the normal tax provisions under Section 45(1) come into force, meaning the tax is payable in the year the transfer takes place.

Illustration

Let’s consider a practical scenario to understand how Section 45(5A) works:

Suppose Mr. X owns a plot of land and enters into a JDA with a developer, ABC Builders, on May 1, 2017. Under the agreement:

• Mr. X hands over possession of the land on May 1, 2017.
• ABC Builders agrees to pay Mr. X ₹60 lakh and construct 10 residential units on the land, of which 6 units will be given to Mr. X.
• The project is completed on June 30, 2019, and the stamp duty value (SDV) of each flat on that date is ₹45 lakh.

Under Section 45(5A), Mr. X will pay capital gains tax in the assessment year 2020-21 (when the project is completed) based on the SDV of 6 flats plus the cash consideration.

Challenges and Key Considerations

• Scope Limitation: The provisions of Section 45(5A) apply only to JDAs involving individuals and HUFs. Corporate entities or firms involved in property development do not benefit from this deferment, limiting its applicability.
• Non-monetary Compensation: Section 45(5A) applies when the owner receives part of the constructed project (like residential units). If the compensation is purely monetary, the section’s provisions do not apply, and capital gains tax is payable upfront.
• Time Delay: For landowners, this provision defers tax liability but also ties them to the project's completion. Delays in construction or issuance of the completion certificate can delay the payment of taxes but also delay the realization of returns.
• Section 53A of the Transfer of Property Act: The underlying concept of 'transfer' in Section 45(5A) is linked to Section 53A of the Transfer of Property Act, 1882. It defines a 'transfer' to include any transaction where possession of property is handed over to the developer, even if full ownership hasn’t been transferred yet.

Conclusion

Section 45(5A) is a relief measure for landowners entering into Joint Development Agreements (JDAs), deferring the capital gains tax to the year of project completion. By aligning taxation with the actual receipt of benefits, the section mitigates the financial burden that landowners previously faced. However, it is crucial to ensure that agreements are registered, and owners should be cautious not to transfer their share before the project’s completion, lest they lose the tax deferral benefits. Proper tax planning and professional advice are essential for maximizing the advantages of Section 45(5A).

This section, while providing relief, still presents complexities, especially with long project durations and valuation issues, making it critical to approach JDAs with careful consideration of tax implications.