Introduction

1. Real estate sector is one of the most litigatious industries given the plethora of Central and State laws applicable to it. The myriad transactions that are possible in the sector often throw up legal issues including the taxation effect of such transactions. The taxation cost is an important factor which often results in make-up or break-up of deals. One such transaction is the Joint Venture between the land owner and the real estate developer, which is carried out either by way of entering into an independent development agreement, popularly known as "JDA" or by forming a separate Special Purpose Vehicle (SPV) (usually as a Limited Liability Partnership) where the Land Owner contributes the land as his capital and the Developer contributes the construction as his capital and the fruits of such business are shared between the land owner and the Developer in a pre-negotiated manner.

In case a SPV is formed for the purpose of development, the Income Tax Act throws up the issue of tax in the hands of land owner due to valuation of land contributed in the SPV. The value of the land contributed in the SPV by the owner upon becoming a partner could be:—

This value recorded in books of SPV entails capital gains tax incidence in the hands of the Owner and corresponding cost allowability of such land in the hands of the SPV as project cost.

The Income-tax Act prescribes through a deeming fiction in section 45(3) of the Act that the value recorded in the books of the SPV shall be treated as "consideration" in the hands of the owner and capital gain shall be calculated accordingly. Life would have been simple had the Act contained only this one provision for such transfer of land by owner to the SPV. The Act has further introduced section 50C w.e.f. 1-4-2003 which is similarly worded as section 45(3), yet treats the valuation adapted by stamp duty authority as the value of consideration as opposed to value recorded in books of SPV upon transfer of capital asset by Owner. Thus, there is a disconnect between section 50C and section 45(3) as regards the value to be recognised as "consideration" for purpose of computing capital gain in the hands of owner of property. Where the value recorded in the books of SPV is the same as market value no problem arises. The issue arises when there is difference between the value recorded in books and stamp office valuation. The assessee (read land owner) is often seen scratching his head as to how to calculate his tax liability, i.e., whether to calculate capital gain by taking the value of property recorded in books as provided in the provision of section 45(3) or whether to apply section 50C of the Act and take value as determined by stamp duty authorities.

Comparison of the provisions of sections 45(3) & 50C

2. (Tabular presentation)

2.1 A comparison of the two provisions throw up the following similarities:—

The Supreme Court in the case of B.T Patil & Sons v. CGT [2001] 247 ITR 588/114 Taxman 301 has held that where the partner contributes his personal asset as capital contribution in the firm, it tantamounts to transfer under section 2(47), because exclusive right in asset gets converted in shared right. Therefore, section 45(3) and section 50C, both apply to transfer of capital asset. Yet the above two provisions are different because section 45(3) talks of amount recorded in books as deemed value of consideration and section 50C talks of value adopted for the purpose of payment of stamp duty.

Decisions till date

3. Unfortunately not many decisions are available on the above controversy. In 2010 the Lucknow Bench of the ITAT in the case of Carlton Hotels (P.) Ltd v. Asstt. CIT [2010] 35 SOT 26 (URO) decided the issue based upon the then available unamended provisions. The bench held that it was immaterial that the value recorded in books of firm by crediting partners capital was less than the fair market value. According to the bench both sections operated in different spheres and, hence, when conditions as laid down in section 45(3) stood satisfied then the provisions of section 45(3) would apply. At that time section 50C was applicable only when the deed of transfer was registered. In the facts of that case, the deed, through which the property was contributed in the firm was not registered and, hence, unamended section 50C was not applicable. The bench did not get an opportunity to adjudicate the situation where the conditions provided in section 50C also stood satisfied along with the conditions laid down in section 45(3). The said decision unfortunately could not be taken to be a precedence after amendment was brought about to section 50C.

Another decision was rendered by the Mumbai ITAT in the case ITO v. Chiraayu Estate & Development (P.) Ltd [2011] 14 taxmann.com 41/47 SOT 200 (URO). This was the case where the assessee had contributed the land in the SPV at cost price. The AO treated the said transaction as bogus transaction and invoked section 69B for undisclosed investment, being difference between cost price and market value and also made same addition under section 45(3) of the Act ignoring the value recorded in books. The ITAT struck down addition under section 69B holding that there was no incriminating evidence that any undisclosed investment was made. It also struck down addition made under section 45(3) holding that once the price was recorded in the books of SPV it was treated as "full value of consideration". Thereafter, the provision does not permit substitution of any value so as to make addition under section 45(3). Though this decision highlights the overriding effect of section 45(3), yet it does not deal with the controversy of applicability of section 50C to such a transaction. Hence, this decision too is of little value as a precedence.

Legislative History

4. The CBDT Circular No.495 dated 22/09/1987 at para 24.1 explained the rationale of introducing the provisions of section 45(3) of the Act w.e.f. 1-4-1988. It mentioned that to overcome the problem of income going untaxed due to the decision of the Supreme Court in the case of Kartikeya V Sarabhai v. CIT [1997] 94 Taxman 164 the provision has been introduced. The Apex Court in that case, in absence of section 45(3), held that the capital gain cannot be computed in the transaction of contribution of capital asset by a partner in the firm since the value of consideration cannot be determined. The Court held that the credit entry made in the partners capital account in the books of partnership firm does not represent the true value of the consideration. It is a notional value only intended to be taken into account at the time of determining the value of the partners share in the net partnership assets on the date of dissolution or his retirement. In other words, the Supreme Court held that the credit entry does not represent the real consideration for the purpose of calculating capital gain under section 48 of the Income-tax Act, 1961. With the introduction of section 45(3), the Income Tax Act statutorily started deeming the notional value of asset recorded in books as the "full value of consideration" for the purpose of calculating capital gains tax under section 48 of the Act.

Section 50C was introduced w.e.f. 1-4-2003 with the avowed objective of arresting the black economy and reducing the involvement of black money involved in transactions of sale and purchase of immovable properties. The said provision introduced the concept of deemed consideration for the purpose of section 48, being higher of the actual sale consideration or the stamp office valuation, thereby taking away the benefits of undervaluation of immovable property. The said section is a deeming fiction which deems the value of consideration as that value which is adopted for purpose of stamp duty where the actual sale consideration is less than the stamp duty value.

Nature of Provisions

5. Section 45(3) is applicable where the person is contributing the capital asset in the firm or AOP/BOI and becoming a partner/member therein. Due to the introduction of section 45(3) the transaction which was earlier going untaxed was made taxable. Hence, the said section is a charging section as it levies tax on a special kind of transaction which is otherwise not taxable. To further assist this charging provision a deeming provision is added which for the purpose of charging tax deems value of consideration as value recorded in books of firm. Therefore, section 45(3) has two limbs which are joined together with the conjunction "and". The first limb is a charging section which levies capital gains tax on the gain arising from contribution of capital asset in the firm by a partner. The second limb is an essential deeming fiction for determining the value of consideration without which the charging provision would fail.

On the other hand, the provisions of section 50C although also a deeming fiction, deems only the value of consideration for the purpose of calculating capital gain in the transaction of transfer of capital asset from one person to another. It is more general and more pervasive in nature as it applies to all transactions of transfer of capital asset, being land and building from one person to another.

Actual Consideration v. Deemed Consideration

6. When we consider the above basic characteristics of both provisions one can argue that provisions of section 50C cannot be applied to deemed consideration as artificially determined under section 45(3). Provisions of section 50C apply to cases of actual accrual or receipt of consideration on transfer. This is because section 50C starts with the phrase "where the consideration received or accruing as a result of transfer…" . The Apex Court has in the case of Kartikeya V Sarabhai (Supra) already held that the amount of consideration which accrues in case of contribution to firm by partner is indeterminable. It has been deemed/determined only due to operation of section 45(3).

It would be prudent here to understand the law on deeming provision. In G. Viswanathan v. Speaker Tamil Nadu Legislative Assembly [1996] 2 SCC 353, the Supreme Court held that by the decision of this Court it is fairly well-settled that a deeming provision is an admission of the non-existence of the fact deemed. The Legislature is competent to enact a deeming provision for the purpose of assuming the existence of a fact which does not even exist. It means that the Courts must assume that such a state of affairs exists as real, and should imagine as real the consequences and incidents which inevitably flow therefrom, and give effect to the same. The deeming provision may be intended to enlarge the meaning of a particular word or to include matters which otherwise may or may not fall within the main provision.

From a perusal of the above concept laid down by the Apex Court one can state that the provisions of section 45(3) deem the value recorded in books as full value of consideration (which is otherwise not), to make the transaction taxable. Therefore, the deeming fiction is linked to the chargeability of the transaction. If we try to give section 50C an overriding effect over section 45(3) then section 50C would fail. This is because in the absence of a charging section 45(3) the contribution of property by partner in firm would go untaxed due to operation of decision of the SC in the case of Kartikeya V Sarabhai (supra). Hence, section 45(3) would have to necessary apply.

The incidence that would flow from applying chargeability of section 45(3) is that the value recorded in books is to be considered as full value of consideration for purpose of calculating capital gains tax under section 48 of the Act.

Different Spheres

7. Whereas section 45(3) is a deeming fiction deeming the value of consideration where there is none to overcome the decision of the Apex Court in the case of Kartikeya V. Sarabhai (supra), Section 50C deems higher of the two values between actual consideration and the stamp office valuation as full value of consideration for the purpose of calculating capital gains tax under section 48. Therefore, both provisions operate in different spheres as also mentioned by the Lucknow ITAT in the case of Carlton Hotels (P.) Ltd. (supra). Thus, Section 45(3) deems the "consideration" which is otherwise not computable. Section 50C deems the "value of consideration" as higher of the two known and determinate amounts, being actual sale consideration or stamp office valuation. Therefore, where the consideration has not actually accrued or not received provisions of section 50C cannot apply.

Counter-argument and fallacy therein

8. A counter-argument could be raised that once section 45(3) has been invoked to charge the transaction under section 48, thereafter the value of consideration has to be taken as determined under section 50C. Therefore, section 45(3) has to be followed by section 50C for the purpose of value of consideration. In authors opinion this argument is unfounded for the reason that section 45(3) is not only a charging section but also a deeming fiction which deems "full value of consideration for the purpose of section 48". Therefore, one cannot accept a part of the provision for chargeability and ignore other part of the same provision which deems the value of the consideration.

Therefore, while charging the transaction once the value recorded in books is treated as full consideration for the purpose of computation of capital gain under section 48 then stamp authority valuation cannot be substituted as full consideration as provided in section 50C. There are no words to this effect either in section 50C or in section 45(3).

Can section 45(3) be rendered otiose?

9. The above argument also gains strength from the fact that if the provisions of section 50C are given prominence over the provisions of section 45(3) then it would create a situation where the provisions of section 45(3) would become otiose. If the intention of the Legislature was to make section 50C applicable even to transactions of contribution of asset in firm by partner, the Legislature could have either repealed section 45(3) while introducing the provisions of section 50C or made suitable amendment removing reference of book value as consideration and linking it with consideration as per section 50C. However, the Legislature in its wisdom has retained section 45(3) as such, even though introducing section 50C only for the reason that section 45(3) brings to tax a transaction which is otherwise not taxable unlike section 50C which is a deeming fiction for determining value of consideration. The Legislature always intended to keep section 45(3) as effective and operative, even though section 50C has been introduced. Thus, there is no reason for ignoring section 45(3) giving precedence over section 50C of the Act.

Special provision v. General provision

10. The provision of section 45(3) is invoked under special circumstances. It deems a value of consideration which otherwise is not computable under general law. A perusal of the provisions of section 45(3) reveals that it is applicable to a very specific situation, being transfer of capital asset by a partner in the firm. Section 50C discussed above is more general in nature applicable where the consideration is known and determinate. As per Latin Maxim "generalia specialibus non derogant" it is a rule of construction that the special provisions prevail over the general provisions. The Supreme Court in the case of D.R.Yadav v. R.K.Singh [2003] 7 SCC 110 has held that where there are two conflicting provisions of law in operation in the same field, the rule that specifically operates in that field would apply over the general rule. Therefore, when there is a specific provision in the statute to deal with a particular kind of transaction then it would be travesty of justice to search for the taxability of that transaction elsewhere merely with an intent to increase tax burden of the assessee.

Conclusion

11. If legislature has thought it prudent to retain section 45(3) of the Act in its original avatar, then nothing can stop the authorities to give effect to such a provision in letter and spirit. The attempt of the revenue to apply the provisions of section 50C for garnering more revenue seems to defy the legislative intent provided in section 45(3) of the Act. No interpretation can render a section nugatory. A clarification in this regard from the CBDT is greatly needed to avoid unwarranted litigation.