Tax on Penalty amt paid by Builder for Delayed Possession

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  1. ZED

    ZED Well-Known Member

    If possible I would like to enter into this debatable issue of penalty, we can bring case laws now. I am interested in this but it would be great if we could actually get a current situation with relevant documents like the agreements with the builder , payment schedule etc. Let me know if you are interested in going in depth
    My preponderance would be taxation and for this purpose I would like to know allied matters aswell (I could also be investing in such property someday)

    I didn't quite get what you meant by "Later same amount of Penalty received gets converted as revenue receipts, when we sell this property."
    Once we reduce the cost of acquisition, the only effect is lower indexation and receipts ,in any case , are going to be of capital nature only ,with the difference that such a capital receipt is taxable [As you would already know capital receipt can be taxed if and only if there is specific provision therefor in the chapter of capital gain] (with exception of deeming provisions)

    On the issue of taxability of Assured rentals from builder :

    Let's both of us go through the scheme (if I my understanding is wrong at any point then you can point it out)

    The builder needs money to complete the construction, he can either go to bank for loan carrying heavy rate of interest [over 20%] or he can rather take that money from us and pay us the interest. We , the prospective buyer would find it attractive since they are offering interest at 14% p.a . In most banks you can get near 9% only , that too in term deposits.

    So builder gets finance with lower cost and we also get interest income at higher rate. Second point to be noted is that the property is still under construction. You can not give it on rent to anyone , but builder is giving you such amount . Since more people like to invest where they can get their regular income readily and with stability ,since it also helps them in planning their expense and hence give a bit advantage than other . Builder is in position to increase the price. We must also consider the present value concept. In nutshell what I wanna say is that this benefits both the parties.

    We will not be able to do proper calculations unless we know what is the proper cost of construction and of finance to the builder

    Lets see the following project Noida

    They are offering interest of 12%-14% P.A till the date of possession
    Type Size INR
    Virtual Office Space [14%] 300 Sq. Ft. Onwards 5250/- PSF
    Lockable Office Space [14%] 500 Sq. Ft. Onwards 5500/- PSF
    First Floor retail Shops [12%] 300 Sq. Ft. Onwards 9400/- PSF
    Ground Floor Retail shops [12%] 300 Sq. Ft. Onwards 10,400/- PSF

    Payment PLAN

    Office Type

    Price (In Rupees)

    Virtual (minimum 500 sq.ft.) Rs. 5,250/- per sq.ft.

    Lockable (minimum 500 sq.ft.) Rs. 5,500/- Per Sq. Ft.

    In case of 100% downpayment
    Pre-lease Rental (per month) is @ Rs. 40/- p.sq.ft. (for 36 months from end of AR period) with Assured Return being 14%

    In other cases (not 100% downpayment) its 12%

    Interesting clause
    In case of continuing default (non-payment of any installments for over 90 days), 20% of total BSP + all Brokerage paid + all AR paid till date will be deducted as Earnest money

    How will you treat it (for both the parties) ?
    In my view , for acquirer , this will still be part of cost of acquisition [not citing any case] but courts have held that cost of acquisition is all the cost which the assessee has incurred for acquiring the property . It would be over and above the value appearing in the registry.

    Treatment in hands of builder
    Is it a capital receipt ? or is it a PGBP income or should it be adjusted from sales value ? Or is it income from other sources?

    Note that for the builder this property is goods and not a capital asset and hence the judgement of Saurashtra Cement would not be applicable.

    My view would be to treat it as business income , since this becomes income of the builder in the normal course of its business , for them its possible that this is a normal event [ofcourse the view can be debated ] If its not a routine event then it could be held as capital receipt also

    "Had the flat is given possession, we would have offset the income with Interest on housing loan. We cannot even reduce this amount in prepayment interest for 1/5 claim. Since the possession is not given to us, we cannot claim municipal taxes and interest against it."

    You are getting assured return even before possession.
    Further after possession this assured return may end (depends upon agreement, some times property is actually let out)
    This is your income, an income from other source . If you have taken loan for the purpose of investing in this property , you would be eligible to claim deduction of interest u/s 24(b) and if there'd be loss then you can offset the loss under income from house property against income from any head
    So I really don't see loss , infact there is more benefit is property is let out , since there is no limit on interest deduction.
    You would still be getting benefit of interest paid and municipal taxes
    Nikil Mohan likes this.
  2. V K Khanna

    V K Khanna Active Member

    I have nothing more to contribute after reading very enlightening and matured comments from the learned and most experienced members of our forum.
    In my case in particular, I am only waiting for registration of my property whether on the basic cost minus compensation or on the basic cost as per the agreement. I will also await reaction of the jurisdictional AO if insists for tax on compensation, I wii pay to earn peace as suggested by @ZED.

    Thanks once again to all who joined the discussion and in particular to Mr R P Singh who raised this issue.
    Last edited: Aug 16, 2015
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  3. Karan Batra

    Karan Batra Well-Known Member

    Very interesting discussion.

    All thanks to our highly knowledgeable experts @V K Khanna & @Chandrashekar M

    @ZED has also contributed a lot to this discussion.

    And its even good to note that these members are now interested in going even deeper into this issue to understand the nitty gritties.
    Last edited: Aug 16, 2015
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  4. ZED

    ZED Well-Known Member

    First of all thank you everyone for taking interest into issue and second and most important thing,

    I AM NO EXPERT, as a matter of FACT, I REALLY AM THE JUNIOR MOST MEMBER of this esteemed club . (Just check my profile, I am a newcomer)

    And Shipla Ma'am , we really can not establish any criteria for comparing the knowledge . I am happy that you found my reply good , but did you noticed that it wasn't I who solved the issue but it was you yourself . I just cited the law in front of you and you yourself concluded . Even on that issue you should be praising yourself only , it was your own understanding of the law , your knowledge.

    Sometimes because of certain experiences we get biased ,though unintentionally, but that biasedness makes us take certain presumptions and it is that presumption which limits our scope of thinking and we start to think on the basis of that biasedness and feel fuzzy. Perhaps this is what happened. (sorry if expressed anything in rude manner) [not good with words]

    Income tax Act is very wide , I haven't been able to read it completely yet . There certainly are lots of area where I will do so bad where one would think I shouldn't speak on such matters. You are giving much higher place than I deserve (atleast for now)

    I felt confidence when I was replying because I knew that if I would be saying anything wrong then the readers can catch that.

    Further, I said in small cases I advice to go for Income from other sources , in big case I would let the querist decide whether he wants to fight or not.

    On this club everyone is my senior including Chandrashekar M , you also Shilpa ma'am. V K Khanna and all the members

    Sorry If I said anything in a manner which hurt anyone)
    Last edited: Aug 16, 2015
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  5. ZED

    ZED Well-Known Member

    Sir you can opt any of these [Further you may take a second opinion]

    1. You can claim it as capital receipt and the cost should not be reduced (as discussed)

    2. If the penalty is not to be treated as a capital receipt
    (a) Income of the son is taxable at maximum marginal rate [30%] I would advice to adjust it from the cost of property

    Since capital gain would be taxable @ 20% [if long term] but income from other source would be taxed at 30%. Its better to reduce tax burden by 10%

    (b) If the income would be taxable @ 20% slab, well I would still suggest to adjust it from cost
    Reason being the indexation is done on the basis of 75% of the Consumer Price Index for Urban non-manual employees , which is much lesser than the actual inflation and this is even without considering the present value factor

    The cheques must be paid accordingly , this would be decisive factor

    Explanation to S.48
    "Cost Inflation Index", in relation to a previous year, means such Index as the Central Government may, having regard to seventy-five per cent of average rise in the [Consumer Price Index for urban non-manual employees for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf.
    Nikil Mohan likes this.
  6. ZED

    ZED Well-Known Member

    Builder can follow any of the method. As per 194 IA , the purchaser has to deduct tax at 1% of the consideration if it exceeds 50 Lacs.

    There is provision in Income Tax Act that credit of TDS shall be admissible only to the extent income is disclosed. Unless the income is disclosed, you can not avail the credit.

    You can now understand what problems we are going to face, suppose builder want to follow completed method, he will disclose his income when structure is completed, but his tax has been deducted today @ 1% of the value and till the time structure is complete, he wont be able to get the credit. His money is blocked

    In case he wants to opt for percentage of completion method, the question is , will he get the credit proportionately? or should full credit be allowed ? There is no clarity in law.

    There is another provision in the Act , S. 199 which says
    All sums deducted in accordance with the foregoing provisions of this Chapter shall, for the purpose of computing the income of an assessee, be deemed to be income received.

    Therefore, since tax has been deducted @ 1% , so much of the income on which tax has been deducted should be treated as income received and full credit should be allowed to the extent of that income. (This is my stand point)
    Nikil Mohan likes this.
  7. gaurav_kumar

    gaurav_kumar Well-Known Member

    @Shilpa. : There is no clarity in this regard given by the govt with respect to the taxability and all the knowledge members are just discussing on what should be done in this case.

    All members are giving their opinions for and against each type of treatment and this is what happens in the professional world in regards to topics where there is lack of clarity.

    If you have a viewpoint or if you are able to find something substantial in any book with regards to this - I request you to kindly share the same and enlighten us.
    Nikil Mohan likes this.
  8. gaurav_kumar

    gaurav_kumar Well-Known Member

    This is a community for online discussions and for helping each other mutually.

    Nobody has any selfish interest in answering queries.

    Please be patient and all your queries would be answered by the knowledge members.
    Nikil Mohan likes this.
  9. ZED

    ZED Well-Known Member

    I think I answered this in very first line of my reply
    I re-iterate if you want

    Decisions where Project Completion method has been accepted
    CITv. Bilahari Investment P. Ltd (299 ITR 1)(SC)
    CIT v Khoday Distilleries Ltd (Kar HC) (ITRC Nos. 19 to 21 of 1993, dated 12.9.1995)
    CIT v. V. S. Dempo & Co. Pvt. Ltd. (131 CTR 203)(Bom)
    And many more

    Decisions where cases relied upon by the Department to substantiate Percentage Completion Method
    P. M. Mohammed Meerakhan v CIT (73 ITR 735)(SC)
    Uttam Singh Duggal & Co. Pvt. Ltd. v. CIT (127 ITR 21)(Del)
    Sri Sukhdeodas Jalan v CIT (26 ITR 617) (Patna)
    And many more

    The method should be consistently be followed (S.145) , it can not be changed at the time of filing of return
    Nikil Mohan likes this.
  10. Chandrashekar M

    Chandrashekar M Active Member

    Mr.ZED, Thank you for your detailed views.

    1. On the issue of taxability of assured rental plan I said we can reduce from the cost in order to save initial payment of taxes under other sources. In the absence of case laws in our favor, I quoted Sourashtra cements case, whether the facts of the case can help us to come to some conclusion. I felt happy, you took pains to open the judgment and analyzed in detail.

    At page 1 of this thread you concluded as, I Quote your words :
    “Where the amount is small and tax has been deducted (on COMPENSATION)I advice to show it under income from other sources [Most people prefer peace of mind than fighting in court and to pay bills of advocate and bearing the risk of loosing, sometimes the cost of appeal will be more than cost saving from tax on compensation] ..”

    This is exactly the point at which I fully agree with you. You have given a practical approach to the case. It is not the matter we should go about taxing under other sources or reducing from the cost. It can be both way depending upon the tax effect. Hence, I appreciate your practical approach.

    Our senior respected member of this forum Mr.Gaurav kumar said as reply to Ms.Shilpa in page No.3 of this thread, I quote :
    “There is no clarity in this regard given by the govt with respect to the taxability and all the knowledge members are just discussing on what should be done in this case. All members are giving their opinions for and against each type of treatment and this is what happens in the professional world in regards to topics where there is lack of clarity. If you have a viewpoint or if you are able to find something substantial in any book with regards to this - I request you to kindly share the same and enlighten us.”

    I agree with his words and it goes in consonance with your practical approach. As Chartered accountant we(sorry, please correct "we" as "you") should take Income tax act strictly not as a science but also as an art, that is art of interpretation.

    Elsewhere in the thread I found you were interpreting some words with reference to act. I consider these are the signs of a successful and progressive professional. We should learn the art of interpreting the words. With my limited exposure to the words used and interpreted in law I want to say that, one of the rules of construction is that when a general word follows a specific word, the former will have a restricted meaning. If we apply the principle of ejusdem generis here, we have to consider that the word in question, should have the meaning analogous to that of the other word, which gives different meaning. There is also other principle of noscitur a sociis according to which, where two or more words which are susceptible to analogous meaning are coupled together, they take color from each other, the meaning of the more general term being restricted to a sense analogous to that of less general. But the more important rule of interpretation is ut res magis valant quam pereat. This is a crucial rule which states that the words of the statute should be given a sensible meaning so as to make them effective.

    Elsewhere in the thread, Mr.Gaurav kumar and yourself were giving interested facts about the real-estate transactions of builders and the taxability aspects. Hence, I have created a discussion thread named : “Taxation of House property, Real estate and Builders”. You can please participate and contribute your enlightened views.

    To sum up, Mr.ZED, let me tell you your deeper ways of analysis and the views reflected are marked here in this forum with certitude and precision. Conflicting opinions must arise in everybody’s professional life, then only you can expand your knowledge and be a successful Chartered Accountant. I find that you have the ability to avert overhanging pall of confusion due to surfeit of conflicting opinions. Finally, I should thank Ms.Divya Mehta for initiating such an interesting subject for discussion, and I think we have discussed enough to draw a conclusion. Thank you, every body for sharing your views, which has enlightened me and every one of us.

    - Regards
    Last edited: Aug 24, 2015
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