Man gets 23 flats from builder, seeks tax exemption on all units after Rs 8 crore LTCG demand; ITAT says this

In a ruling that could benefit many landowners entering redevelopment agreements with builders, the Bengaluru bench of the Income Tax Appellate Tribunal (ITAT) has held that a taxpayer was entitled to claim exemption under Section 54/54F on all 23 flats received under a Joint Development Agreement. The Tribunal treated all the flats as one residential house for the purpose of the exemption, resulting in no capital gains tax liability despite holding that the JDA itself amounted to a transfer of the property.

The ruling is important because disputes over the timing of capital gains taxation and the availability of tax exemption under redevelopment agreements have been among the most litigated issues in property taxation.

What was the case about?

The taxpayer, an individual, jointly owned about 3 acres and 10 guntas of land in Bengaluru with two other co-owners. In March 2011, they entered into a Joint Development Agreement (JDA) with a developer to construct a residential and commercial project on the land.

Under the agreement, the landowners were to receive 69 flats in the completed project, with the taxpayer’s share being 23 flats. The developer also paid the landowners a non-refundable advance, part of which was received in cash.

Years later, following a survey conducted on the developer, the Income Tax Department reopened the taxpayer’s assessment. It argued that the land had already been transferred in the year the JDA was signed because possession had been handed over to the developer for construction. On that basis, it computed a long-term capital gain of over Rs 8 crore in the taxpayer’s hands.

Taxpayer said no transfer had taken place

The taxpayer challenged the assessment, arguing that the developer had only been allowed to enter the land to carry out construction work. According to him, this was merely a licence to develop the property and not legal possession that would amount to a transfer under the Income-tax Act.

He also pointed out that he had paid capital gains tax later when some of the flats received under the agreement were actually sold. Therefore, he argued that tax should not arise merely because the development agreement had been signed.

ITAT disagrees on timing of tax

The Tribunal did not accept this argument.

It observed that under the Joint Development Agreement, the developer had received possession of the land and substantial development rights. The developer had also started carrying out development activities. Therefore, the transaction amounted to a “transfer” under Section 2(47)(v) of the Income-tax Act in the year the agreement was executed.

The Tribunal said that merely describing the developer’s possession as a licence in the agreement would not change the true nature of the transaction if the developer had effectively been given possession to undertake the project.

It also clarified that there are two separate taxable events in a Joint Development Agreement.

The first arises when the landowner transfers development rights to the builder under the JDA. The second arises later if and when the landowner sells the flats received under the agreement. According to the Tribunal, the later sale of flats cannot postpone the taxation arising from the transfer of development rights.

Tribunal finds flaw in tax calculation

While agreeing with the tax department on the timing of taxation, the Tribunal found fault with the method adopted to calculate the capital gains.

The Assessing Officer had treated the developer’s construction cost as the value of the consideration received by the landowner.

The Tribunal said this approach was legally incorrect.

It observed that the builder’s cost of construction represents the builder’s expenditure and cannot automatically become the landowner’s income. Instead, the value of the consideration should be based on the stamp duty value of the flats received by the landowner, along with any cash consideration received under the agreement. The Tribunal also directed the tax department to allow the indexed cost of acquisition and improvement while recomputing the capital gains.

Big relief on Section 54F

The biggest relief for the taxpayer, however, came on the question of exemption under Section 54/54F of the Income-tax Act.

The taxpayer argued that the 23 flats allotted to him under the redevelopment agreement should be treated as investment in a residential house and therefore qualify for exemption from capital gains tax.

The tax department disagreed. It argued that each flat should be treated separately and the exemption could not be extended to all the units.

The Tribunal, however, relied on earlier judgments of the Karnataka High Court and the Delhi High Court to hold that, for the assessment year involved in the case, all 23 flats could be treated as one residential house for the purpose of claiming exemption under Section 54/54F. As a result, although it upheld the taxability of the Joint Development Agreement, it also ruled that the entire capital gain qualified for exemption, leaving no tax payable.

Tax experts, however, say the ruling should not be read as a blanket benefit for every redevelopment project.

Ashish Mehta, Partner at Khaitan & Co., points out that the Tribunal’s decision is based on the legal position that existed before April 1, 2015. He says courts had consistently held that multiple flats received under a redevelopment arrangement could be regarded as “a residential house” for claiming exemption under Sections 54 and 54F. But after the amendment made by the Finance (No. 2) Act, 2014, the law specifically restricts the benefit to “one residential house in India.” As a result, landowners entering into Joint Development Agreements today cannot automatically rely on this ruling merely because they receive multiple flats.

Why the ruling still matters

The order is significant because it deals with two of the biggest tax questions that arise in redevelopment agreements — when capital gains become taxable and how the exemption under Sections 54 and 54F should be applied.

The Tribunal reaffirmed that, under the law applicable before the introduction of Section 45(5A), capital gains could arise in the year the Joint Development Agreement was executed if possession of the property was handed over to the developer. At the same time, it also made it clear that the exemption cannot be denied merely because the landowner receives several flats in the same redevelopment project.

According to Mehta, taxpayers entering into redevelopment arrangements today are in a different legal position. He says Section 45(5A), which now applies to eligible individuals and Hindu Undivided Families, generally shifts the tax event to the year in which the completion certificate for the project is issued. Therefore, wherever applicable, taxpayers should structure redevelopment agreements in a manner that allows them to benefit from Section 45(5A) and carefully evaluate the timelines for claiming exemption under Sections 54 and 54F.

Documentation becomes crucial

The ruling also underlines the importance of maintaining proper records throughout the redevelopment process.

Mehta says taxpayers should preserve the registered Joint Development Agreement and any supplementary agreements, documents relating to handing over of possession, allotment letters for the flats, stamp duty valuation records, completion or occupancy certificates, and documents establishing the cost of acquisition and improvement of the original property. These records become critical if the exemption claim is scrutinised during assessment.

He also cautions that the Revenue may continue to argue in post-2015 cases that each flat is a separate residential house, since the law has changed. While this ITAT ruling could still be cited as persuasive in similar disputes involving older redevelopment agreements, the amended provisions will govern transactions executed after the law was changed.

What taxpayers should know

For taxpayers, the ruling serves as a reminder that the tax treatment of redevelopment agreements depends heavily on when the agreement was executed.

Those covered by the law applicable before April 2015 may still find support in earlier High Court decisions that treat multiple flats as one residential house for exemption purposes. But for more recent agreements, the amended provisions of the Income-tax Act and the specific facts of each case will play a much larger role in determining the tax outcome.

Disclaimer: This article is based on the order passed by the Bengaluru Bench of the Income Tax Appellate Tribunal in the case of Himmadihalli Bachanna Krishna Murthy vs Income Tax Officer for Assessment Year 2011-12. The ruling is based on the specific facts of the case, including the terms of the Joint Development Agreement and the law applicable to the relevant assessment year. Tax treatment of redevelopment agreements may differ depending on the date of the agreement, the nature of possession transferred, subsequent amendments to the Income-tax Act, including the introduction of Section 45(5A), and individual facts and circumstances. The judgment may also be subject to further appeal. Taxpayers should consult a qualified tax professional before taking any decision based on this ruling.

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