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Capital gains computation for encroached/litigated properties

[] The market value of a property that has been encroached upon or is under litigation, may be significantly lower than its ready reckoner value. We examine the options for buyers and sellers, in terms of computing the capital gains on such properties

Capital gains under the income tax laws, are computed by deducting the cost of acquisition of the property from sale consideration of the same. Depending on the holding period of the property, one is allowed to enhance the cost of acquisition, by using the cost inflation index notified by the government every year. The sale consideration, as mentioned in the agreement, may not always be considered for income tax purposes. The income tax laws have elaborate provisions to determine sale consideration with respect to land and buildings.

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Determination of sale consideration for capital gains, on sale of land or buildings

Logically speaking, for the computation of capital gains, the sale price, as mentioned in the agreement, which is the price that the seller is supposed to have received, should be taken and the cost of acquisition deducted from that value. However, the seller may resort to disclosing a lower value in the agreement of sale, to minimise the tax liability. This also allows the buyer to invest his unaccounted money in the deal, at the same time. Underreporting of the sale consideration for land and buildings, meant that the state government lost out on revenue that would have accrued to it, had the sale transaction been recorded at the real consideration.

Looking at the rampant use of unaccounted money in real estate transactions, the government had introduced Section 50 C under the Income Tax Act, which provides for benchmarking the rate at which the transactions of sale of land and building should be considered, for capital gains purposes. In order to make sure that it got the stamp duty that should have accrued to it, state governments introduced the ‘ready reckoners’, for the purpose of payment of stamp duty with respect to real estate transactions. The rates notified by the state government are also known as ‘circle rates’ in the northern part of India.

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Tax implications on encroached properties, where the sale consideration is lower than the ready reckoner rate

As per the income tax laws, for a property that is transacted at a significantly lower consideration than its ready reckoner rate, it is not only the seller but also the buyer of the property, who has to pay tax on the difference between the value as per the ready reckoner rate and the sale consideration mentioned in the sale agreement, under Section 56(x) of the Act. So, such transactions have twin tax implications, for the same amount. For the difference between the ready reckoner value and the apparent consideration, the seller is taxed under the head ‘capital gains’, while the buyer is deemed to have received a ‘gift’ of this difference amount and is taxed under the head ‘income from other sources’.

Option for sellers of encroached properties, where the market value is significantly lower than the stamp duty rates

The rates mentioned in the stamp duty reckoner are not sacrosanct. The seller can always contend that the market value of the immovable property is not as per the ready reckoner but is actually as per the apparent sale consideration mentioned in the agreement. The Income Tax Act provides for two remedies to the buyer and seller, in circumstances where the actual sale price of a property is significantly lower than the circle rate. This may particularly true in cases where the property is encroached upon or is tied up in litigation.

The first option available with the seller, is to contend that the value as per the stamp duty ready reckoner has been contested before the stamp duty authorities. Since the buyer has to pay the stamp duty, the seller does not get any chance to contest the stamp duty valuations. However, as such transactions have income tax implications for the buyer as well, it is in the interest of the buyer to contest the stamp duty valuation, so as to avoid the difference being taxed as his income.

The second option available to the seller, is to request the assessing officer to refer the valuation of the property to a valuation officer of the Income Tax Department. The seller has to convince the valuation officer with the relevant facts and documents, about the real value of the property being significant lower than the value it would have fetched, had the property been free from any such infirmities.

Precautions to be taken, while drafting the agreements for encroached properties

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In case of encroached properties, it is always advisable to avail of the services of a firm of solicitors, for preparing the documents and agreement, in relation to the sale of such properties. The buyer and seller have to ensure that all the relevant facts and details about the property that affect its valuation, are properly elaborated in the agreement. Such details would include the extent to which the property has been encroached upon, the period for which the property has been encroached, number of encroachers, etc.

In case of redevelopment of an area that has been encroached and has illegal constructions on the land, the buyer may have to pay the third party for evicting them from the place or the buyer may have to provide them with alternative accommodation in lieu of the encroached land being surrendered. The agreement between the buyer and the seller should have all these details.

It is also advisable for the buyer and seller to obtain a detailed valuation report from a valuer of repute, so that the same can be used in future to establish the real value of the property being sold, in case the matter gets litigated in the Income Tax Department. It is important for both, the buyer and the seller, to prepare the relevant documents at the stage of transaction itself. According to several decision of the Income Tax Tribunal, as well as the high courts, the income tax officer is under an obligation to refer the valuation of a property to the departmental valuer, if the seller so demands at the time of assessment.

(The author is a tax and investment expert, with 35 years’ experience)

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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