1st

RESIDENTIAL
REFRESHER COURSE
UMBERGAON CLUB & RESORT, GUJARAT

Paper 1 - Case Studies on Taxation of Real estate developers

and Contractors

By,

CA Romesh S A Sankhe,

Mumbai
Speaker’s Profile

Romesh is a Manager in Deloitte Haskins & Sells, Mumbai.

Romesh is commerce graduate from Mumbai University and an Associate Member of the Institute of
Chartered Accountant of India (ICAI). He has more than five years of enriched experience in the field of
Corporate as well as Cross-border taxation. He has advised organisations on various domestic tax issues,
handled numerous Scrutiny Assessments, appeals and also represented clients before higher Income Tax
authorities. His Cross-border taxation experience involves providing advisory on issues such as
Permanent Establishment and attribution of profits, Inbound-Outbound Strategy Structuring,
Withholding tax implications, etc. along with transfer pricing study of various industry sectors namely
Film distribution, Engineering goods & services, Manpower recruitment, Share broking, IT Enabled
services, Professional consultancy etc.

Romesh has been speaker in various forum organised by National Academy of Direct Taxes (NADT)
Nagpur, Western India Regional Council of ICAI, Alliance India etc. on direct tax issues.

Contact details
Romesh Shrikant Anusaya Sankhe
(M) 9892 892504
(E) romesh_sankhe@rediffmail.com
Case studies
1 RESTRUCTURING OF THE REAL ESTATE BUSINESS THROUGH ADMISSION OF PARTNER IN A
PARTNERSHIP FIRM
1.1 Facts
a. ABC & Associates (“ABC”) is a partnership firm engaged in real estate development. The
partners of ABC are D Private Limited (“DPL”), E Private Limited (“EPL") and two individuals in a
profit sharing ratio of 60%, 30% and 10% respectively.

b. On 1 April 2007, due to paucity of funds, ABC is not able to develop the balance area and hence
the partners decided to treat ‘the proportionate cost of development rights in the unsold /
undeveloped plot of land together with TDR purchase’ as ‘investment’ which was earlier shown
as ‘work in progress’ in its books.

c. This investment was then revalued to reflect the value as on date and the difference in the
investment value on account of such revaluations was transferred to the partner’s current
capital accounts.

d. The projected balance sheet of ABC as on 31 October 2009, is as under

(Rs in crores)

Liabilities Amount Assets Amount

Capital Account of partners 0.00 Investments 250.00

[Rs.100,000]
[Unused TDRs]

Current capital Account of 150.00 Cash and bank balances 5.00

partners

[on account of revaluation of

immovable property]

Unsecured loans 105.00

Total 255.00 Total 255.00

 e. ABC has identified some potential investors who will be admitted as partners in ABC against
injection of necessary funds in the partnership firm for development and construction of the
balance unsold area.

f. The new partners will bring in equity capital contribution of Rs.250 Crores approximately in ABC.
On injection of fresh cash capital in the firm, the new profit sharing ratio among the partners
will be as follows;
• New Partners 99.5%
• DPL, EPL and Others 0.5%

g. Fresh capital infusion of Rs.250 Crores would be utilised to pay off the unsecured loans and
repayment of partners’ current capital accounts as on 31 October 2009.

1.2 Issues
In light of the above the facts, the following issues have been raised for your consideration:

A. Are the firm and the partners thus correct in their belief that there would be no tax liability on
reconstitution of the partnership firm and in the profit sharing ratio of the existing partners on
admission of new partners?

B. Are the partners, therefore, correct in their belief that on withdrawal of the capital (sums) from
the firm against credit balances lying in their current account, there would be no tax liability /
capital gains tax liability in their hands?

C. Are the partners correct in their belief even if they retire from the partnership firm immediately
after withdrawal of their balances in the current capital accounts or in the immediately
succeeding assessment year, there would be no tax liability either in their hands or in the hands
of the partnership firm?

D. Whether the above mentioned arrangement by ABC will be termed as device to avoid tax as
contemplated in the case of McDowell and Sunil Siddharthbhai?

1.3 Reference Material

1.3.1 Section 2(14), Section 2(47) and Section 45(4) of the Income Tax Act.

1.3.2 Observations of Supreme Court in Sunil Siddharthbhai v. CIT [1985] 156 ITR 509
“We have decided these appeals on the assumption that the partnership firm in question
is a genuine firm and not the result of a sham or unreal transaction and that the transfer
by the partner of his personal asset to partnership firm represents a genuine intention to
contribute to the share capital of the firm for the purpose of carrying on the partnership
business. If the transfer of the personal asset by the, assessee to a partnership in which
he is or becomes a partner is merely a device or ruse for converting the asset into money
which would substantially remain available for his benefit without liability to income-tax
 on a capital gain, it will be open to the income-tax authorities to go behind the
transaction and examine whether the transaction of creating the partnership is a
genuine or a sham transaction and, even where the partnership is genuine, the
transaction of transferring the personal asset to the partnership firm represents a real
attempt to contribute to the share capital of the partnership firm for the purpose of
carrying on the partnership business or is nothing but a device or ruse to convert the
personal asset into money substantially for the benefit of the assessee while evading tax
on a capital gain. The, Income-tax Officer will be entitled to consider all the relevant
indicia in this regard, whether the partnership is formed between the assessee and his
wife and children or substantially limited to them, whether the personal asset is sold by
the partnership firm soon after it is transferred by the assessee to it, whether the
partnership firm has no substantial or real business or the record shows that there was
no real need for the partnership firm for such capital contribution from the assessee. All
these and other pertinent considerations may be taken into regard when the Income-tax
Officer enters upon a scrutiny of the transaction, for, in the task of determining whether
a transaction is a sham or illusory transaction or a device or ruse, he is entitled to
penetrate the veil covering it and ascertain the truth”.

1.4 Analysis

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2 ALLOWABILITY OF INTEREST
2.1 Facts
a. FGH & Associates (“FGH”) is a partnership firm engaged in real estate development. In the past,
certain business transactions were funded by partners through their current capital accounts.

b. There was an understanding amongst the partners that they would be entitled to withdraw such
current capital account balances and for this purpose the firm may borrow if the partners desire
 to do so. Thus, FGH has made substantial borrowings in the past which were utilized by the
partners for withdrawal of their own current capital in the firm and for non-business purposes.
FGH has not claimed any interest expenditure on such borrowings in its tax returns, but has
reserved its right to claim such interest expenditure through a note filed in its tax returns filed
from A.Y.2007-08 to A.Y.2009-10.

2.2 Issues
In light of the above the facts, the following issues have been raised for your consideration:

A. Is the firm correct in its belief that despite the loan funds being used by the partners for
withdrawing their capital lying in current account, interest paid on borrowed funds to the extent
of current account capital utilized for purchase of immovable property is allowable business
expenditure either under Explanation to sec 24(b) or under sec 36(1)(iii) once the project is
completed and until the construction is completed such interest would be allowed to be
capitalised even in the event of any express provision / condition not contained in the
partnership deed?

B. Is the firm also correct in its belief that even if interest expenditure is not claimed in the tax
return but the same is claimed by way of a note in the computation of total income
accompanying with the return, its claim will not get prejudiced?

2.3 Reference Material

Section 24(b), Section 36(1)(iii), Section 43 and Section 139(5) of the Income Tax Act.

2.4 Analysis

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3 ENTRY STRATEGY AND CHOICE OF ENTITY

3.1 Facts
a. IJK & Associates (“IJK”) is a partnership firm engaged in real estate development. They have
been approached by a foreign investor in USA, for a strategic collaboration in real estate
business to be carried on various cities in India such as Mumbai, Bengaluru, Chennai, Kolkata
and Delhi.

b. Certain characteristics of this proposed collaboration are as under:

i. All the proposed projects will be compliant with the exchange control regulations
ii. The projects will be mix of housing and commercial, hence partners wish to create
separate entities for each project
iii. Partners are also looking at financial and operation flexibility in operations
iv. The foreign investor has a operating company in Singapore

3.2 Issues
In light of the above the facts, the following issues have been raised for your consideration:

A. How are you proposing this transaction to be structured into India?

B. Also the client wishes to know which of the following forms will be better for it in
achieving the most of the desired objectives
• Private Limited Company
• Partnership Firm
• Limited Liability Partnership
3.3 Reference

3.3.1 Rules and regulation dealing with the various business forms mentioned above.

3.3.2 Article 13 of India-Singapore tax treaty

“ARTICLE 13 : CAPITAL GAINS - 1. Gains derived by a resident of a Contracting State from

the alienation of immovable property, referred to in Article 6, and situated in the other
Contracting State may be taxed in that other State.
2. Gains from the alienation of movable property forming part of the business property
of a permanent establishment which an enterprise of a Contracting State has in the
other Contracting State or of movable property pertaining to a fixed base available to a
resident of a Contracting State in the other Contracting State for the purpose of
performing independent personal services, including such gains from the alienation of
such a permanent establishment (alone or together with the whole enterprise) or of such
fixed base, may be taxed in that other State.
3. Gains from the alienation of ships or aircraft operated in international traffic or
movable property pertaining to the operation of such ships or aircraft shall be taxable
only in the Contracting State of which the alienator is a resident.
4. Gains derived by a resident of a Contracting State from the alienation of any property
other than those mentioned in paragraphs 1, 2 and 3 of this Article shall be taxable only
in that State.”

3.4 Analysis

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4 DEDUCTION UNDER SECTION 80IB (10)

4.1 Facts
a. LMN Private Limited (“LMN”) is a company engaged in real estate development. They are
currently developing a project in Mumbai called ‘Heaven on Earth’. The key characteristics of
the proposed plan for ‘Heaven on Earth’ are as under:

i. The project is of 5 residential buildings

ii. The dates of receipt of approval from Brihnmumbai Municipal Corporation (“BMC”) for
‘Heaven on Earth’ are as under;
• 30 September 2007 for first 3 buildings,
• 28 March 2008 for 4th building,
• 30 April 2008 for 5th building,
iii. In the BMC plan, first 3 building are shown as Phase I and balance 2 as Phase II, and
approval has been obtained accordingly
iv. Area of the total project is 4.5 acres, equally divided among all the 5 buildings
v. The 4th and 5th building are part of Slum Rehabilitation Development (“SRD”) program
for which all the approvals are obtained except from CBDT (“Central Board of Direct
Taxes”)
vi. Each building has 100 residential units of 1000 Square feet each and 5 Commercial
establishments of 500 Square feet each, in addition to above every building has 20
terrace flats where 50 square feet additional space will be allotted to the flat owners
and 10 square feet parking allotted to all the flat owners
 vii. Three companies have approached LMN for a bulk buying of 5 flats each at a 10%
discounted price than the normal
viii. 30 people are wishing to buy 2 flats in Heaven of Earth, some of them wish to buy it for
their residential use and some of them wish to buy it for investments

4.2 Issues
In light of the above the facts, the following issues have been raised for your consideration:

A. LMN wishes to seek advice on the proposed direct tax implications on the sale of
‘Heaven on Earth’ project along with possible tax planning avenues and dos and don’ts
for the way forward ?

4.3 Reference

Section 80IB(10)
“The amount of deduction in the case of an undertaking developing and building housing
projects approved before the 31st day of March, [2008] by a local authority shall be
hundred per cent of the profits derived in the previous year relevant to any assessment
year from such housing project if,—
(a) such undertaking has commenced or commences development and construction
of the housing project on or after the 1st day of October, 1998 and completes
such construction,—
(i) in a case where a housing project has been approved by the local
authority before the 1st day of April, 2004, on or before the 31st day of
March, 2008;
(ii) in a case where a housing project has been, or, is approved by the local
authority on or after the 1st day of April, 2004, within four years from
the end of the financial year in which the housing project is approved by
the local authority.
Explanation.—For the purposes of this clause,—
(i) in a case where the approval in respect of the housing project is obtained
more than once, such housing project shall be deemed to have been
approved on the date on which the building plan of such housing project
is first approved by the local authority;
(ii) the date of completion of construction of the housing project shall be
taken to be the date on which the completion certificate in respect of
such housing project is issued by the local authority;
(b) the project is on the size of a plot of land which has a minimum area of one acre:
Provided that nothing contained in clause (a) or clause (b) shall apply to a
housing project carried out in accordance with a scheme framed by the Central
Government or a State Government for reconstruction or redevelopment of
 existing buildings in areas declared to be slum areas under any law for the time
being in force and such scheme is notified by the Board in this behalf;
(c) the residential unit has a maximum built-up area of one thousand square feet
where such residential unit is situated within the city of Delhi or Mumbai or
within twenty-five kilometres from the municipal limits of these cities and one
thousand and five hundred square feet at any other place; [and]
(d) the built-up area of the shops and other commercial establishments included in
the housing project does not exceed five per cent of the aggregate built-up area
of the housing project or two thousand square feet, whichever is less.]
The following clauses (e) and (f) shall be inserted after clause (d) of sub-section (10) of
section 80-IB by the Finance (No. 2) Act, 2009, w.e.f. 1-4-2010 :
(e) not more than one residential unit in the housing project is allotted to any person
not being an individual; and
(f) in a case where a residential unit in the housing project is allotted to a person
being an individual, no other residential unit in such housing project is allotted
to any of the following persons, namely:—
(i) the individual or the spouse or the minor children of such individual,
(ii) the Hindu undivided family in which such individual is the karta,
(iii) any person representing such individual, the spouse or the minor
children of such individual or the Hindu undivided family in which such
individual is the karta.
[Explanation.—For the removal of doubts, it is hereby declared that nothing
contained in this sub-section shall apply to any undertaking which executes the
housing project as a works contract awarded by any person (including the
Central or State Government).]

4.4 Analysis

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