Expected business profit on entering into development agreement in respect of land held as stock-in-trade cannot be taxed as capital gain

Brief of the case:

In this case ITAT examined the issue that where an assessee entered into an land development agreement by holding land as stock-in-trade, the expected business profits arose as a result of agreement can be taxed as income from capital gain. Hon’ble ITAT held that no matter how reasonable is it to assume that the assessee will make these profits and thus cannot be brought to tax at this stage.

Facts of the case:

• Assessee is engaged in the business as a builder and was absolute owner of a piece of land.
• Assessee declared land stock in trade and on 07.05.2009 entered into a development agreement with Menorah Realties Pvt Ltd (MRPT).
• As per agreement the assessee was to transfer entire land holding to this project and will receive 40% of total saleable area in consideration of the land being used for this housing project.
• By way of a subsequent modification to this agreement, in consideration of delay in execution of project, the assessee was to get an additional 2% share in the constructed area, parking space and undivided interest in the property.
• On these facts AO asked the assessee to show cause as to why the capital gains arising on transfer of capital asset via the joint development agreement not to be brought to tax in this assessment year i.e. 2010-11.
• The AO proceeded to compute the capital gains by taking the cost of construction of assessee’s share in the built up area as consideration for which the land was transferred.

Contention of the revenue:

• In terms of the clear provisions of Section 45(1), profit and gains arising from the transfer of a capital asset effected in a previous year are to be brought to tax as income of the previous year in which the transfer took place.
• The provisions of Section 2(47)(v), “transfer” includes “any transaction involving the allowing of possession of any immoveable property to be taken or retained in part performance of a contract of the nature referred to in Section 55A of the Transfer of Property Act, 1882”.
• AO relied upon to the decision of Hon’ble jurisdictional High Court, in the case of CIT Vs Dr T K Dayalu [(2011) 202 Taxman 531 (Kar), wherein it is held that the capital gains will arise in the year in which full control and possession of the land in question is given.
• A reference was also made to Hon’ble Bombay High Court’s judgment in the case of Chatubhuj Dwarkadas Kapaida Vs CIT [(2003) 260 ITR 491 (Bom), which was so followed by Hon’ble Karnataka High Court, in arriving at this conclusion in Dr T K Dayalu’s case (supra).
• It does not make a difference because if the profit arising on trans fer of land cannot be taxed as capital gains, it can be taxed as a business profit anyway. That is precisely what the learned CIT(A) has held too.

Contention of the assessee:

• Even though the assessee had entered into a development agreement in the relevant previous year, no gains arose as a result of this agreement since the proposed building project was not even cleared by the regulatory bodies.
• The licence to construct the building project was received in the subsequent previous year and therefore, no capital gains could be said to have been arisen in this year.

Held by CIT (A):

• Notional profit of transfer of land could indeed not be taxed as capital gains, he was of the view that it would be taxable as business profits because, as against reduction of closing stock due to transfer of interest in land, the closing stock of the assessee has to go up by the notional value of the gains inasmuch as closing stock of rights in constructed area in the project to be developed is to be taken at estimated cost of construction to which the assessee was entitled without incurring any costs.
• The land transferred by the assessee is a stock-in-trade.

Held by ITAT:

• In view of the uncontroverted findings by the learned CIT(A), it is now a settled position that the land transferred by the assessee was held as a part of stock in trade and the gains on the transfer of this land could only arise by the virtue of the increase of closing stock value in respect of the right to 42% share in the constructed building. There is no appeal or cross objection against the order passed by the CIT(A) and the learned representative state so at the bar.
• Once the land is held to be a part of the stock in trade, it ceases to be a capital asset in view of the fact that Section 2(14) and therefore, the provisions regarding capital gains are admittedly not attracted on the facts of this case. Hence, the definition of ‘transfer’ under section 2 (47) of the Act, and of Section 53A of the Transfer of Property Act- which is relevant in the Income Tax Act only for the limited purposes of connotations of expression ‘transfer’ under section 2(47) only, have no bearing on the adjudication about taxability of notional profits in the hands of the assessee.
• Unlike in a case of a capital gain which arises on parting the capital asset at the first stage itself, it is a case of business transaction which is completed when the rights so acquired by the assessee are exercised; none can make profits by dealing with himself, as is the settled legal position in the light of the settled legal position in the case of Sir Kikabhai Premchand Vs CIT [(1953) 24 ITR 506 (SC).