Written in : May 1998

Why do people enter into 'development agreements' instead of selling property? There are several reasons for this.

The main reason is that your land has become gold. Urban land prices having shot up through the sky, there are now fewer buyers who are willing or able to pay cash down for purchasing land, specially one which is large. Large properties - often even smaller ones - are usually required by builders who wish to build flats or offices to sell. Builders are not often willing to invest money up front in cash into land and then into buildings. They instead offer 'development deals' where land is usually exchanged for proposed built up area. You, therefore, enter into development agreements because you have no choice.

On the other hand, you are yourself interested in developing your land and building flats on it. This is because you find it far more profitable to do so than just sell the land. However, you probably do not have financial or managerial resources to undertake the project. These, you expect, the developer to contribute so that both will benefit out of it.

In the first instance, you get to acquire built up area even if you were not keen about it. In the second instance, you get what you want. But in both cases you are probably likely to sell the built up area eventually - either to make profits out of it, or to liquidate it to pay taxes etc.

A question that becomes crucial in such cases is whether you have become a businessman - a builder. If you have, tax law treats your income differently. And the difference is critical. Let us understand how.

Sometime back, in one of the articles I had explained how the meaning of 'transfer' of property was altered to plug legal loopholes which helped land owners avoid capital gains tax. One such instance is relevant here.

Suppose you owned an asset as an investment. You decide to do business with it. That is, you convert the asset from an investment in your hands to a business asset, as stock in hand to deal with. From the point of time when you decided to become a businessman, the character of the asset changed. In law, as it stood a few years back, the difference between the market value of the property at the time the character of property changed and your original cost was not taxable as income - on the simple principle that you cannot make profits out of yourselves.

People started using this concept in land deals. They would 'convert' their land holdings into stock in trade and then sell it. Thus they were able to avoid considerable capital gains tax.

No wonder government came out with a plug to the loophole. Law was amended to say that if any person converts his investment into stock in trade, there would be a deemed transfer resulting in capital gains.

The law is like this. If you convert your investment into stock in trade, or treat it as stock, then it will be considered that you have transferred the asset. The market value of the asset on the date of such 'transfer' would be considered to be your sale value and the difference between that and the original cost is to be treated as the capital gains (of course, subject to indexation, other benefits and deductions). .

There is one difference, though. While there is a 'deemed' transfer, you are charged to tax only in the year you actually sell the asset in business. You do not have to pay tax till then. It has interesting implications. .

Suppose you own land. You convert it into your stock in trade on April 1, 1997. Thereafter you build an apartment complex on it, or give it on development to a builder. The construction takes two or three years. Then the flats are sold. The capital gains tax is payable by you in the year of actual sale and not before. It is the time of sale deed that is relevant here and not anything else. Till that time no tax is payable

The law ensures that you do pay capital gains tax and do not avoid it. It also helps you in timing your tax payment to suit your liquidity and other requirements.