Real estate and infrastructure sector is the growth engine for the development of economy of any country. Development of real estate involves huge amount of investment and high degree of skill, efforts and time. For real estate development, huge amount of investment is required in acquiring land, for obtaining land-conversion permission from the concerned authority for the intended purpose, for developing the project as per norms of the regulatory authority, for carrying out the construction activity and for marketing the project. The real estate project may be in the nature of development of Industrial Township, Commercial Complex, Residential Township, or Group Housing Society etc.
It generally takes several years in development and completion of a real estate project.
Present is the age of collaborative science, where the resources of different agencies are collaborated and put together for harnessing the expertise of different agencies. For development of real estate, model of joint development arrangement has emerged as a popular model wherein land owner and developer combine their resources and efforts.
Under a typical joint development agreement, land owner contributes his land and enters into an arrangement with the developer to develop and construct a real estate project at the developer’s cost. Thus, land is contributed by the land owner and the cost of development and construction is incurred by the developer. The land owner may get consideration in the form of either lump sum consideration or percentage of sales revenue or certain percentage of constructed area in the project, depending upon the terms and conditions agreed upon between them.
In this manner, the resources and efforts of land owner and developer are pooled together so as to bring out the maximum productive result. The cost of land in a real estate project entails substantial part of total cost of the project. In such arrangement, developer is not required to make investment for acquiring land at the initial stage and he can utilize his expertise of project development with limited resources in a much efficient manner. On the other hand, land owner, who may not be having requisite experience and expertise for developing the project, gets better price for his land in comparison to what he would have got in the case of outright sale of land. Thus, it creates a win-win situation for both the parties.
In fact, it can be said that the joint development arrangement is a commercial arrangement of convenience where in both the parties try to exploit their respective resources in the best possible manner and without much financial investment. The land owner contributes his land which he is already holding and the developer utilizes his experience and expertise of development and marketing of real estate project.
With the development of real estate industry, different forms of joint development arrangements have evolved over a period time. The sky rocketing land prices has also contributed to the creation of development of real estate under joint development arrangements. Various forms of joint development arrangement which are seen in practice may be as under:-
1. Owner of an old house is inclined to develop the property in modern style with increased floor area including basement and stilt area which may have been allowed by the regulatory authorities. In such a case the owner hands over the house to the developer for the development and the floors constructed are shared between them. In addition, the developer may provide in a given case certain monetary consideration and alternative residence to the owner to live during the development period. Such arrangement has been seen mostly in the Metro cities.
2. Large real estate project for development of residential or commercial complexes require huge investment. The developer may not be in position to invest in acquisition of land for development of such project. Therefore, joint development arrangement has been evolved to develop large real estate projects. In such a case, land owner contributes his land whereas the development is undertaken by the developer and the consideration for land is given by the developer to the land owner linked with the development of the project. The consideration in such cases is paid not only in monetary terms but also by sharing developed units in the project as per the agreed terms.
A typical joint development agreement is generally structured incorporating different components having financial implications, which are discussed below:–
A joint development arrangement is the pooling of respective resources by the land owner and the developer of the real estate which may be illustrated as – Mr. ‘O’ owns a plot of land which may be developed as a real estate project of residential or commercial nature but he does not have the requisite experience and expertise of development and marketing of the project. Mr. ‘O’ collaborates with Mr. ‘D’ who does not have the finances to invest in acquiring land which forms substantial part of total cost of the project but he has experience, expertise and reputation for development of project and marketing it. They enter into collaboration agreement contributing their respective resources.
For the development of real estate project, costs are required to be incurred for obtaining various approvals from the regulatory authorities including change of land use, payment of external and internal development charges, construction costs of the real estate, marketing costs of the project such as advertisement expenses, brokerage/commission to the agents for sale of project and financial costs, etc.
Generally, all such costs are incurred by the developer in the case of joint development arrangement. However, there is no hard and fast rule to this proposition and as per mutual terms agreed upon by the parties, some of the above costs may be incurred or shared by the owner of the land also.
In joint development arrangement, there is usually no sale of land by the land owner to the developer by way of transfer of title. Instead, the land is handed over by the owner to the developer for the development of the real estate. Therefore, title of land is generally not transferred in favour of the developer. The land owner executes power of attorney in favour of the developer, granting all rights of development, inter alia, including the right of representation and obtaining the permission of various regulatory authorities and hands over the possession of land for the purpose of development and construction. Further, power of attorney is executed by the owner of land in favour of developer or his nominee for marketing and selling of the developed units in the project.
It is a unique situation in joint development arrangement that the developer gets the right to transfer the ownership/title deed of the developed unit including the undivided portion of the land attached with the developed unit without acquiring the title of the land transferred in its name by way of execution of the conveyance deed. The ownership of the land is generally vested in the developer in accordance with the provision of section 53A of the Transfer of Property Act, 1882.
Rights are usually granted by the owner of the land to the developer for marketing the project and receiving the sale consideration from the customers. The financing of the project and payment of the consideration to the land owner is done by the developer by pre launching of the project, entering into agreement with the buyers for the developed units in the project and receiving advance and further construction-linked payment from the customers. In certain cases, it may be agreed between the parties to keep the sale proceeds in a joint account to be shared by both of them in the agreed ratio.
It is very significant as to in what manner, the terms regarding granting of the marketing rights and conveying the title of the developed property to the customers are drafted in the joint development agreement, which will eventually decide the relationship, mutual rights of the owner and the developer and the tax implications flowing therefrom. It is significant as to at what point of time and in what manner, the developer gets the right to transfer ownership of the developed units to the customers which may eventually decide the transfer of ownership rights of the land from the owner to the developer which in turn would have the tax consequences.
In a joint development agreement, right in the nature of license is granted by the land owner to the developer to enter upon the plot of land for the purpose of development. It is the essence of the joint development arrangement to hand over the possession of the land for the purpose of undertaking construction and development of the project. Further in most cases, possession of the land is given not only for the development of the project but for all other purposes, inter alia, including for selling the developed units in the project to the customers and transferring the ownership rights of the developed units to the customers.
It is significant as to in what manner the terms regarding the handing over the possession of the land to the developer are drafted in the joint development agreement, as such stipulation would have far reaching implications to decided the point of time of taxability regarding the transfer of land in the hands of the land owner.
Developer gets the right to develop the project as residential or commercial units, to prepare the overall plan and to get the map sanctioned from the regulatory authorities, to carry out the construction himself or by engaging other contractors/sub-contractors, to develop various utilities such as water, sewerage, power etc. and further to develop the maintenance system.
Generally, all the managerial responsibilities for the development and marketing of the project are undertaken by the developer. However, in certain cases, some of the responsibilities may be shared by the owner or his consent may be required before taking major decisions.
The land owner may get the sale consideration for the land in different manner, as per the terms decided between both the parties such as:
1. Refundable/non-refundable security/advance money at the initial stage
2. Lump sum amount of consideration to be received at different stages
3. Sharing of sale revenue generated as per mutually agreed ratio
4. Sharing of constructed/developed area as per mutually agreed ratio
5. A different combination of all or any of the above.
Permission for mortgage of the land may be given by the land owner so as to enable the developer to raise the funds for the development, by way of creating the charge on the land. The permission for mortgage may be granted on the entire land or the proportion of the land falling to the share of the developer.
There may be different kind of stipulations as may be agreed between the parties regarding the fate of the project and payment/repayment of further consideration or compensation in case of breakdown or termination of the agreement.
In joint development arrangement, land owner contributes his land with a view to fetch better price for which he may agree to get the sale consideration in installments in future or in kind by way of getting some portion of the developed units in the project. One of the primary considerations which remain in the mind of the land owner is that he should get the sale consideration of his land in cash or in kind, present value of which is higher than the amount of sale consideration that he can get by way of open market sale of the land.
The land owner in such a situation is actually an investor and not an entrepreneur.
The developer undertakes the project as entrepreneur who undertakes the risks of business and at the same time gets rewards keeping in view the prevailing market and economic conditions. The developer collaborates with the land owner since he does not have the sufficient funds to invest in acquisition of land which constitutes major part of investment in real estate project. The developer makes payment to the land owner out of generation of sale consideration of real estate from the customers by way of initial booking amount and further construction linked payments.
In effect, a Joint Development Agreement is in the nature of joint venture between the land owner and the developer. There is no hard and fast rule regarding terms and conditions of Joint Development arrangement to be decided between the parties. The terms and conditions of such agreement may be decided by the parties depending upon various factors such as need and relationship of the parties, commercial considerations, goodwill and reputation of the developer, tax considerations etc.
From the point of view of accounting treatment and attraction of income tax liability, a real estate project developed as per JDA is unique and distinct from other normal transactions of purchase and sale of goods, due to which complex accounting and tax issues do emerge. An attempt is being made in this book to discuss and try to resolve such issues. The peculiarity of such transactions may be for the following reasons:
1. Real estate project takes several years in completion covering several accounting years.
2. The monetary size of real estate transactions is very large involving huge sum of money including huge tax amount. The financial stakes of both the land owner and the developer are quite high. Development of real estate project involves high degree of business risks and rewards.
3. Sale agreement of the real estate unit is entered with the customer when the real estate is under development and the real estate unit/flat does not come into existence.
4. Development of real estate project involves different stages such as pre launch, booking of the unit, entering into developer-buyer agreement, handing over possession, conveyance of sale deed etc.
5. Generally, Joint development agreement for the development of the real estate project is drafted in complex manner using different kind of variants for sharing costs and revenues of the project and defining rights and obligations of different parties under the agreement.
6. Since the completion of the real estate project takes several years, the economic market conditions keep on fluctuating and the project may not sail through smoothly, which may create hindrance and delays in completion of the project. Due to paucity of funds developer may not be in position to make timely payment of consideration as agreed with the land owner. It may give rise to the disputes of different nature between the parties.
7. Sometimes there may be breakdown or termination of the joint development arrangement between the parties due to fluctuating market conditions and disputes of varying nature arise between them.
8. The law regarding transfer of ownership of property under civil law and the transfer of capital asset recognized under the Income-tax Act do have different parameters.
9. In the process of development of the real estate project, certain intangible rights may also be created which in itself may create a transferable intangible asset.
10. Accounting and tax issues are not fully converged and at times, may be at variance with each other.
11. There is no regulatory authority or specific and effective law to regulate real estate industry and real estate developers.
12. In the case of real estate transactions, it has been seen in practice that huge amount of cash dealing out of the books are also detected on investigation by the authorities.
13. There is conflict of interest of the land owner and the developer in drafting JDA so as to protect their respective interests which makes drafting of JDA a complex and cumbersome exercise.
Complex nature of real estate transactions and cautious drafting of joint development agreement from the point of view of both the parties may result in real substance of the transaction distinct from its form due to which several disputes of different nature may arise between the parties.
Drafting of a joint development agreement is a highly specialized job. Both the parties have to ensure that inbuilt safeguards are incorporated to take care of their respective interests. Joint Development Agreement should be drafted in a manner so as to have, inter alia, clarity of terms as agreed between the parties, protection of interests of both parties, legal enforceability in case of need, fair exit-route for both the parties in case of any dispute having regard to tax considerations & implications. While drafting Joint Development Agreement, the following points should be carefully observed, which may have legal and tax implications of wide ramifications:
1. In what manner and at what point of time, ownership rights of the land are transferred by the land owner to the developer so as to decide the capital gain tax liability in the hands of the land owner.
2. Whether possession of the land is handed over to the developer in a manner so as to grant license to enter upon and possess land only for the development or the developer enjoys the possession of the land beyond that. Whether there is transfer of ownership/beneficial rights in the land in terms of the provisions of the Transfer of Property Act, 1882.
3. Whether exclusive rights to sell the developed real estate units and enter into buyers’ agreement with the customer are granted to the developer under Joint Development agreement or as per other document executed between the land owner and the developer.
4. In what manner sale consideration of the land is determined and paid by the developer to the land owner. Whether sale consideration is determined in monetary terms or in kind or as combination of both and how the timing of the payment of the consideration is settled between them.
5. Whether rights and authority to mortgage the land is granted to the developer to avail the credit facilities from the banks against the security of the land.
6. In what manner and at what point of time, legal title or ownership right of the developed unit is acquired by the customers.
7. Alongwith the JDA, what kind of other documents, e.g. Power of Attorney, Supplementary Agreement, Memorandum of Understanding, etc. are required to be executed between the land owner and the developer determining or altering their rights & obligations and tax liability under the Income-tax Act and various other laws.
8. Whether the terms provided in Joint Development Agreement may result into creation of a separate legal entity or joint venture in the form of Association of Persons (AOP) or otherwise.
9. Whether any kind of principal-agent relationship or partners’ relationship is created between the parties so that the action of one party may affect the rights and obligations of the other party.
10. Applicability and planning of liability under other tax laws, e.g. Service Tax, VAT, Sales Tax, Stamp Duty etc.
11. Whether the terms of Joint Development Agreement result into conversion of the land in the hands of the land owner from capital asset to business asset which may alter the chargeability of tax liability in his hands altogether.
12. Whether there are adequate terms in Joint Development Agreement providing dispute resolution mechanism and exit route to both the parties in case the real estate project does not take off in the desired manner.
In the case of joint development arrangement of real estate, significant accounting and income tax issues may emerge which have serious bearing of the tax liability on the owner of land as well as on the developer of the project.
1. In a case when owner enters into joint development arrangement with the developer, the land in the hands of owner remains as capital asset or business asset and the consideration for land received by the owner is to be taxed as capital gain or as business income?
2. Applicability of the provision of section 45(2) and determination of tax liability under the Income-tax Act in case capital asset is converted into business asset in the case of land owner?
3. At what point of time, “transfer” of land takes place and income is to be recognized by the land owner in both the situations, when land is treated as capital asset or business asset particularly keeping in view the provisions of section 2(47) defining transfer in the case of capital asset?
4. How is the sale consideration of the land to be determined, particularly when consideration is determined partially or fully in a manner other than in monetary terms?
5. In case land transferred by the land owner is agricultural land, what would be the tax liability/implications thereof?
6. Taxability and various other issues arising out of deeming provisions of income under sections 45(2), 50C, 50D and 56 of the Income-tax Act?
7. Availability of exemption from the capital gains as per the provisions of sections 54 to 54F of the Income-tax Act?
1. In what manner revenue is to be recognized and income is to be offered for taxation by the developer?
2. Whether income should be recognized following Completed Contract Method (CCM) or Percentage Completion Method (PCM) keeping in view the applicability of Accounting Standard (AS) 7 & AS 9 and the Guidance Note issued by the Institute of Chartered Accountants of India (ICAI)?
3. Impact of the provisions of section 145 of the Income-tax Act with respect to the method of accounting followed in the preparation of financial statements?
4. Significance of using estimates for accounting purpose and applicability of the principle of matching concept for recognition of income?
5. Whether future losses recognized in accordance with the accounting principles of AS 7 are allowed as expenditure under the Income-tax Act?
6. Allowability of borrowing cost, sale commission & advertisement expense as period cost or as part of project cost?
7. Bearing of estimates and foreseeable losses on determination of MAT liability?
8. Taxability and various other issues arising out of deeming provision of income under section 43CA of the Income-tax Act?
1. Applicability of Accounting Standard 9 (AS 9) read with the Guidance Note for Real Estate Transactions (Revised 2012) and Accounting Standard 7 (AS 7) issued by ICAI in the case of owner as well as developer?
2. Issues regarding Recognition of Revenue for a particular accounting year and determination of assets and liabilities at the end of the accounting year.
3. Developer is required to follow Percentage Completion Method (PCM) or Completed Contract Method (CCM) of accounting?
4. Application of the principle of prudence & matching concept in the case of accounting for real estate developers.
5. Manner in which use of estimates is to be done for revenue recognition?
6. Manner of recognition of future losses?
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