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Owing to the large population, there is always a huge demand for real estate in India and demand mostly overtakes supply. This demand and supply correlation and the desire in people to own more leads to inflation in the value of the real estate and in turn means huge gains in the hands of the seller. It is unlikely that such gains fall out of the tax bracket.
Nov 2020 update:
The Finance ministry increased the safe harbour rate under section 43CA of income tax, i.e the rate of variation that will be allowed between the actual sale consideration value and stamp value of the property is increased from 10% to 20%.
The income tax law has broadly classified incomes into 5 different categories for taxation purpose. One of the categories is ‘Capital gains’.
Capital gains are income on sale of any capital asset in the hands of seller. Capital asset is defined to include various assets including real estate. So, any gain on sale of land or building by the owner is taxable as capital gain.
Sale consideration reduced by cost of acquisition (indexed cost of acquisition for land or building held for more than 24 months) is taxable as capital gain.
Over a period of time, just like any other tax provision, there were certain tax evasion measures adopted by parties to the transaction, in capital gain taxation of land or building as well.
People started understating the value of properties in the sale agreement and paying a substantial part of the consideration in cash in order to reduce tax liability in the hands of the seller which in turn led to a loss to the Government and unaccounted black money in the society.
In order to curb such large scale undervaluation of real estate and to bring unaccounted money into the tax net, the Government introduced Section 50C by Finance Act, 2002.
Section 50C is applicable only to land or building or both. Section 50C uses value adopted by the Stamp Valuation Authority (SVA) for the purpose of levying stamp duty on registration of properties, as guidance value to determine undervaluation of land or building if any in the sale agreement.
In case sale consideration received or claimed to be received by seller on sale of land or building or both is less than value adopted by stamp valuation authority, such value adopted by SVA would become actual sale consideration received or accruing to the seller. Therefore, capital gain would be Valuation as per stamp valuation authority reduced by cost/indexed cost of acquisition.
However, Budget 2018 has brought about an amendment in section 50C whereby no adjustments shall be made in a case where the variation between stamp duty value and the sale consideration is not more than five percent of the sale consideration. This has been introduced in order to minimize hardship in case of genuine transactions in the real estate sector.
The Finance ministry increased the safe harbour rate i.e the rate of variation that will be allowed between the actual sale consideration value and stamp value of the property to 20% from 10%.
While there can be varied genuine reasons between the parties for having transaction of sale of land or building for a consideration lower than the value adopted by SVA, Section 50C provides safeguard only against fluctuation in the value of property caused due to considerable gap between different stages of transaction of sale.
To explain this further, there have been litigations in the past in cases where the value of the asset on the date of agreement to sell and actual sale differs due to economic factors such as demand and supply.
In such cases, considering the value adopted by SVA as sale consideration would cause undue hardship to taxpayers by compelling them to pay tax on something that is never received.
In order to remove this anomaly in the law, Finance Act 2016 amended Section 50C. As per the amendment, in case the date of agreement fixing the sale consideration and actual date of registration of sale of land or building is not the same, the value adopted by SVA as on the date of agreement can be taken as sale consideration.
However, in order to avail this benefit, at least a part of sale consideration is received by way of account payee cheque or bank draft or ECS on or before date of agreement of transfer. This amendment provides relief to taxpayers involved in sale of land or building as generally negotiations take considerable amount of time.
There is a possibility that the value adopted by SVA may not be depicting the Fair Market Value (FMV) at all times or the seller himself may not be satisfied with the value adopted by SVA based on factors known to him.
Though, stamp duty is generally borne by purchaser, the purchaser may not be very concerned with the value adopted by SVA given that the amount he would be shelling out by way of stamp duty would be meagre compared to cost of purchase.
However, it makes a huge difference to the seller as it impacts his income tax which can be substantial based on the value. If stamp duty is not borne by the seller, he may not be to question or contend the value adopted by SVA before the valuation authorities.
As it is a matter of income tax for the seller, he is allowed to question the value adopted by SVA and claim the value is more than FMV under Section 50C before the income tax authority unless such value is already questioned before any other authority or court.
In such cases, income tax officer is required to make a reference to valuation officer and market value will be determined by such valuation officer. Valuation officer, while determining market value, has to call for records/documents from taxpayer if required and give taxpayer an opportunity of being heard and pass an order in writing, stating his valuation. Any value determined by the valuation officer can also be questioned before higher authorities.
To determine the market value, a valuation officer is provided with a reference to benefit the taxpayer and save him from undue hardship. Such reference provided to the valuation officer does not impact the taxpayer in a negative way. Even when a reference is made to valuation officer, the value determined by valuation officer or adopted by SVA, whichever is lower will be taken as sale consideration for computing capital gains.
For example, if value adopted by SVA is Rs 12,00,000 as against Rs 8,00,000 sale consideration claimed to be received by seller and value determined by valuation officer is Rs 15,00,000, sale consideration as per Section 50C will be Rs 12,00,000.
In the same example if value determined by valuation officer is Rs 10,00,000, sale consideration for the purpose of capital gains will be Rs 10,00,000.