2025 (8) TMI 1413 - AT - Income Tax

Development agreements treated as licence under section 52; not a 'transfer' under section 2(47)(v), no capital gains

Dy. CIT, Circle-1, Ghaziabad Versus M/s. Devidayal Aluminium Industries Pvt. Ltd. And (Vice-Versa)

Dy. CIT, Circle-1, Ghaziabad Versus M/s. Devidayal Aluminium Industries Pvt. Ltd. And (Vice-Versa) - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether development agreements executed by the assessee with a developer amounted to a 'transfer' within the meaning of section 2(47)(v) of the Income-tax Act, thereby attracting capital gains treatment under section 45(2) upon conversion of land into stock-in-trade. 2. Whether advances, security deposits and amounts credited to escrow arising from the said development agreements are taxable as business income in intervening assessment years prior to completion/settlement of projects. 3. Whether ongoing commercial disputes, litigation and arbitration affecting project completion preclude accrual of taxable income on account of the development agreements prior to final settlement. 4. Whether the assessee was obliged to adopt fair market value at date of conversion of capital asset into stock-in-trade for computing income in the year of conversion, and whether conversion triggered immediate assessment under section 45(2). 5. Whether interest under section 234C for non-payment/shortfall of advance tax is exigible for the impugned assessment year where transfer/assessment event is alleged to have arisen only upon later completion/settlement. 6. Whether penalties under section 221 (penal consequences for default in payment of tax) are sustainable where underlying additions/assessments founded on the alleged transfer are reversed. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Whether development agreements constituted a 'transfer' under section 2(47)(v). Legal framework: Section 2(47)(v) defines 'transfer' to include certain arrangements conferring rights to enjoy immovable property; section 45(2) deals with capital gains on conversion of capital assets into stock-in-trade. Principles of part performance (section 53A, Transfer of Property Act) and the distinction between license/permissive rights and transfer of title/possession are relevant. Precedent treatment: The Tribunal relied on precedents holding that mere permissive licence or developer acting as confirming party, without transfer of title or legal possession, does not amount to transfer under section 2(47)(v). The Court considered decisions distinguishing transfer from contractual/licence arrangements and affirmed that development agreements not conveying title/possession cannot be treated as transfer. Interpretation and reasoning: The Court examined the clauses of the development agreements (notably clause providing developer right to enter for measurements/preparations while legal possession remains with owner, and clause making developer a confirming party for sale deeds). The Tribunal found that (i) legal title and possession remained with the landowner; (ii) the developer was granted limited permission for development activities rather than transfer of possession or title; (iii) such arrangement resembles a licence (easement/permission) and does not satisfy requirements of section 2(47)(v) or attract part performance under section 53A. The Tribunal also noted subsequent commercial disputes and arbitration, undermining certainty of completion and transfer. Ratio vs. Obiter: Ratio - where development agreement does not convey title or legal possession and merely confers limited permission to enter or act as confirming party, it is not a 'transfer' under section 2(47)(v) and does not trigger capital gains under section 45(2) on conversion. Obiter - observations on legislative response (introduction of section 45(5A) by Finance Act, 2017) and general commentary on industry practice and accounting treatment. Conclusions: The Tribunal concluded that the development agreements in question did not constitute a transfer within section 2(47)(v). The CIT(A) was correct in reversing the Assessing Officer's treatment that led to assessment of capital gains/business income in the earlier assessment years. Issue 2 - Taxability of advances, security deposits and escrow receipts as business income prior to project completion. Legal framework: Income accrues on the basis of accrual principle and method of accounting regularly employed (section 145). Taxability of advances depends on whether rights to income have accrued and whether commercial certainty exists; AS-7 principles and accounting practice for developers may be relevant. Precedent treatment: Tribunal relied on authorities holding that advances received under development agreements where no sale or transfer took place cannot be brought to tax as income of the year of receipt; expected profits unrealized prior to exercise of rights or completion are not taxable on mere expectation. Cases distinguishing accrual from realization and permitting taxation only upon reasonable certainty or completion were followed. Interpretation and reasoning: The Tribunal observed that (i) the assessee followed mercantile accounting; (ii) receipts were shown as security deposits/advances and ultimately accounted as income upon final settlement (in assessment year where projects attained finality); (iii) in the absence of transfer or final settlement, there was no reasonable certainty of accrual of taxable income; (iv) ongoing litigation/arbitration further negatived reasonable certainty; (v) therefore the Assessing Officer's adoption of receipt basis for part of business and assessing amounts from escrow in earlier years was contrary to law and accepted accounting practice. Ratio vs. Obiter: Ratio - advances/security deposits under development agreements where no transfer or reasonable certainty of project completion exists are not taxable as business income in intervening years; taxation may arise on final settlement/completion when income accrues. Obiter - comparison with cases where revenue recognition on execution of registered conveyance/deed is appropriate. Conclusions: Advances and escrow amounts received prior to project completion were not taxable as business income in the impugned earlier assessment years; amounts were properly brought to tax in the year of final settlement (assessment year 2015-16 for two projects), and the Assessing Officer's additions for earlier years were deleted. Issue 3 - Effect of litigation/arbitration and absence of reasonable certainty on accrual of income. Legal framework: Accrual of income requires reasonable certainty; unsettled litigation impacting the ability to complete transactions may prevent accrual. Established doctrine separates contingent/anticipated profits (not taxable) from realized/accrued income. Precedent treatment: The Tribunal placed weight on precedent distinguishing accrual of income in presence of litigation - anticipated profits not taxable until rights are exercised or settlements are final. Interpretation and reasoning: The existence of commercial disputes culminating in arbitration and Supreme Court involvement (reference to arbitration award timeline) indicated lack of reasonable certainty that the development agreements for the relevant projects had crystallised into rights giving rise to taxable income during the earlier years. This supported the conclusion that accrual had not occurred prior to final settlement. Ratio vs. Obiter: Ratio - ongoing disputes/arbitration that render realization uncertain prevent accrual and taxation of anticipated profits. Obiter - none beyond general application of accrual principle. Conclusions: Litigation/arbitration prevented accrual of taxable income in earlier years; taxation upon final settlement was appropriate and accepted by Revenue for completed projects. Issue 4 - Obligation to adopt fair market value on conversion and applicability of section 45(2). Legal framework: Section 45(2) prescribes computation of capital gains where capital asset is converted into stock-in-trade; it requires adoption of fair market value at conversion date in certain circumstances. However, applicability presupposes a transfer event as defined. Precedent treatment: Tribunal considered precedents holding that section 45(2) applies only when conversion leads to sale/transfer and that absent a transfer event (section 2(47)(v)), there is no immediate capital gains consequence. Interpretation and reasoning: Since development agreements were not transfers, the convert-to-stock argument did not attract immediate section 45(2) consequences. Further, where conversion is relevant, adoption of market value for computation is required in the year of sale; but the Tribunal found no obligation to adopt market value in the earlier years where no transfer/realization occurred. Ratio vs. Obiter: Ratio - section 45(2) and fair market value computation arise only where conversion and transfer conditions are met; absent transfer, section 45(2) is not triggered. Obiter - commentary on accounting practice and recognition timing. Conclusions: No requirement to adopt fair market value for computation in the impugned earlier years because the conditions giving rise to section 45(2) did not apply. Issue 5 - Liability to interest under section 234C for advance tax instalments where transfer/assessment event occurred later. Legal framework: Section 234C prescribes interest for deferment/shortfall in advance tax installments; applicability depends on tax liability being determinable in the relevant instalment periods. Precedent treatment: The Tribunal relied on the factual finding that tax liability on account of development agreements accrued only upon project completion/settlement (recognized in assessment year 2015-16). Interpretation and reasoning: Given that taxable income on account of the projects was only assessed in assessment year 2015-16 (completion date 17.02.2015), the question of liability to interest for earlier advance tax instalments requires fresh computation by the Assessing Officer consistent with the finding on accrual/taxability. The Tribunal therefore restored the interest issue to the AO for recomputation and factual verification. Ratio vs. Obiter: Ratio - where tax liability is found to arise only upon later event, interest under section 234C must be recomputed in light of correct timing of accrual. Obiter - none significant. Conclusions: Interest under section 234C was not summarily sustained; matter remitted to Assessing Officer for recomputation based on the Tribunal's findings regarding timing of accrual. Issue 6 - Sustainabilty of penalties under section 221 where underlying assessments are set aside. Legal framework: Penalties for default in payment are contingent upon existence of tax liability; if underlying additions/assessments are deleted, consequential penalties lack foundation. Precedent treatment: Tribunal applied the principle that penalties fall with the deletion of the tax demand that gave rise to alleged default. Interpretation and reasoning: Because the Tribunal reversed the Assessing Officer's additions and held that taxability did not arise in the earlier years, penalties levied under section 221 for non-payment/default were without foundation and were therefore to be deleted. Ratio vs. Obiter: Ratio - consequential penalties cannot be sustained where the principal tax liability is vacated. Obiter - none. Conclusions: All section 221 penalties imposed in the impugned years were reversed.