Property owners face a double whammy

Property owners face a double whammy
The Hindu Business Line, July 18, 2009, Page 5

Your negotiating skills as a property buyer may be of no use going by the amendments proposed by the Budget to Section 56 of the Income-Tax Act, 1961.

While a property seller will pay long-term capital gains tax on the sale proceeds, from October 1, 2009, the buyer is to be taxed on the difference between the fair market value (as mentioned in the real estate ready-reckoner or set by the district valuation officer) and the lower negotiated sale value.

The amendment to Section 56, according to tax practitioners, presumes that there is a nexus between the buyer and the seller to evade tax even if a distressed seller sells at below market rates (or fair market value) or a buyer manages to drive a good bargain.

The Income-Tax Department has defined property to include immovable property (land, building or both), and movable property such as shares, securities, jewellery, archaeological collections, drawings, painting, sculptures, or any work of art.

Consider this scenario: Suppose a property bought for Rs 20 lakh in 2000 is sold by the owner in an emergency situation at Rs 45 lakh on or after October 1, 2009 against the fair market value of the property of Rs 50 lakh.

According to the existing rules, only the seller has to pay a long-term capital gains tax (at 10 per cent) of Rs 2.5 lakh under Section 50C of the Income-Tax Act, 1961. Capital investments are considered long-term if the holding period is three years or more.

With the proposed amendment, the buyer (if he/she falls in the 30 per cent income-tax slab) would also have to pay the exchequer Rs 1.5 lakh, that is, the difference between the fair market value (Rs 50 lakh) and cost of acquisition (Rs 45 lakh).

Now, should the buyer sell the property after, say, three years, for Rs 1 crore, his/ her acquisition cost will be reckoned as Rs 45 lakh and not Rs 50 lakh, and he/she (as seller) will have to pay long-term capital gains tax on Rs 55 lakh.

Double Whammy

"It's a double whammy for property buyers," said Shravan V Sharma, chartered accountant. The fair market value as determined by the ready-reckoner, according to Sharma, is arbitrary.

It uses the same yardstick to determine property rates for both a dilapidated and a relatively new building in the same locality in a city like Mumbai.

Vaibhav Manek, partner, KAV & Co, said, "Fair market value ideally indicates the willingness of a buyer and a seller to settle a property transaction at a mutually agreed price. If a buyer manages to negotiate the property price at a lower rate then there is no reason why the difference between the fair market value and the lower negotiated price should be deemed his/her income and be subject to tax."

Manek suggested that it would be better if a safe harbour clause was introduced under Section 56 whereby the buyer can prove to the authorities that he/she actually paid a lower price for the property.