Realty Investors Take Equity Route To Offset Tax Burden

Though the realty sector has been hit by the general economic slowdown, smart property investors, who raked in the moolah when the going was good, made use of the equity markets to reduce the tax they paid on those gains.

According to tax consultants, people whose income is derived from other sources, say a salaried employee, can and have in the past offset derivatives losses against short-term capital gains made in property transactions to reduce tax incidence on the property gains.

Gains from property are deemed short-term if they are held for less than three years. Once a derivatives loss is offset against the gain, the balance short-term capital gain is clubbed with the salary income and taxed at the normal rate.

Tax experts, like Ernst and Young director (financial services) Sameer Gupta, point out that in the context of shares, Central Board of Direct Taxes (CBDT) issued a circular in June 2007 laying down the tests for distinction between shares held as stock in trade vis-a-vis those held as investment.

Some of these tests include the scale and frequency of the transactions, whether owned funds or borrowed funds were utilized for the transactions, the accounting treatment, the motive behind entering into the transactions, etc. They add the tests are indicative and not decisive, and need to be examined on a case-to-case basis, including their applicability to futures transactions.

“It may be argued that a gain or loss arising from an exchange-traded futures transaction (NSE/BSE F and O) is in the nature of a short-term capital gain or loss as a person buying or selling a futures contract is creating a right or interest (in buying/selling a specific number of shares on a net settlement basis) and that when this right/interest is transferred by way of squaring off the transaction, there is a capital gain or a loss,” said E and Y’s Gupta.

Other tax experts buttress this argument by pointing out that a capital asset in the Income-Tax (IT) Act means property of any kind held by an assessee, whether or not connected with his business or profession.

“Under Sec 2 (47) of the I-T Act, a transfer in relation to a capital asset is defined as including the sale, exchange or relinquishment of the asset or extinguishment of any right therein or the compulsory acquisition thereof under any law. The word property used in Sec 2 (14) of the I-T Act is a word of the widest amplitude and the definition has re-emphasized this by the use of words “of any kind”. Thus any right which can be called property will be included in the definition of capital asset,” said senior vice-president (finance) of Tata Sons FN Subedar, drawing attention to a Bombay High Court decision in Tata Services versus Commissioner of Income-Tax case of 1979.

The implication of this is that a derivatives contract entered into by a person, and not held as stock in trade, is a capital asset and that when the futures contract is settled, the accrued gain or loss arising from the settlement of the contract is a capital gain or loss, added Mr Subedar.

Interestingly, while derivatives losses can be genuine, as is likely to be the case over the past nine months which has seen the Sensex declining by 38%, investors can also buy losses in a structured deal with brokers in order to set off the derivatives loss against the short-term capital gain arising on sale of immovable property in the same financial year.

Share brokers say this, though illegal, is not an unknown market practice. They are also quick to point out that structured deals wherein one party buys a loss while the other books a gain is restricted to the ‘unscrupulous’ variety of brokers and is not prevalent among reputed and big institutional and retail brokers.

Explaining the modus operandi of such transactions a broker said this practice was prevalent in the case of Nifty futures. Say, investor A wants to buy a loss and investor B wants to book a profit. The broker punches in a buy and sell order, respectively, on two different terminals using A’s client code for both the transactions (buy and sell).

Depending on how the index moves, the transaction can be squared off on the same day and the client code changed when the transaction is reversed. For instance, if investor A has bought and the Nifty futures move down, the broker changes the client code for the sell transaction by replacing A’s client code with B’s code. At the end of the transactions the broker is paid a commission by both parties to the deal.

Orbit Corporation MD Pujit Aggarwal says realty investors could make good profits even before construction is complete. For example, an investor gives a down payment of Rs 10 lakh for a property worth Rs 1 crore, construction of which will be complete in two years.

However, if the valuation of the property changes in six months to Rs 1.2 crore, the investor could sell it and make a cool profit of Rs 20 lakh on an investment of Rs 10 lakh. “This mostly happens when realty market is on a high,” Mr Aggarwal said.

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  1. Posted October 1, 2008 at 1:59 am | Permalink

    Developers such as Unitech, Peninsula Land, HDIL and Future Capital, the financial services arm of the Future Group, are in talks with investors including some leading private equity funds for raising investments for their projects, after the collapse of Lehman Brothers, whose third party fund, Lehman Brothers Real Estate Partners had committed an investment of over $ 1 billion to these companies. Even the private equity players are equally upbeat about property investments. Mr. Bharath Banka, Chief Executive of Aditya Birla group’s private equity division, “The current credit crisis, which is expected to continue for a few more months, opens up avenue for private equity firms to make large investments in the real estate sector. Long term returns will be higher in real estate for investments made during this point of economic cycle.”For more view-

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