An Insight on Development Rights Agreement

All About Development Rights Agreement

1. Meaning

A popular mode of developing property, especially in Mumbai, is by way of an Agreement granting Development Rights, popularly known as “Development Agreement” or “DA”. DAs are the by-products of outdated legislations such as the Urban Land Ceiling Regulation Act. The owner of the land grants development rights to a builder /developer to carry out various activities such as, to:

(a) obtain the necessary permissions

(b) construct the building

(c) market and sell the flats

(d) receive the consideration and

(e) form a society / association of flat purchasers

Thus, while the owner retains the possession of the land, he gives a licence to the builder to enter upon his land, construct the building and market and sell the flats so constructed. DAs are increasingly accepted because of their many advantages both for the owner and the developer. The developer does not have to block huge funds in buying the land and thereby he can improve his cash flow. He may pay a DA premium but it would be significantly lower than buying the land on an outright basis. This is one of the biggest advantages of a DA structure. As regards the owner of the land, he gets an opportunity to share in the profits of the development. With real estate prices touching all-time highs, most owners do not want to lose out on the potential gains they can make from selling the flats. Thus, in several cases, a DA is a win-win situation for both parties.

2. Consideration for DA

In consideration for the above rights, the owner may be given a lump sum consideration. However, in several cases, the owner shares the constructed area or shares a percentage of the profits from the development with the developer.

3. Kapadia’s judgment

The Bombay High Court in the case of Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom) has threadbare examined the concept of a DA in the context of the point of taxation of the land owner. It looked at whether a DA can be treated as a part performance of a contract u/s. 53A of the Transfer of Property Act. The court has laid down the following 6 conditions necessary to attract s.53A of the Transfer of Property Act:

(a) there should be a contract for consideration;

(b) it should be in writing;

(c) it should be signed by the transferor;

(d) it should pertain to immovable property;

(e) the transferee should have taken possession of the property; and

(f) the transferee should be ready and willing to perform his part of the contract.

It further held that if under the Development Agreement a limited power of attorney is intended to be given to the Developer and even if the actual power of attorney is not given, then the date of such Development Agreement would be relevant to decide the date of transfer u/s. 2(47)(v) read with s.53A of the Transfer of Property Act. For this purpose, the date of the actual possession or the date on which substantial payments are made would not be relevant. If the contract as a whole indicates passing of or transferring complete control over the property in favour of the developer, then the date of the contract would be relevant to decide the year of chargeability. In this case the Court held that the conditions of s.53A were fulfilled and hence, capital gains tax was attracted u/s. 2(47)(v) of the Income-tax Act.

4. DA or Partnership or AOP

4.1.In several cases, the owner and the builder enter into a profit sharing arrangement, which is quite similar to that under a partnership. An issue in such a case would be, whether the arrangement is one of a Development Rights Agreement or is a partnership? The income-tax and stamp duty consequences on the owner and the developer would vary depending upon the nature of the arrangement.

4.2.S. 6 of the Indian Partnership Act is relevant for this purpose. It provides that the sharing of profits or of gross returns arising from property by persons holding a joint or common interest in the property does not of itself make such persons partners. The relevant extracts are given below :

“6. Mode of determining existence of partnership.- In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together.
Explanation I. – The sharing of profits or of gross returns arising from property by persons holding a joint or common interest in that property does not of itself make such persons partners.
Explanation II.- The receipt by a person of a share of the profits of a business, or of a payment contingent upon the earning of profits or varying with the profits earned by a business, does not of itself make him a partner with the persons carrying on the business; and, in particular, the receipt of such share or payment –

(a)by lender of money to person engaged or about to engage in any business,

(b) by a servant or agent as remuneration,

(c) by the widow or child of a deceased partner, as annuity, or

(d) by a previous owner or part-owner of the business, as consideration for the sale of the goodwill or share thereof,

does not of itself make the receiver a partner with the persons carrying on the business.”

4.3.In addition to profit sharing, mutual agency is also a key condition of a partnership. Each partner is an agent of the firm and of the other partners. The business must be carried on by all or any partner on behalf of all. What would constitute a mutual agency is a question of fact.

Recently, the Bombay High Court in the case of Sanjay Kanubhai Patel, 2004 (6) Bom C.R. 94 had an occasion to directly deal with this issue. The Court after reviewing the Development Rights Agreement, held that it is settled law that in order to constitute a valid partnership, three ingredients are essential. There must be a valid agreement between the parties, it must be to share profits of the business and the business must be carried on by all or any of them acting for all. The third ingredient relates to the existence of mutual agency between the concerned parties inter se. The Court held that merely because an agreement provided for profit sharing, it would not constitute a partnership in the absence of mutual agency.

4.4.In some cases, the income-tax may also contend that it is not a DA arrangement but an Association of Persons or an AOP and hence, it is the AOP which should be taxed. This stand may have several repercussions under the Stamp Act, deduction u/s. 80-IB(10), etc. It is important to note that unlike in the case of a partnership, the condition of mutual agency is not necessary in the case of an AOP.

4.5.From the above discussions, it would be clear that a proper structuring of the transaction and a proper drafting of the relevant documents is essential to achieve the desired results.

5. Stamp Duty

5.1.In Maharashtra, under the Bombay Stamp Act, 1958, a DA attracts stamp duty @ 1% of the market value of the property. However, if stamp duty has been paid under Art.48(g) dealing with a Power of Attorney in respect of the same property, then stamp duty on a Development Agreement would only be Rs. 100.

5.2.The term “market value” is defined by s.2(na) of the Bombay Stamp Act to mean the higher of :

• the price which the property covered by the instrument would have fetched if sold in an open market on the date of execution of the instrument (which in other words means the Stamp Duty Ready Reckoner Value); or
• the consideration as stated in the instrument

5.3.The Gujarat Stamp Act also contains an express provision to this effect. The Stamp Acts of several other States do not contain an express provision for levying stamp duty on a DA.