Exemptions under Capital Gains U/s.54 & 54F with judicial analysis

There has been substantial increase in the sale of properties resulting in capital gain to the land owners giving the land to the developers and entering into Joint Development Agreement, receiving more than one flat from the builder and yet avoiding capital gains tax.  When a person is selling a residential flat in order to book profit he has to pay either short-term or long-term capital gain on the difference between the net sale consideration and the actual cost of acquisition. The Income-tax Act  has also specified various exemptions that are available on long-term capital gains. It is expected that a person who is dealing in the investment in real estate sector should be aware of these provisions in order to maximize his profit or pay only a minimum capital gain. Further, exemption is also available in respect of long-term capital gains arising from the sale of original capital asset ( not being a residential house), where the net sale proceeds are invested in the purchase of a new residential house (new asset) within the prescribed time-limits.

 Exemption from capital gain

  1. As per section 54 of the ITA, the capital gain arises from the transfer of a long-term capital asset (being buildings or lands appurtenant thereto), being a residential house, the income of which is chargeable under the head “Income from house property” shall be exempt to the extent such capital gain is invested in the purchase of another residential house property. According to section 54F any long-term capital gain arising to an individual or HUF from the transfer of any capital assets, other than residential house property, shall be exempt in full, if the entire net sales consideration is invested in purchase of a residential house.
  1. Sections applicable for claiming Capital gains exemption

Section 54 – Section 54 provides exemption to capital gains arising from the transfer of a residential house property (being building or lands appurtenant thereto, the income of which is chargeable under the head “Income from house property”)

In respect of the above section, following points should be noted:–

(1) Only an Individual or Hindu undivided family can claim exemption.
(2) Under section 54 exemption is available only if the capital asset which is transferred is a residential house property (i.e.,building or land appurtenant thereto) whose income is taxable under the head “Income from house property”. The exemption is available whether the residential house property is self occupied (in such a case income of house property is nil or negative) or let out.
(3) The house property which is transferred should be a long-term capital asset, i.e., held for more than 36 months.
(4) To claim the exemption the taxpayer will have to invest the capital gains either for the purchase of another residential house property (old or new) within a period of one year before or two years after the date of transfer or in the construction of another residential house property within a period of three years after the date of transfer.

If the whole of capital gains are invested in the cost of the house so purchased or constructed, the entire capital gains will be exempt from tax. If, however, the amount of capital gains is greater than the cost of the house so purchased or constructed, the difference between the two will be chargeable to tax. Exemption under section 54 can be availed even if the taxpayer owns more than one house on the date of transfer.

As per the provisions of section 54, if the new house property is transferred within a period of three years of its purchase or construction, the amount of capital gains arising therefrom, together with the amount of capital gains exempted earlier, will be chargeable to tax in the year of transfer as short term capital gains.

Capital Gain Account Scheme – Although as per section 54 the assessee is given 2 years to purchase the house property or 3 years for the construction of the house property, yet the capital gains on the transfer of the original house property is taxable in the year in which it is sold. The Income-tax return of that year is required to be submitted in the relevant assessment year on or before the specified due date for filing the Income-tax return. Hence, the assessee will have to take a decision for the purchase/construction of the house property till the date of furnishing of the income-tax return, otherwise the capital gain would become taxable.

To avoid the above situation, the Income-tax Act specifies an alternative in the form of deposit under the Capital Gains Account Scheme.

The amount of capital gain which is not utilised by the assessee for the purchase or construction of the new house before the date of furnishing of the Income-tax return should be deposited by him under the Capital Gains Account Scheme, before the due date of furnishing the return. In this case the amount already utilised by the assessee for the purchase-construction of the new house shall be eligible for exemption.

In case the assessee deposits the amount in the Capital Gains Account Scheme but does not utilise the amount deposited for the purchase or construction of a residential house within the specified period, the amount not so utilised shall be charged as capital gains of the year in which the period of 3 years from the date of sale of the original asset expires and it will be long-term capital gain of that previous year.

Section 54F – The ITA grants exemption of capital gains arising from the transfer of a long-term capital asset other than a house property under section 54F. The conditions to be fulfilled are as follows:-

(i) The assessee should be an individual or a Hindu Undivided Family (HUF).
(ii) The asset transferred should be any long-term capital asset but other than a residential house.
(iii) The assessee should have purchased, within one year before the date of transfer or two years after the date of transfer or constructed within three years after the date of transfer (or from the date of receipt of compensation in the case of compulsory acquisition), a residential house (hereinafter referred to as “new house”).
(iv) The assessee should not have sold or transferred the new house within three years of its purchase or construction.
(v) The assessee should not own on the date of transfer of the original asset more than one residential house (other than the new house). He should also not purchase within a period of one year after such date or construct within a period of three years after such date any residential house whose income is taxable under the head “Income from House property”(other than the new house).
(vi) The assessee also has the option of depositing this amount in Capital Gains Account Scheme as explained in section 54 above, before the due date of furnishing the Income-tax return.

 

Judicial Interpretations By Hon’ble Courts/Tribunals

Whether exemption under section 54 of ITA is available if capital gain arising from sale of more than one residential house is invested in one residential house? [Income Tax Appellate Tribunal order, in the case of Dy. CITv. Ranjit Vithaldas 2012 137 ITD 267/23 taxmann.com 226- mum 

In the above case the Tribunal held that no rulings had been brought on record by the counsel of Income Tax Deptt. to show that the capital gain arising from sale of more than one residential house could not be invested in one residential house. The provisions of section 54 as pointed out earlier apply to transfer of any number of residential houses by the assessee, provided the capital gain arising therefrom is invested in a residential house. The exemption under section 54 is available if capital gain arising from transfer of a residential house is invested in a new residential house within the prescribed time-limit. Thus, there is an inbuilt restriction that capital gain arising from the sale of one residential house cannot be invested in more than one residential house. However, there is no restriction that capital gain arising from sale of more than one residential house cannot be invested in one residential house. In case capital gain arising from sale of more than one residential houses is invested in one residential house, the condition, that capital gain from sale of a residential house should be invested in a new residential house, gets fulfilled in each case individually because the capital gain arising from sale of each residential house has been invested in a residential house. Therefore, it has been held that even if two flats are sold in two different years, and the capital gain of both the flats is invested in one residential house, exemption under section 54 will be available in case of sale of each flat, provided the time-limit of construction or purchase of the new residential house is fulfilled in case of each flat sold.

Whether exemption from capital gains is available if the assessee purchases two adjacent flats in the same building? [CIT v. D. Ananda Basappa – 2009 – 180 Taxman 4 (kar)

In the aforesaid case the Hon’ble Karnataka High Court observed that where the assessee had purchased two adjacent flats in the same building and made suitable modifications to treat them as a single residential unit, exemption under section 54 would be available in respect of investments made in both the flats.

Could exemption under section 54 be claimed in respect of more than one residential flat acquired by the assessee under a joint development agreement with a builder, wherein the property owned by the assessee was developed by the builder who constructed eight residential flats in the said property, four of which were given to the assessee? [CIT v. Smt. K. G. Rukminiamma (2011) 196 Taxman 87/(2010) 8 taxmann.com 121 

The assessee, the owner of a property, entered into a joint development agreement with a builder to develop the property. Under the agreement the builder constructed eight residential flats and handed over four residential flats to the assessee. The entire cost of construction and other expenses were borne by the builder. The issue under consideration was whether capital gains exemption under section 54 could be claimed in respect of the four residential flats treating them as “a residential house”? In this case, the Revenue contended that the benefit of section 54 could be availed only in respect of one residential flat and in respect of the remaining three residential flats, the assessee would not be entitled to deduction under section 54.

The Karnataka High Court, applying the decision in D. Anand Basappa (supra) to the present case, held that all the four flats were situated in the same residential building and, hence, would constitute “a residential house” for the purpose of section 54. Therefore, the assessee would be entitled to deduction under section 54 in respect of all four flats.

  Exemptions from capital gain under sections 54 and 54F can be claimed even if residential house is purchased outside India [Mrs. Prema Shah v. ITO (2006) 100 ITD 60 (mum) 

In the above case the Tribunal held that ” In short we are of the considered view for the reasons stated hereinabove, the assessee is entitled to the benefit under section 54 of the Act. It does not exclude the right of the assessee to claim the property purchased in a foreign country, if all other conditions laid down in the section are satisfied, merely because the property acquired is in a foreign country”.

 From the aforesaid judgment, the following crucial points emerge:-

LOCATION OF THE NEW HOUSE PROPERTY – In availing both the exemptions under sections 54 & 54F, there are no restrictions in regard to the location of the new house property. Since there are no provisions in both the sections which say that the new house property should be located in India, it can be located very well outside India for claiming the said exemption. Thus, if an individual or an HUF sells any long-term capital asset to purchase a new house property outside India, he can still claim exemption under section 54 (sale of a residential house property) and under section 54F (sale of any long term capital asset, other than a residential house property).

RESIDENTIAL STATUS – Both the above sections restrict the exemption to an individual or an HUF. But the sections do not disallow the exemption on the basis of the residential status. Thus, the exemption is available independent of the residential status of the individual, e.g., a NRI residing in the USA and having foreign income can also claim exemption under sections 54 and 54F on the sale proceeds arising from the sale of any long-term capital asset in India.

REFUND CLAIM – The individual who is claiming exemption either under section 54 or under section 54F can also claim the refund if he has paid any tax on the capital gains arising on the sale of the long-term capital asset. After fulfilling the conditions for availing of the exemption as per the section applicable, including making an investment in a new residential property outside India, he can claim exemption through filing his return within the due date.

Capital gain exemption-whether available if the land is owned by assessee’s spouse?

Section 54F provides deduction in respect of capital gain arising from the sale of any long-term capital asset, other than a residential property. If we apply the provisions, the deduction of the capital gain is available to the extent of the investment made in the cost of the new residential house purchased. The assessee may have a serious doubt whether the residential property should be owned in the assessee’s name or not in order to claim the deduction? Further, to claim the exemption one of the requisite conditions is that the assessee should own the house property in his own name. However, in case the land on which the house is being constructed is owned by the spouse, exemption under section 54F would still be available, the reason being that the ownership of the house is important rather than the land on which it is constructed. Further, on interpretation of the section granting the said exemption, it can be seen that for the purpose of capital gains land and building, both are considered as separate capital assets and to avail of the benefit of exemption, the assessee must own the house. In contrast, it is strictly interpreted in section 54 that the assessee should purchase the house in his own name. But various contradictory rulings have been issued by the Income Tax Department wherein exemption from capital gains has been allowed to the assessee for investment in the sole or joint names with spouse under section 54 of the ITA.

 Exemption from capital gain under section 54F is available when the house is purchased jointly with spouse, if the taxpayer, invests wholly in it. [CIT v. Ravinder Kumar Arora (2011) 15 taxmann.com 307/203 taxman 289 (Delhi)  

In this case the taxpayer who was an individual sold a plot of land and claimed capital gains arising therefrom as exempt under section 54F by purchasing residential house property in the joint name with his wife to avoid litigation after his death. The tax authority allowed only half of the exemption claimed on the ground that the property was purchased jointly with his wife’s name. On appeal, while the first appellate authority ruled in favour of the tax authority, the Tribunal ruled in favour of the taxpayer. Aggrieved by this the tax authority appealed to the High Court.

It was held that the taxpayer independently invested in the purchase of the house property, though jointly with his wife and paid stamp duty, corporation tax, commission and legal expenses in connection with the purchase. His wife did not invest any amount and, therefore, the conditions under section 54F of the ITA stood fulfilled and the property had to be treated as purchased in his name. Purchase of the property in joint name would not make any difference. The taxpayer was the actual and constructive owner of the property. Section 54F states that the property should be purchased by the taxpayer but does not stipulate that it should be purchased in the name of the taxpayer only. Hyper-technical ground should not impede the object of the provision which is to be provide impetus to housing construction. The court also placed reliance on various decisions of the High Courts in granting exemption under similar circumstances under section 54. Thus, the claim of the taxpayer was allowed.

Capital gains exemption from sale of multiple houses [Rajesh Keshav Pillai v. ITO [2011] 44 SOT 617/7 taxmann.com 11 (Mum.)

In the aforesaid case, the taxpayer sold two separate flats and earned long-term capital gains. The taxpayer bought two different flats and claimed that the long-term capital gain was exempt under section 54. The first appellate authority, following the judgement of the Special Bench in ITO vs. Ms. Sushila M. Jhaveri [2007] 107 ITD 327 (Mum.) (SB), held that the benefit of section 54 was available in respect of only one flat and not on two flats.

On appeal, the Tribunal held that, though section 54 refers to capital gains arising from ‘transfer of a residential house’, yet it does not provide that the exemption is available only in relation to one house. If the taxpayer has sold multiple houses, then the exemption under section 54 is available in respect of all houses, if the other conditions are fulfilled. If more than one house is sold and more than one house is bought, a corresponding exemption under section 54 is available. However, the exemption is not available on an aggregate basis, but has to be computed considering each sale and the corresponding purchase, adopting a combination beneficial to the taxpayer.

 Whether capital gains of multiple years can be claimed? [Smt.Anagha Ajit Patnekar v. ITO [2006] 9 SOT 685 (Mum.)]

During assessment year 1997-98, the taxpayer had earned capital gain on account of sale of shares and claimed deduction under section 54F in respect of capital gain utilized for purchase of a residential flat in the one year preceding the sale of shares. The Assessing Officer argued that in the earlier assessment years 1995-96 and 1996-97, similar capital gain had arisen to the taxpayer in respect of sale of shares for which he had sought exemption under Section 54F in respect of purchase of the same residential flat and, hence, he could not claim exemption in respect of same residential flat in assessment year 1997-98.

The Mumbai Bench of the ITAT held that there was no bar in section 54F for claiming deduction for the second time or third time for the same property, if the capital gain which has arisen in the case of the taxpayer is within the cost of the property. In the instant case, the total capital gain in all the three assessment years 1995-96 to 1997-98 was less than the total cost of the residential flat. Further, from the language of section 54F it is clear that the Legislature has provided leverage to the taxpayer for claiming exemption under section 54F, by allowing him to invest in the purchase of residential property within one year prior to or within two years after the date of transfer. In all the assessment years, these conditions were satisfied. Therefore, until the cost of purchase of the residential property was exhausted by the amount of capital gain claimed to have been invested, exemption under section 54F could not be denied.

 Capital gain exemption – Whether it can be granted partly for purchase of a residential house and partly for construction of the house? [B.B.Sarkar v. CIT [1981] 7 Taxman 239] (Cal.)

In the aforesaid case, the Calcutta High Court held that where a taxpayer spends capital gains partly for purchase of another house and partly for further construction on it, he is still entitled to exemption under section 54. The High Court held that section 54 contemplates fulfillment of two alternate conditions, viz., purchase or construction, but where both the conditions are fulfilled within the time stipulated, the taxpayer would also be entitled to the relief.

  Construction of house started well before the transfer of old house – Whether exemption would be available [CIT v. J.R.Subramanya Bhat [1986] 28 Taxman 578 (Kar.)]

As held by the Karnataka High Court in the aforesaid case, construction of the new house property may be commenced even before the transfer of the old house property. It is not necessary that the construction should commence only after such transfer. The High Court held that the material condition is that the construction must be completed within stipulated period from the date of transfer and, thus, eligible for exemption.

 Registered Purchase Deed not executed-whether capital gain exemption would be available? [CIT v.. Dr. Laxmichand Nagpal Nagda [1995] 78 Taxman 219 (Bom.)]

The Bombay High Court in the aforesaid case held that taking into consideration the letter as well as spirit of section 54, the word ‘purchase’ is not used in the sense of legal transfer. Further, the High Court held that in this case the taxpayer had paid the full consideration, obtained the possession of the flat and it was actually put to use and, hence, exemption under section 54 was clearly available, though no registered purchase deed was executed.

  Builder handed over the possession of the flat to the taxpayer beyond the specified period-whether capital gain exemption would be available [CIT v. R.L. Sood [2000] 108 Taxman 227 (Delhi)]

The Delhi High Court in the aforesaid case also held that payment of substantial amount to the builder for purchase of a new flat within the specified period would entitle the taxpayer to exemption under section 54, even though the builder might have handed over the possession of the flat to the taxpayer beyond the specified period.

Investment made within time-but construction not completed within the statutory time-limit-whether exemption from capital gain would be available? [Smt. Shashi Varma v. CIT [1997] 224 ITR 106 (MP)]

The Madhya Pradesh High Court in the aforesaid case, held that where the investment of capital gains in the purchase of a flat had been duly made within two years of the sale, the taxpayer would be entitled to exemption under section 54, even though the construction was not completed within the statutory time-limit. In this connection, the High Court relied upon the CBDT’s circular clarifying to the effect that investment made under the self financing scheme of the Delhi Development Authority or other co-operative societies or similar bodies, where a house property was allotted to a taxpayer, would be treated as a case of construction for the purpose of section 54.

 Construction undertaken from borrowed funds and the sale proceeds invested in private bank – Whether capital gain exemption would be available? [ITO v. K.C. Gopalan [1999] 107 Taxman 591 (Ker.)]

In the aforesaid case, the taxpayer had sold his land along with the building. His claim under section 54 in respect of exemption from capital gains was rejected by the Assessing Officer on the ground that the sale price received by the taxpayer was deposited in private banks and the construction of the building had been undertaken from borrowed funds. The Kerala High Court held that there was no provision in the Statute that the taxpayer should utilize the same amount which he obtained by way of sale consideration for the purpose of meeting the cost of the new asset. The taxpayer was entitled to the exemption under section 54, which squarely related to the cost of the acquisition of a new asset in the nature of a house property for the purpose of the taxpayer’s residence. The said asset having been acquired within the specified period and the conditions prescribed under section 54 having been fulfilled, the benefit of the exemption could not be denied.

 Where assessee invested sale proceeds of capital asset into residential house which was again sold and sale proceeds whereof were invested in other residential house, deduction under section 54F was allowable. Asstt. CIT v.Sultana Nazir [2012] 21 taxmann.com 385 (Chennai)

In yet another interesting and unique case, the Chennai Bench of the Income Tax Appellate Tribunal in the aforesaid case held that the taxpayer was eligible to claim an exemption under section 54F in respect of such deemed long-term capital gain arising from the sale of the new asset by investing the sales proceeds in another new residential house within the specified period. The facts of the case were as follows:-

The taxpayer sold a plot of land (property X) during the tax year 2005-06 and a part of these sale consideration arising sale was invested by the taxpayer in the purchase of a residential house (property Y) within the same tax year. Accordingly, the long-term capital gain (LTCG) arising on sale of property X was claimed as exempt under Section 54F. The taxpayer sold Property Y in the tax year 2006-07 and purchased another residential property (property Z) within two days of the sale of Property Y.

The Assessing Officer (AO) considered the LTCG claimed as exempt in the tax year 2005-06 as the taxpayer’s income for the tax year 2006-07.

On appeal by the taxpayer the CIT(Appeals) granted the claim for exemption in respect of the investment in Property Z by disregarding the purchase/sale of property Y altogether.

The matter reached the Tribunal and the Tribunal ruled as follows:-

The Tribunal pointed out that since the taxpayer had sold the property Y within three years of purchase, the AO was correct in adding back the deemed LTCG. But the taxpayer had invested the sale proceeds in the purchase of property Z within a period of two years in which Property X was sold. Therefore, the taxpayer was eligible for exemption in respect of the said investment out of this deemed LTCG.

 Several Independent units can constitute “a residential house” and would be eligible for section 54/54F deduction. [CIT v. Gita Duggal [2013] 30 taxmann.com 230/214 Taxman 51 (Delhi)]

The assessee entered into a development agreement pursuant to which the developer demolished the property and constructed a new building comprising of three floors. In consideration of granting the development rights, the assessee received Rs. 4 crores and two floors of the new building. The Assessing Officer held that in computing capital gains, the cost of construction of Rs. 3.43 crores incurred by the developer on the development of the property had to be added to the sum of Rs. 4 crores received by the assessee. The assessee claimed that as the said capital gain was invested in the said two floors, she was eligible for exemption u/s 54. The AO rejected the claim on the basis that the units on the said floors were independent & self-contained and not “a residential house” and granted exemption for only one unit. The CIT(A) and Tribunal upheld the assessee’s claim by relying on decisions in D. Ananda Basappa (supra) and K.G. Rukminiamma (supra). On appeal by the department to the High Court, the High Court dismissed the appeal and observed as follows:–

As held in D. Ananda Bassappa & K.G. Rukminiamma’s cases (supra), the Revenue’s contention that the phrase “a” residential house would mean “one” residential house was not correct. The expression “a” residential house should be understood in a sense that building should be of residential in nature and “a” should not be understood to indicate a singular number. Also, section 54/54F uses the expression “a residential house” and not “a residential unit”. section 54/54F requires the assessee to acquire a “residential house”. So long as the assessee acquires a building, which may be constructed, for the sake of convenience, in such a manner as to consist of several units which can, if the need arises, be conveniently and independently be used as an independent residence, the requirement of the section should be taken to have been satisfied. There is nothing in these sections which requires the residential house to be constructed in a particular manner. The only requirement is that it should be for the residential use and not for commercial use. If there is nothing in the section which requires that the residential house should be built in a particular manner, it seems that the income-tax authorities cannot insist upon that requirement. A person may construct a house according to his plans, requirements and compulsions. A person may construct a residential house in such a manner that he may use the ground floor for his own residence and let out the first floor having an independent entry so that his income is augmented. It is quite common to find such arrangements, particularly post-retirement. One may build a house consisting of four bedrooms (all in the same or different floors) in such a manner that an independent residential unit consisting of two or three bedrooms may be carved out with an independent entrance so that it can be let out. He may even arrange for his children and family to stay there, so that they are nearby, an arrangement which can be mutually supportive. He may construct his residence in such a manner that in case of a future need he may be able to dispose of a part thereof as an independent house. There may be several such considerations for a person while constructing a residential house. The physical structuring of the new residential house, whether it is lateral or vertical, cannot come in the way of considering the building as a residential house. The fact that the residential house consists of several independent units cannot be permitted to act as an impediment to the allowance of the deduction under section 54/54F. It is neither expressly nor by necessary implication prohibited.

Conclusion

  1. Since the taxing provisions have included the exemption from capital gains tax for the benefit of individuals and HUF, one can plan his tax planning exercise in order to save maximum taxes on the income earned. The aforesaid judgments and precedents would definitely help in formulating the investment plan combined with tax planning avenues which will help not only to lower the tax liability but will also help in effectively structuring the transactions without getting into contentious issues. It is suggested that the above cited cases should be borne in mind while claiming the exemption either under section 54 or section 54F and can be usefully relied upon after careful consideration of the facts of the case and the appropriate circumstances.
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