Income from transfer of capital assets situated in India

Any gain arising from a capital asset whether movable or immovable shall be deemed to accrue in India in case the capital asset is situated in India at the time of transfer. It is immaterial that agreement is entered outside India or consideration is paid outside India.

Apportionment of profits [Explanation (d) to section 9(1)(i)]
In the case of a business of which all the operations are not carried in India, only that part of income shall be deemed to accrue or arise in India which is reasonably attributable to the operations carried on in India.

Where the goods are manufactured in India and were sold out side India, the profit will be apportioned in two parts—one for manufacturing operations and another for selling operations. The profits which could be reasonably attributed to selling operations will not be deemed to accrue in India. (C.I.T. v. Ahmedbhai Umerbhai 18 I.T.R. 472).

In cases where the income attributable to operations carried out in India cannot be ascertained, Rule 10 of Income-tax Rules 1962 provides

(a) such percentage of the turnover so accruing or arising as the Assessing Officer may consider to be reasonable having regard to the facts and circumstances of the case; or
(b) any amount which bears the same proportion to the total profits and gains of the business of the assessee computed in accordance with the provisions of the Act as the receipts so- accruing or arising bear to the total receipts of the business; or
(c) in such other manner as the Assessing Officer may deem suitable.

Source : Income taxmanagement

What constitutes capital Asset for Capital Gains Under Income Tax Act.

Profits or gains arising from the transfer of a capital asset made in a previous year is taxable as capital gains under the head “Capital Gains”. The important ingredients for capital gains are, therefore,

1. existence of a capital asset,
2. transfer of such capital asset and
3. profits or gains that arise from such transfer.

In this Post we are discussing Meaning of Capital Asset for Calculation of Capital gain.

Capital asset means property of any kind except the following:

Assets Excluded from the definition of The Capital Assets

a) Stock-in-trade, consumable stores or raw-materials held for the purpose of business or profession.

b) Personal effects like wearing apparel, furniture, motor vehicles etc.., held for personal use of the tax payer or any dependend member of his family. However, jewellery, even if it is for personal use, is a capital asset. The Finance Act, 2007 has modified the definition of Personal effects w.e.f. 1.4.2008. ‘Personal effects’ now include movable property including wearing apparel and furniture held for personal use by the assessee or any member of his family dependent on him, but excludes:-

1. Jewellery
2. Archaeological Collections
3. Drawings
4. Paintings
5. Sculptures or
6. Any work of art

c) Agricultural land in India other than the following:
1. Land situated in any area within the jurisdiction of municipality, municipal corporation, notified area committee, town area committee, town committee, or a cantonment board which has a population of not less than 10,000 according to the figures published before the first day of the previous year based on the last preceding census.

2. Land situated in any area around the above referred bodies upto a distance of 8 kilometers from the local limits of such bodies as notified by the Central Government .
d) 6 1/2 per cent Gold Bonds, 1977, 7 per cent Gold Bonds, 1980, National Defence Gold Bonds, 1980 and Special Bearer Bonds, 1991 issued by the Central Government.

e) Gold Deposit Bonds under Gold Deposit Scheme, 1999 notified by the Central Govt.

Though there is no definition of “property” in the Income-tax Act, it has been judicially held that a property is a bundle of rights which the owner can lawfully exercise to the exclusion of all others and is entitled to use and enjoy as he pleases provided he does not infringe any law of the State. It can be either corporeal or incorporeal. Once something is determined as property it becomes a capital asset unless it figures in the exceptions mentioned above or the Capital Gains is specifically exempted.

In the following cases, income from Capital Gains is specifically exempted:

1. UTI 64 :Income from transfer of a unit of the Unit Scheme, 1964 referred to in Schedule I to the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 and where the transfer of such asset takes place on or after 1.4.2002.

2. Equity Shares :income from transfer of an “eligible equity share” in a company purchased on or after 1.3.2003 and before 1.3.2004 and held for a period of twelve months or more. Eligible equity share means equity share in a Company
o that is a constituent of BSE-500 Index of Mumbai Stock Exchange as on 1.3.2003 and is traded in a recognized stock exchange in India.
o allotted through a public issue on or after 1.3.2003 and listed in a recognized stock exchange in India before 1.3.2004 and its sale is entered into on a recognized stock exchange in India.

3. Capital Gains of a political party subject to provisions of Section 13A of the I.T Act, 1961

4. Agriculture Land :In the case of an individual or HUF, capital gains arising from the transfer of agricultural land, where such land is situated in any area falling within the jurisdiction of a municipality or a cantonment board having population of at least 10,000 or in any area within such distance, not being more than 8 kms, from the local limits of any municipality or cantonment board. Such land should have been used for agricultural purposes during the period of two years immediately preceding the date of transfer. Further, such transfer should be by way of compulsory acquisition under any law and the said capital gains should have arisen from the compensation received on or after 1st April, 2004.

5. Long term capital gain of Equity Shares /Funds :Capital gains arising from the transfer of a long term capital asset, being an equity share in a company or unit in an equity oriented fund where such a transaction is chargeable to securities transaction tax and takes place on or after 1st October, 2004.

Source : Simpletaxindia

Provision of Capital Gain Tax in respect of selling a House or Flat

Generally, people have a good understanding about capital gain taxes. However, when it comes to the actual transaction, they seek professional help. Broadly, the scope of capital gain tax is covered in this article. Hope this helps

Illustration – Mr.Ramdas has sold a flat at Bangalore at 20th April 2015 for a sale price of Rs.95 lakhs. He does not know the capital gain tax payable on such sale.

Scenario A – The above information is insufficient to calculate capital gain tax. One has to know when the property was purchased. Suppose, the property was purchased on or after 20th April, 2012 i.e., within 36 months prior to the sale, then the flat is considered as Short Term Capital Asset.

Tax on Short Term capital Asset – If Mr. Ramdas had purchased the flat for Rs.60 Lakhs in January 2013, then the capital gain is equal to (a) Sale price less cost of purchase price. So, the income tax is on Rs.35 Lakhs (i.e., Rs.95 Lakhs Less Rs.60 Lakhs) at the rate applicable as per tax slabs. (Means the basic exemption limit is allowed to be taken while paying short term capital gain)

Deduction under chapter VIA such as investment u/s 80 C, 80D etc. – The taxpayer is allowed to take the benefit u/s 80c, 80D, 80E etc., from the short tax capital gain earned during the year through sale of property. Suppose, Mr. Ramdas invests Rs.1,50,000 in ELSS mutual fund or 5 year Fixed Deposit in a bank, out of the taxable income of Rs.35 Lakhs, he can reduce Rs.1.50 Lakhs towards investments and then compute applicable taxes.

Scenario B – If Mr. Ramdas had purchased the flat prior to 20th April 2012 i.e., holding property over 36 months, then it is classified as Long Term Capital Gain (LTCG). In this case, the tax is computed as (a) Sale Price Less (b) Indexed cost of purchases. Even the tax rate is less for Long Term Capital Gain, currently it is at 20.6%

What is the indexed cost? As the cost of acquisition is historical value, one has to adjust it with the impact of inflation on the value. So, if the purchase price is adjusted with the inflation rate, it helps to counter the erosion in the value of the asset over a period of time.
Where to find inflation index (or indexed cost)? It is notified by the Central Government every year taking 1981-82 as base year. For example, the cost inflation index for 2011-12 is 785 and for 2014-15 is 1024.
Deduction u/s 80C – Like in the case of Short term Capital Gain, can one claim the deduction u/s 80C, 80D, etc., from LTCG? NO. Deduction under Chapter VI A will not be available in respect of long term capital gains.

What about basic exemption limit? Yes. Only a resident individual/HUF can adjust the exemption limit against LTCG. Thus, a non-resident individual and non-resident HUF cannot adjust the exemption limit against LTCG.

Is there any way, payment of tax on Long Term Capital Gain (LTCG) can be avoided or reduced? Yes. There is an option

Option – A: Reinvestment in another property: Where gain from one house property is reinvested in another house property, to the extent of investment, the capital gain tax is exempt. (Section 54) The points to be noted are –

• The property transferred must be a long-term capital asset
• Purchased 1 residential house in India within one year before the date of sale or
• Within 2 years after the date of sale or
• Construct one residential house within 3 years after the date of transfer.

Option – B: Investment in Bonds: Any long term capital gain shall be exempt if the whole of the amount of such capital gain is invested in long term specified Capital Gain Bonds (Section 54EC). This facility is in addition to reinvestment u/s 54. (Which means, one can avail both benefits together/concurrently)

How to Save Income Tax through Cost Inflation Index

What is Cost Inflation Index :

The rising cost of all articles, popularly known as inflation, has its impact on every investor. An index which accounts for annual inflation can be called cost inflation index. In layman’s language we can say that it is tool used to measure the rate of inflation in an economy. Such an index is used for various purposes, including in income tax. In India, Section 48 of the Income Tax Act defines the index as what is notified by the Central Government every year, having regard to 75% of average rise in the Consumer Price Index (CPI) for urban non manual employees for the immediate preceding year.

How cost inflation index is useful in reducing income tax in India?

We know that indexation of the cost of asset allows the investors to save a substantial amount of income tax on his long term capital gains arising out of selling of movable / immovable properties, if he takes the advantage of the cost of inflation index allowed under IT Act. However, this indexation is available only on fulfilling certain criteria.

Let us go through some of the basic rules for this indexation :

(a) Cost of acquisition of the asset whether movable or immovable is first to be multiplied by the cost of inflation of the year in which the asset is being transferred.

(b) The resultant figure obtained as above under (a) will then be divided by the cost of inflation index for the year in which the asset was acquired.

(c) The cost of inflation for various years since 1981 is given below. In case the asset was purchased before 1st April, 1981, the cost inflation index for the purpose of acquisition is to be taken as the one on 1st April, 1981

(d) The costs incurred on the improvement of the said asset are to be similarly adjusted with the help of the cost of inflation index i.e. by multiplying the cost inflation index for the year in which the improvements to the said asset were done.

It should be noted that the benefit of cost inflation index is not available for short term capital gain or losses. This means that the sale of the assets if acquired within a period of less than three years (36 months) from the date of purchases, will be treated as short term capital gains or losses. In such cases, the benefit of indexation can not be availed. Moreover, this benefit is also not available to Non Resident Indians. we can say that investors can pay much less tax for the assets held by them for over 3 years by taking advantage of the indexation.

Frequently asked questions on Exemption of Capital gains

Is the relief under section 54 is available to multiple sales & purchases of residential houses?

In case of multiple sale and purchase of residential houses, the exemption cannot be calculated considering the aggregate of capital gain and aggregate of investment in the residential houses. The exemption will be available in relation to each set of sale and corresponding investment in the residential house and the combination which is beneficial to the assessee has to be allowed. (Rajesh Keshav Pillai vs. ITO 7 Taxmann.com. 11 (mum)(2010)

  1. Whether deduction u/s 54 is available for capital gains arising from sale of more than one house, however the sale proceeds are invested in one house?

There is no restriction placed in section 54 which restricts exemption only in respect of sale of one residential house. Even if assessee sells more than one house in the same year and the capital gains is invested in a new residential house, the claim of exemption cannot be denied if other conditions are fulfilled. (DCIT vs. Ranjit vithaldas (2012) 23 taxmann.com 226 (ITAT-mum)

  1. Can assessee claim exemption under section 54 for acquisition of more than one house?
  • Where more than one residential house is purchased out of the sale proceeds of one residential house, exemption u/s 54 can be claimed only in respect of one house, provided the other conditions of Sec 54 are satisfied.(C.kaushik vs. ITO 185 ITR 499 (BOM)(1990).

In Gulshanbanoo R. Mukhi v. JCIT 83 ITD 649 (ITAT- Mum) (2002),it was held that exemption is allowed only for one flat.

However, two or more residential houses purchased can be classified as one single residential house, the exemption under section 54 can be allowed. Some of the relevant judicial pronouncements are:

  • Two adjacent residential units but used as one single residential house, exemption allowed. [D. Anand Basappa v. ITO 309 ITR 329 (Kar.) (2009)]
  • Fact that residential house consists of several independent units cannot be a hindrance to allowance of exemption u/s 54 – Held, yes [Prem Prakash Bhutani Vs. CIT 110 TTJ (Del) 440 (2007)]
  • Two adjoining flats converted into single residence, exemption allowed. [ACIT v Mrs. Leela P. Nanda 286 ITR (AT) 113 (Mum) (2006)]
  • Four flats purchased in same building but on different floors because of large size of family, which maintained a common kitchen and a common ration card, exemption allowed. [Vyas (K.G.) v ITO 16 ITD 195 (Bom.)(1 986)]
  • Allowable in the case of adjacent & contiguous flats.[ITOv. Mrs. Sushila M. Jhaveri 107 ITD 327 (ITAT- Mum. SB)(2007)]
  • Several self occupied dwelling units which were contiguous and situated in the same compound and within the common boundary having unity of structure should be regarded as one residential house. [Shiv Narain Choudhary v. CWT 108 ITR 104 (All)(1 997)]
  • More than one units converted into one single house allowed for the purpose of sec. 54F as well. [Neville J. Pereira v. ITO 8 Taxmann. com 68 (Mum. ITAT) (2010)]
  • Two flats which were not adjacent to each other and were separated from each other by common passage, lobby, staircase, etc., they could not be regarded as a single unit and, therefore, assessee was entitled to benefit of deduction under section 54F in respect of one of those two units. [ACIT vs Sudhakar Ram [2011] 16 taxmann.com 175 (Mum.-ITAT)]
  • However, the claim for exemption u/s 54 is not admissible in respect of two independent residential houses situated at different locations. [Pawan Arya v. CIT 11 taxmann.com 312 (P&H) [2011]]
  1. Whether the property purchased in the joint name with wife is eligible for exemption u/s 54/54F?

Section 54F mandates that house should be purchased by assessee and it does not stipulate that house should be purchased in name of assessee. Property purchased by assessee in joint name with his wife for ‘shagun’ purpose because of fact that assessee was physically handicapped and the whole consideration was paid by assessee, assessee entitled to exemption u/s 54F. – CIT vs. Ravinder kumar Arora 15 taxmann.com 307 (Delhi)(2011)

Other relevant judicial pronouncements

ü  Merely because sale deed is in joint name, assessee could not be denied benefit of deduction u/s 54. – DIT vs. Mrs. Jennifer Bhide 15 taxmann.com 82 (kar)(2011)

ü  House property in the name of HUF sold but new house purchased in the name of Karta and his mother to claim the benefit of sec. 54F. The residential house which is purchased or constructed has to be of the same assessee. [Vipin Malik (HUF) Vs CIT 183 Taxman 296 (Delhi) (2009)]

ü  Exemption u/s 54F is allowed only when the new residential property is purchased by the assessee in his own name and not in name of his adopted son. [Prakash v. ITO 173 Taxman 311 (Bom.) [2008]]

ü  Sec. 54 clearly says that if the assessee is owner of the property, he is entitled to exemption even if the new property purchased is in the name of his wife but the same is assessed in the hands of the assessee. [CIT v. V. Natarajan 154 Taxman 399 (Mad.) [2006]]

  1. Whether the nexus between capital gain and amount of investment u/s 54 is necessary?

Assessee is not required under the provision for section 54 to establish the nexus between the amount of capital gain and the cost of new asset.

Held that the assessee had initially utilized the sale proceeds on sale of its residential flat in commercial properties and, later on, he purchased two residential flats within a period specified in sub-section (2) of section 54. The Revenue’s main dispute was that the sale proceeds were utilized for purchase of a commercial property and residential house was purchased out of the funds obtained from different sources, as such, the identity of heads has been changed. [Ishar Singh Chawla Vs. CIT 130 TTJ (Mum) (UO) 108 (2010) and Ajit Naswanit Vs. CIT 1127 Taxman 123 (Delhi) (Mag.) (2001)]

  1. To avail exemption u/s 54F, the residential property should be acquired out of personal funds or sale proceeds?

If the assessee constructs or purchases a residential house out of the borrowed funds, he is not eligible for deduction u/s 54F of the Act. If it is not construed in such a manner the object of introduction of the beneficial provisions would be frustrated. The fiscal provisions are to be construed in such a manner, so that its objects of introduction can be achieved.[Milan Sharad Ruparel 005 ITR 0570 (ITAT – Mum) [2010].

However a different view was taken in Bombay Housing Corporation v. Asst. CIT 81 ITD 545 (Bom.-ITAT) (2002), Where assessee utilized the sale consideration for other purposes and borrowed the money for the purpose of purchasing the residential house property to claim exemption under section 54,it was held that the contention that the same amount should have been utilized for the acquisition of new asset could not be accepted.

Other relevant judicial pronouncement:

There is no requirement for claiming exemption under section 54 that same amount of sale consideration should be utilized for acquisition of property, even borrowed funds can be utilized for that purpose. [Prema P. Shah Vs ITO 101 TTJ 849 (Mum-ITAT)(2006)]. Also see J.V. Krishna Raovs DCIT [2012] 24 taxmann.com 104 (Hyd.-ITAT).

  1. Whether exemption under section 54 is allowable if residential units of a house property are purchased from different persons?

Execution of four different sale deeds in respect of four different portions of property did not materially effect nature of transaction or nature of property acquired since property in question was being used by assessee for her own purposes and investment made in purchase of same was, therefore, eligible for deduction under section 54.[CIT V. Sunita Aggarwal (2006) 284 ITR 20(Del)]

In CIT vs Smt. Jyothi K. Mehta [2011] 12 taxmann.com 440 (Kar.), it was also held that the fact that the assessee could not have purchased both the flats in one single sale deed or could not have narrated the purchase of two premises as one unit in the sale deed could not make any difference. The two flats purchased were situated side by side. Builder also stated that he had effected modifications to the flats to make them one unit by opening the door in between the two apartments.

Q . Whether exemption u/s 54 can be claimed on the basis of a mud structure?

Exemption u/s 54 cannot be allowed for sale of a mud structure whereupon there was never any structure fitting to be described as “habitable residential house”. [M.B. Ramesh vs ITO 320 ITR 451 (Kar.) [2010]]

  1. Whether benefit u/s 54(1) is available in case of sale of land adjoining to the building?

The land appurtenant to the building means that the ownership of building and land appurtenant should be of same person. If building is owned by one person and land is owned by another, it will be the case of land adjoining to the building and by no stretch of imagination it can be called land appurtenant to the said building and therefore, benefit of section 54(1) would not be available to such land adjoining to a building. [P.K. Lahri v. CIT 146 Taxman 349 (ALL.)(2005)]

Q   Is it necessary that a person should reside in the house to call it a residential house.

The popular meaning of words ‘residential house’ is a place or building used for habitation of people. It is not necessary that a person should reside in a house to call it a residential house. If it is capable of being used for the purpose of residence than the requirement of the section 54F is satisfied and benefit could not be denied. [Amit Gupta v. DCIT 6 SOT 403 (Delhi)(2006) & Mahavir Prasad Gupta 5 SOT 353 (Del)(2006)]

Q    Can the assessee claim exemption under section 54 in respect of investment in modification or renovation of the existing house?

Exemption is available only when the investment is in the consideration of a house and not for investment in modification or renovation. Admitted facts are that the assessee had a fairly big house to which the assessee made addition of 140 sq. meters of plinth area. However, it is the conceded position that the assessee has not constructed any separate apartment or house. Section 54F does not provide for exemption on investment in renovation or modification of an existing house. On the other hand, construction of a house only qualifies for exemption on the investment. Even addition of a floor of a self contained type to the existing house would have qualified for exemption. However, since the assessee has only made addition to the plinth area, which is in the form of modification of an existing house, she is not entitled to deduction claimed u/s 54F of the Act. [Mrs. Meera Jacob vs ITO 313 ITR 411 (Kerala) (date of order 9/06/2008)]

Q   Whether exemption under section 54 is allowable for addition of floor to the existing house from the sale proceeds of residential house sold?

Assessee owned two residential houses. He sold one house and utilized its sale proceeds to construct first floor on his second house after demolishing old structure, in this case exemption will be allowable under section 54. [CIT vs P.V. Narsimhan [1989] 47 Taxman 89 (Mad.)

However, in CIT v. V. Pradeep Kumar [2007] 290 ITR 90/ [2006] 153 Taxman 138 (Mad.), it was held that a mere extension of existing building would not give benefit to assessee under section 54F. Section 54F emphasizes construction of residential house and such construction must be real one and should not be a symbolic construction. Followed by ACIT vs T.N. Gopal [2009] 121 ITD 352 (Chennai-ITAT) (TM)

Q   Whether the expenditure to make a residential house habitable will be included in the cost of new asset?

The words used about the amount spent on purchase of new asset are ‘cost thereto’ and not ‘price thereto’. The cost includes purchase as well. Consequently, the words used signify that the amount of purchase will include other necessary expenditure in this behalf to make a residential house habitable and taken together that will be the cost of the new asset. The Tribunal had perused the items of the report of the architect. The residential house was in a state of general disrepair and was inhabitable. Consequently, the necessary repairs carried out to make the same habitable would constitute part of the cost of new house. [Gulshanbanoo R. Mukhi v. JCIT 83 ITD 649 (ITAT- Mum) (2002)]

Q   Whether exemption under section 54F would be allowable where assessee is already a co-owner of another flat?

The word ‘own’ appearing in section 54F includes only such residential house which is fully and wholly owned by one person and not a residential house owned by more than one person. The assessee was already a co-owner of another flat. Being a co-owner, assessee was not the absolute owner of another residential flat, and exemption under section 54F could be denied on this ground. [ITO vs Rasiklal N. Satra [2006] 98 ITD 335 (Mum.-ITAT)]

Q  Whether determination of title to the property would commence from the first date of allotment or the subsequent date of allotment of the actual flat number and delivery of possession for the purpose ofassessing long term capital gains.

Title to the property is transferred with the issuance of the allotment letter and payment of installments is only a follow up action and taking of the delivery of possession is only a formality. [Vinod Kumar Jain Vs CIT TIOL­706-P&H (2010)]

Q   Whether exemption under section 54 would be allowable where residential house property is purchased within time limit specified under section 139(4)?

The due date for furnishing return of income as per section 139(1) is subject to extended period provided under sub-section (4) of section 139 and, if a person had not furnished return of previous year within time allowed under sub-section (1), assessee could file return under sub­section (4) before expiry of one year from end of relevant assessment year. Therefore, section 54 deduction could not be denied to assessee on this count. [CIT v. Ms. Jagriti Aggarwal 15 taxmann.com 146 (P & H) (2011)]. Also see ITO vs Smt. Sapana Dimri [2012] 19 taxmann.com 15 (Delhi), Kishore H. Galaiyavs ITO [2012] 24 taxmann.com 11 (Mum.)

Q   Is there any requirement that the assessee should file the return before the due date under section 139(1) to claim exemption under section 54/54F?

Where the assessee had fulfilled the condition for depositing the amount of capital gain in a specified bank account before the due date prescribed for furnishing the return of income under section 139(1),there is no requirement that the assessee should file her return of income before the due date prescribed under section 139(1). [Esther Christopher Mascarenhas v. ITO 9 Taxmann.com 99 (Mum.-ITAT) (2011)]

Merely because investment is made after due date of filing of return, section 54F exemption cannot be denied where investment is made prior to filing of return under section 139(4). [R.K.P. Elayarajan vs DCIT [2012] 23 taxmann.com 206 (Chennai-ITAT)]

Q  Whether property purchased in foreign country is also eligible for exemption u/s 54?

Section 54 does not exclude the right of the assessee to claim property purchased in a foreign country, if all other conditions laid down in the section are satisfied. Merely because the property acquired was in a foreign country, the exemption under section 54 cannot be denied.The new house may be in India or outside India. [Prema P. Shah Vs. ITO 101 TTJ 849 (Mum-ITAT)(2006)]

However, in Leena J. Shah vs ACIT [2006] 6 SOT 721 (Ahd.-ITAT), it was held that the benefit under section 54F is not allowable for a residential house purchased/ constructed outside India.

Q   Whether cost of residential house includes the cost of plot?

The cost of the plot together with cost of the building will be considered as cost of new asset provided the acquisition of the plot and also the construction thereon are completed within the period specified in these sections. [Circular no. 667, dated 18-1 0-1 993]

Q   Whether the deemed cost of new asset means the amount which has already been utilized by assessee for purchase or construction of new asset or it also includes the amount deposited as per requirements of sub-section (4) of section 54F?

For purposes of sec 54F, deemed cost of new asset is amount which has already been utilized by assessee for purchase or construction of new asset plus amount deposited as per Capital gain account scheme, 1988. [ACIT v. Vikas Singh 16 taxmann.com 127 (Delhi) [2011]]

Q   Whether booking of flat with a builder amounts to construction or purchase?

Booking of flat with a builder is a case of construction and not purchase of residential flat and therefore, time period 3 years is applicable. [Kishore H. Galaiyavs ITO [2012] 24 taxmann.com 11 (Mum.)]

Q   Is allotment of flat under self-financing scheme treated as construction or purchase of a house?

Under Government schedules confining to two years’ period for construction and handing over possession thereof is impossible and unworkable under section 54 and, thus, if substantial investment is made in construction of house, it should be deemed that sufficient steps have been taken satisfying requirement of section 54 [Smt. Shashi Varma vs CIT [1997] 224 ITR 106 (MP)]

Q   Whether deduction under section 54 be available where builder have not even allotted the plot within 3 years?

The main thrust of the section 54F is construction of a residential house; the Legislation in its wisdom has specifically provided the period of three years, it cannot be enlarged to indefinite period for the reason that no construction activity could be started within a period of 3 years by the builder because of which no plot was ever handed over to the assessee.[Pankaj Wadhwani vs CIT 18 Taxmann.com 33 (Indore- ITAT)[2012]]

Q   Whether for purpose of claiming exemption under section 54, possession of flat booked with builder had to be taken within the time period specified?

If the assessee had made investment within period of three years, exemption under section 54 could not be denied for the reason that possession had not been taken. There may be delay in taking of possession because of many factors not under control of assessee, merely because of this exemption could not be denied. [Kishore H. Galaiyavs ITO [2012] 24 taxmann.com 11 (Mum.)]

In CIT vs R.L Sood [2000] 108 Taxman 227 (Delhi), it was held that on payment of substantial amount in terms of purchase agreement within four days of sale of his old house, assessee acquired substantial domain over new residential flat within specified period, it could be said that assessee complied with requirements of section 54. Merely because builder failed to hand over possession of flat within specified period, assessee could be denied benefit of benevolent provision of section 54.

Q   Does exchange of old flat with a new flat under a development agreement amounts to construction of new flat for purpose of claiming deduction under section 54?

Exchange of old flat with a new flat to be constructed by the builder under development agreement amounts to transfer under section 2(47) of the Income Tax Act, 1961. The acquisition of a new flat under a development agreement in exchange of the old flat amounts to construction of new flat. The provisions of section 54 are applicable and assessee is entitled to exemption if the new flat had been constructed within a period of 3 years from the date of transfer.  – Jatinder kumar Madan vs. ITO (2012) 21 taxmann.com 316 (mum)

Q     Can deduction u/s 54 be claimed for purchase of a share in the residential house property where the assessee presently resides?

Section 54 nowhere states that a residential house which is purchased by an assessee so as to enable the assessee to get exemption under the provisions of section 54 should not be the one in which the assessee was residing. Merely because the assessee was residing in a residential house which was purchased by her, exemption under section 54 could not be denied. [CIT vs Chandan Ben Magan Lal 245 ITR 182 (Guj) (2000)]. Also see CIT vs TN Arvinda Reddy 120 ITR 46 (SC) (1979), ITO vs RasikLal N Satra 98 ITD 335 (Mum) (2006)]

Q     Whether transfer of only interest in flats under construction could be treated as transfer of residential house?

Where the assessee transferred only his interests in two flats under construction of which possession was not taken and was not fit for human habitation, such transfer could not be treated as transfer of residential house. Hence, the capital gain derived by the assessee related to a capital asset held by him for a period of more than 36 months and, therefore, the gain arising from the transfer of his rights in the said flats constituted long­term capital gains. The assessee would, therefore, be entitled to grant of exemption under section 54F. [Jagdish Chander Malhotra v ITO (1998) 64 ITD 251 (Del)]

Q     Whether the assessee is entitled to deduction under section 54F for purchase of flat under construction before the expiry of statutory period of two years from the date of the capital gain?

Where assessee invested amount of capital gain on sale of shares in purchase of flat before expiry of statutory period, benefit of deduction under section 54F could not be denied to assessee on ground that building was under construction stage and assessee had chosen to pay entire advance. [ACIT vs Sudhakar Ram [2011] 16 taxmann.com 175 (Mum.-ITAT)]

Section 54F does not prescribe completion of construction of residential house and thrust of said section is on investment of net consideration received on sale of original asset and start of construction of a new residential house. [Smt. Rajneet Sandhu vs DCIT [2011] 16 taxmann.com 210 (Chd.-ITAT)]

Q   Can construction of house property start before the date of transfer.

Exemption on capital gains under section 54 cannot be refused merely on ground that construction of new house had begun before sale of old house.[CIT v. HK Kapoor 150 CTR 128 (All) (1998)]

Q   Can the assessee simultaneously take benefit of both purchase and construction of residential house property?

If an assessee is entitled to relief on fulfillment of either of the two conditions specified under section 54, i.e., either purchasing a house property within one year or constructing the house within two years, it would be improper to read that on fulfillment of both the conditions, he would be disentitled to that relief. Section 54 does not contemplate two kinds of relief; it only contemplates fulfillment of two alternative conditions. If both the conditions are satisfied within the time stipulated, the assessee does not become disentitled to the relief if the other conditions are fulfilled. If a floor is constructed to the new house or if it is renovated it remains as one house only, especially when there is no evidence that two different houses bearing two different municipal numbers were constructed. Therefore, benefit can be availed jointly. [BB Sarkar v. CIT 132 ITR 150 (Cal)(1 981)].

Q   Where the minor has transferred an asset, will the exemption under section 54F/54EC be allowed to the minor or the parent.

Provisions of section 64(1A) i.e. clubbing of income of the minor with the income of the parent have to applied in the end after computing income of minor under Income Tax Act.

Where proceedings under Act for assessment of income of a minor child are required to be taken, minor child can be treated as an assessee under section 2(7) for purposes of section 54F. Benefit under section 54F cannot be denied to minor child on ground that father of minor child has a residential house at time of transfer of capital asset. [ACIT vs Madan Lal Bassi [2004] 88 ITD 557 (CHD.)]

In case of clubbing of income of minor child, deduction under section 54EC is to be allowed on minors’ income from LTCG separately and only net income is to be clubbed [DCIT vs Rajeev Goyal [2012] 22 taxmann. com 34 (Kol.-ITAT)]

Q   What is the date of investment in respect of section 54EC?

For the purposes of the provisions of Section 54EC, the date of investment by assessee must be regarded as date on which payment was made and received by the National Housing Bank. [Hindustan Unilever Ltd. v. DCIT 191 Taxman 119 (Bom) [2010]]

Q   Whether the benefit under section 54EC could be availed where bonds are purchased in joint name?

Merely because bonds are in joint name, assessee could not be denied benefit of deduction u/s 54EC. As far as it is established that the complete consideration has flown from the assesse, the benefit could not be denied on this ground.[DIT vs Mrs. Jennifer Bhide 15 taxmann.com 82 (Kar.) [2011]]

Q   Can exemption under Section 54EC be claimed where REC Bond were purchased prior to date of sale of property?

Section 54EC clearly states that the investment in specified bonds is to be made “within a period 6 months after the date of such transfer”, the intention of the legislature is clear. Had the legislature wanted to give liberty to the assessee to invest before or after the date of transfer, they would have explicitly said so, as has been provided in section 54 & 54F of the Act. Since such specific words are not used insection 54EC , deduction cannot be allowed to the assessee. [Smt. Dakshaben R. Patel vs ACIT [2012] 22 taxmann.com 237 (Ahd.-ITAT)]

Q   Is exemption u/s 54EC is available from capital gains on deemed transfer u/s 4 6(2) of the Income Tax Act 1961?

Capital Gains in the hands of shareholder on distribution of assets by company in liquidation u/s 46(2) is a deemed transfer not an actual transfer which has specifically been taxed under that section. Exemption u/s 54EC is available from gains on actual transfer and not from gains u/s 46(2).[CIT V. Ruby Trading Co. Ltd. 32 Taxman 500 (Raj) [1987] ]

Q Whether the benefit under section 54EC  and 54F can be taken simultaneously?

Deduction under section 54EC cannot be denied on ground that assessee has availed exemption under section 54F also in respect of a part of capital gains. [ACIT vs Deepak S. Bheda[2012] 23 taxmann.com 159 (Mum.)]

Q Whether the benefits u/s 54, 54F & 54EC are available from gains of depreciable capital asset?

In CIT V. Assam Petroleum Industries Pvt. Ltd. 131 Taxman 699 (GAU.) [2003], it was held that, where a depreciable asset is held for more than 36 months before its transfer, then such depreciable capital asset is Long Term Capital Asset. However, according to section 50(1)&50(2), the gains or loss on DCA shall always be short term.

It was further held that benefit u/s 54,54F & 54EC which are available from gains of a LTCA shall be available from gains of Depreciable capital asset.

EXEMPTIONS SECTION 54, 54EC & 54F OF INCOME TAX ACT, 1961

The assessee can claim exemption from capital gains on sale of residential house property under the following sections:

Particulars Sec. 54 Sec. 54EC
Exemption claimed Individual/ HUF Any person Individual/ HUF
POH of Capital asset Long-Term Long-Term Long-Term
Eligible specific asset A residential house property Any LTC asset Any LTC asset (other than aresidential house property)provided on the date of transfer the tax payer do not own more than one residential house property from the A.Y. 2001-02 (except the new house as stated in 4 infra)
Type of asset should be acquire to get the benefit of exemption Residential house property Bonds of national highway authority of India or Rural Electrification Corporation. A residential Property
Time limit for acquiring the asset Purchase:1 yr backward or 2 yrs forward.Construction:3yrs forward 6 months forward Purchase:1yr backward or 2yrs forward.Construction: 3yrs forward
Relevant datefor acquiringthe new asset From the dateof transfer ofhouse propertybut in case ofcompulsory acquisitionfrom thedate of compensation. From the date oftransfer of longterm capital assetbut in the caseof compulsory acquisition from the date of receipt of compensation. From the date of transferof capital asset but in caseof compulsory acquisitionfrom the date of receipt of
Amountexempted Investment inthe new assetor capital gain, whichever is lower. Investment inthe new assetor capital gain, whichever is lower. Investment in the new asset/net sale considerationcapital gain
Exemptionrevoke in asubsequentyear If the new assetis transferredwithin 3 yrs ofits acquisition. If the new assetis transferred or itis converted in tomoney or a loan is taken on security of the new asset within 3 yrs of its acquisition. If the new asset is transferredwithin 3 yrs of its acquisition.If another residential houseis purchased within 2 yrs of transfer of original asset, orIf another residential house is constructed within 3 yrs of the transfer of original asset.

Different questions Sec. 54 Sec.54EC Sec. 54F
When the exemption is revoked it is taxable as LTCG/STCG in the year in which the default is committed. STCG LTCG LTCG
Scheme of deposit is applicable Yes No Yes

 

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.

Capital Gains liability in Joint Development Agreements

The scope of Capital Gains in Joint Development Agreement is a vast one and is made with an eye on the tax consequences of the transaction. The last decade has viewed the tremendous growth in the Real Estate; it also witnessed the growth in legal disputes regarding tax matters. A Joint Venture between the landowner and a Developer is considered the most preferable way for the development of property.

In a Joint Development Agreement between Landowner and Developer for construction of residential buildings on a land measuring X acres of landowner, the common issues which generally arises are as following:

  1. a) When does the Capital gain Tax arise for the landowner and developer?

=  Is it at time of signing the joint development agreement ?

=  or at the time of receiving the constructed residential buildings ?

=  or at the time of selling the residential buildings?

b) In case, if there is breakdown of joint development project, does landowner has to pay the capital gains tax.

As per S.45 (1) of the Income Tax Act, any gain arising from the transfer of a capital asset during a previous year is chargeable under the head “Capital Gains” in the immediately following assessment year.

However, S.45(2) of Income Tax Act, gives certain exemptions to not to treat certain assets as capital assets like any stock in trade, consumable stores or raw material held for the purposes of business or profession. And, as per the facts Developer is engaged in Construction business, so for him, constructed property is stock-in-trade. It cannot be treated as a “capital asset”. Any surplus that is generated by developer on sale of stock-in-trade would be chargeable to tax as business income. Therefore, Developer is not liable to pay capital gains tax.

In case, in the Joint Development Agreement, arrangement between the landowner and developer is such that developer has to bear certain portion of capital gains tax, then only developer will be liable for the payment of capital gains tax which is to be borne by the landowner or else the landowner has to bear the capital gains tax.

Now, the question arises when the incidence of capital gains tax arises?

# The point where the capital gains are deemed to accrue will purely depend on the terms of Joint Development Agreement. Where the agreement is of such nature that possession is given in part performance of a contract, the liability of capital gains tax will arise on the handling over of such possession to the builder.

# If the possession is not transferred but deferred until the construction is completed, the liability to capital gains tax will arise in the year in which the developer completes the construction.

# Where the landowner and builder execute joint development agreement, if the consideration is receivable in built-up area to be constructed and handed over by the builder to the landowner, it is advisable to avoid the applicability of section 53A of the Transfer of Property Act. This can be achieved by mentioning in the agreement that license is granted to the builder to enter the premises and construct the building. The possession is retained by the landowner, which will be handed over as and when the built-up area is constructed and delivered. By this stipulation, the transfer will take place only in the year in which the built-up area is received and not before.

In the case of In re Jasbir Singh Sarkaria, [2007]164 TAXMAN 108 (AAR- New Delhi) , it has been held that-

1) Where the agreement for transfer of immovable property by itself does not provide for immediate transfer of possession, the date of entering into the agreement cannot be considered to be the date of transfer within the meaning of sub-clause (v) of section 2(47) of the Income-tax Act.

2) To attract sub-clause (v) of section 2(47), it is not necessary that the entire sale consideration upto the last installment should be received by the owner.

3) In the case, having regard to the terms of two agreements and the irrevocable GPA executed pursuant to the agreement, the execution of GPA shall be regarded as the “transaction involving the allowing of the possession” of land to be taken in part performance of the contract and therefore, the transfer within the meaning of section 2(47)(v) must be deemed to have taken place on the date of execution of such GPA.

4) Once it is held that the transaction of the nature referred to in sub-clause (v) of section 2(47) had taken place on a particular date, the actual date of taking physical possession need not be probed into. It is enough if the transferee has by virtue of that transaction a right to enter upon and exercise the acts of possession effectively.

In case, the Joint Development Agreement between the Landowner and Developer breaks down and the project is not completed, then whether Landowner is liable to pay capital gains tax?

(i). If the developer is liable for the breaking down of the joint development agreement, then either the landowner will get compensation from the developer for the breach of contract or developer have to do specific performance as per the terms of the Joint Development Agreement, in both cases landowner will acquire. And, for charging what landowner has acquired from the developer under capital gains tax, it should be first comes under the definition of “capital asset”

In the case of CIT v. Vijay Flexible Containers [1990] 186 ITR 691 (Bom.), the assessee a firm entered into an agreement with a person to purchase the property at a particular rate. The assessee also paid a sum of Rs. 17,500 as earnest money. As the vendor failed to perform his part of the contract, the assessee was constrained to file a suit for specific performance of the agreement for sale, or in the alternative, for damages for its breach. Consent terms were arrived at in the suit and a decree was passed in favour of the assessee for the sum of Rs. 1,17,500 and interest. The question arose whether that amount received by the assessee was a capital asset.

A Division Bench of the Bombay High Court held that under the agreement to purchase the property, the assessee had acquired the right to have the immovable property conveyed to him and under the law, he was entitled to exercise that right not only against his vendors but also against a transferee with notice or a gratuitous transferee. The assessee could have also assigned that right. Hence, what he acquired under the said agreement for sale was therefore property within the meaning of the Income-tax Act, 1961, and consequently a capital asset. The Court further held that his giving up of the right to claim specific performance by conveyance to him of the immovable property was a relinquishment of the capital asset and therefore there was a transfer of a capital asset within the meaning of the Income-tax Act.

(ii). In a Joint Development Agreement, when the project starts, the Developer pays a consideration to the Landowner for starting the project. Even if the project is not completed because of breakdown of Joint Development Agreement, then whether the consideration paid by the Developer at the beginning of project will be treated as capital asset for Landowner?

In the case of K.R. Srinath v. Asst. CIT,[2004] 141 Taxman 268 (Mad.), Where the assessee initially paid advance under an agreement for the purchase of a property, reserving right to specific performance of the agreement, and later received consideration under another agreement under which the earlier agreement was cancelled and the vendor was allowed to sell the property to any person at any price, there was a relinquishment of right by the assessee which amounted to ‘transfer’, and the resulting gain was assessable as capital gains. Since the assessee had paid a sum for acquiring the right to acquire the sale deed, it could not be said that there was no cost of acquisition so as to take the view that there could be no assessment to capital gains.

Hence, even if the Joint Development Agreement between the Landowner and Developer breaks down, if the landowner has acquired due to Joint Development Agreement, then what landowner has acquired will come under the definition of “capital asset” and Income Tax department can levy capital gains tax on that capital asset.