July 26, 2019

Has your client recently sold a property?

Arvind Rao

Founder, Arvind Rao & Associates

Has your client recently sold a property?

Albert Einstein once remarked that “The hardest thing in the world to understand is Income Tax”. Yes, Income tax is complicated, but then so is life, isn’t it? And in many ways, life is more complicated than income tax. So, while the Income Tax Act (the Act’) has volumes of sections and sub-sections, provisos and explanations, all of these put together too cannot always seem to provide a ready answer to questions posed by tax payers while interpreting tax provisions in real-life.

Such real-life situations are then resolved by a wider [read as sometimes liberal] interpretation of the Act’s language by higher appellate authorities and Courts. Here, every case is different, the facts and merits of each case are often unique. Not everything is black and white. It’s the grey areas where your clients need maximum guidance. Your clients might have queries pertaining to such situations and as their first point of contact for all things related to their personal finances, financial advisors like you should be aware of these interpretations while you have these important conversations with clients.

One of the common pain points when it comes to such interpretations is that of the provisions related to deductions available from Long Term Capital Gains earned on the sale of property. The general provisions that we are all aware of are as follows:

• Section 54 of the Act provides that if a tax payer sells a residential house property and invests the long-term capital gains earned in a new residential property, then the long-term capital gains will be exempt to the extent amount so invested.

• Section 54F on the other hand provides that if a taxpayer sells any capital asset, other than a residential house property, and earns long-term capital gains, he/ she can invest the sale proceeds in new residential house property. In such cases, the deduction can be claimed to the extent of the sale proceeds that is invested.

• Please mark two major differences between these 2 deductions – One, is that the former allows reinvestment of house sale proceeds into a house while the latter allows reinvestment of sale proceeds of any other capital asset (shares, gold, art, etc) into a house. Secondly, under section 54, you need to focus on investing only the long-term capital gains, while for 54F, you need to focus on investing the entire sale proceeds.

• In both the above cases, the prescribed time period for the reinvestment is 1 year before the date of sale or 2 years from the date of sale in case a new property is being purchased. In case the new property is being constructed, then the time allowed is 3 years from the date of sale.

On the face of it, these provisions seem very simple – a taxpayer needs to sell an asset and buy another asset and claim exemption. But, property matters have a long history of not being so simple.

This article presents five such recent cases that deal with special situations [read as those which are not expressly covered under the provisions of the Act] when it comes to claiming exemptions, specifically from long-term capital gains u/s 54 and 54F of the Act. These are sure to be a handy tool for you to address your clients’ concerns and guide them towards a better resolution to their problems

1. Bangalore Tax Tribunal has held that non-filing of tax returns within the time allowed under the Act cannot be a reason for disallowance of the claim for deduction u/s 54. In the given case, the tax payer had sold a property and reinvested the money into the sale of a new residential property but had failed to file his return within time. When his case was reopened for non-filing, the tax officer refused to allow him deduction u/s 54 as no return was filed. The tax payer claimed to have not received any notices from the tax office, as it was being sent to the address of the property that was sold. Consequently, he filed his return for the first time before the appellate authority. The Tribunal observed that while the tax officer had accepted the computation of long-term capital gains on the sale of a property, had only disallowed the claim for deduction on account of non-filing. Hence, the case was ruled in favor of the tax payer.

2. Mumbai Tax Tribunal has ruled that long-term capital gains invested to buy tenancy rights cannot qualify for deduction u/s 54 of the Act. In cities like Mumbai, pagadi properties are a pretty common occurrence and one has to pay a modest sum to even acquire the tenancy rights in these properties. A tax payer had invested his long-term gains to acquire tenancy rights in a certain property. While deciding on his appeal, the Tribunal observed that tenancy rights cannot be equated with ownership rights and section 54/ 54F are clear that exemption is available only for construction/purchase of a new house property. Accordingly, the appeal was ruled down.

3. Mumbai Tax Tribunal in another case has held that while computing long-term capital gains on sale of property where payments have been made in installments [linked to stages of construction or for any other reason], indexation of each installment can only be made with reference to each year in which the payments are made. In the said case, the tax payer had indexed the entire cost of the property with reference to the year in which the property was first registered, although the payments continued for over 4 years after that date. The Mumbai Tribunal relied on a preceding Gujarat High Court decision in a similar matter and ruled against the tax payer.

4. Ahmedabad Tax Tribunal has interpreted section 54F quite liberally and ruled that sale proceeds invested for the sake of a new residential home in the name of HUF will also qualify for a deduction. In the given case, the tax officer was not keen on allowing the exemption as HUF is a separate taxable entity. The tax payer had argued that although the new house had been constructed on the plot purchased in the name of the HUF, no money was spent by HUF. Plus, the HUF consisted of no strangers but himself, his wife and two sons. Accordingly, the Tribunal ruled the case in favor of the tax payer.

5. The Bombay High Court has held that while calculating the holding period of a residential house for the purpose of capital gains, where there is a gap between the date of allotment and date of registration, the period should be reckoned from the date of allotment itself.  In this case, the tax officer argued that allotment cannot be the conclusive, as the transfer of an asset in favor of the buyer would be complete only on the date the agreement is registered. All the lower appellate levels disagreed with the tax officer’s view and the High Court did not interfere with their decision.