Interesting aspects of capital gains tax

Did we tell you about this terrific book that we have been reading? It’s got all the essential ingredients that a potboiler needs to have – drama, intrigue and suspense. The plots and sub-plots are so intricately woven by the author that each page will leave you guessing. We won’t give away more but we fully recommend reading The Income Tax Act, 1961. This week, we are going to examine one of the above mentioned sub-plots of this thriller that deals with capital gains.

Sec. 54 gives exemption to an individual or HUF on Long Term Capital Gains (LTCG) arising from transfer of a long-term asset, being buildings and lands appurtenant thereto, and being a residential house, self-occupied or not, provided the assessee has purchased within 1 year before or 2 years after the date of sale or has constructed within 3 years after that date, a residential house. If only a part of the capital gain is used, the exemption would be prorata.

In the current scenario, this requirement of construction being completed within three years has become too tight. Recognising this fact, the recent Finance Act 2016 has amended Sec. 24 by raising the requirement of the construction being completed within three years to five years, only for the exemption on interest payable on housing finance. Corresponding amendments have not been inserted for Sec. 54 and Sec. 54F. Hopefully, corrective action will be taken by the next budget.

Three points are worthy of careful note —

There is no time limit for commencement of construction though for completion, the limit is before expiry of three years from the transfer date of the original asset — 165ITR571 (Kar.) CIT v JR Subramanya Bhat, (1987). Hence, all costs incurred on the construction, irrespective of when incurred, can be claimed as acquisition cost.

Exemption is available on purchase of new property made within 1 year before the sale of the old house. But for construction, the exemption is not available if the construction is completed even by a day before the sale of the old house. Illogical!

The assessee need not apply the amount from the sale proceeds for purchasing another residential house — Lalit Marda v ACIT [2008] 23SOT250 (Kol). For instance, he can take a loan to purchase or construct and use the sale proceeds any which way.

Though the stipulations of Sec. 54F are similar to those of Sec. 54, there are 3 differences —

It requires reinvestment of the net consideration (sale value less expenses) whereas Sec. 54 is content with reinvestment of only the amount of capital gains.

It is applicable if the assessee is not an owner of more than one residential house, other than the new asset, on the date when he earns long-term capital gains. Sec. 54 has no such stipulation.

The third difference, though crucial, is not comprehended by many. In the case of Sec. 54, the assessee is required not to sell the newly-acquired property within three years from the date of its purchase or construction. If this condition is not satisfied, the cost of the new asset is to be reduced by the amount of LTCG exempted from tax on the original asset and the difference between its sale price and such reduced cost will be chargeable as STCG of the year in which the new asset is sold.

In the case of Sec. 54F, the assessee is also required not to sell the new property within three years. Additionally, he should not purchase within one year or construct within three years another residential house. We strongly feel that the period ‘one year’ is a mistake and should read as ‘two year’ for consistency of Provision a(ii) of Sub-section (1) with Subsection (2) and also with Sec. 54.

Where the new asset is transferred within three years from the date of its purchase or its construction, the amount of capital gain not charged u/s 45 shall be deemed to be LTCG of the previous year in which such new asset is transferred.

Where the assessee purchases, within two years or constructs, within three years after the date of the transfer of the original asset, any residential house other than the new asset, the amount of capital gain arising from the transfer of the original asset not charged u/s 45 shall be deemed to be the LTCG of the previous year in which such residential house is purchased or constructed.

Quite confusing! The wisdom of imposing different punishments for the same offence is not comprehensible. This creates confusion galore. The different figures of ‘one year’ and ‘two years’ appearing in these provisions are possibly a result of this confusion.

Joint holding of new house

Director of Income-Tax (International Taxation) and Another v Mrs. Jennifer Bhide 349ITR80(Kar) — The assessee had included name of her husband as joint owner in the sale deed as well as investment made in the NHAI bonds. The High Court held that the assessee would be entitled to exemption of the entire investment specially because the entire investment had flowed from the assessee and no consideration had flowed from her husband.

Acquisition date

Pallonji M. Mistry v CIT [2009] 178Taxman341 (Bom): Date of purchase would be the date on which the assessee takes possession of the house and not the date of registration of the sale deed. There is no requirement that there has to be a registered deed of conveyance for a person to be treated as an owner.

Crossing time limit

The concession gets withdrawn if the period of two or three years crosses even marginally. There are many decisions which condone delays under various situations —

Kishore H Galaiya v ITO[2012] 24taxmann.com11 (Mum Trib) As long as the assessee has invested the requisite amount in construction of new residential house within three years from the date of transfer, but the taking of the possession was delayed because of default of the builder and other factors not under the control of the assessee the exemption cannot be denied.

Shashi Verma v CIT 152CTR227(NB) 1999 —At present it is not easy to construct a house within this stipulated period, especially under government schemes. Therefore, if substantial investment is made in the construction, then it should be deemed that sufficient steps have been taken to satisfy the requirements of Sec. 54.

16taxmann.com210 (Chd - ITAT) [2011] —Sec. 54F does not prescribe completion of construction and its thrust is on investment of net consideration received on sale of original asset and start of construction of a new residential house.

V. A. Tharabai v DCIT [2012]19taxman.com276 (CheTrib) — Assessee could not construct residential house within 3 years because owners of the land filed a petition for injunction on which civil court ordered status quo. It was held that the amount spent by assessee in purchasing land be allowed for deduction.