Capital Gains on Land and Building-A Practical Approach

The Income Tax law on capital gains on the transfer of movable and immovable assets is a much debated subject from its inception and a lot of clarity has emerged over a period of time through various amendments to the law, judicial decisions and  clarificatory notifications/ circulars.The Entry  82 of List I to the Constitution of India empowers Parliament to levy taxes on income other than agricultural income

Though section 2(24) of the Income Tax Act 1961 (Act) does not contain any  specific definition of the term”income”, it is an inclusive provision and also names  various kinds of receipts which are termed as income and taxable  under the Act unless specifically exempted  under section 10. If we just browse through the list of items  which are termed as income except the receipt as specified in item 2(24)(vi),all the receipts are revenue in nature.  The income tax law aims to tax revenue receipts under its ambit unless such receipts are specifically exempted  and exempt all the capital receipts except the capital gains which are specified in section 45 of Act. As  the Act does not contain any  definition of the terms “Revenue Receipts” and “Capital Receipts” we have to rely on the general definitions and various judicial pronouncements to classify a receipt whether it is capital or revenue and its taxability under the Act. Despite the fact that the Act has given clear cut and comprehensible guidelines to tax both revenue receipts and capital gains other than the exemptions conferred by it, still there are certain unexplained issues in the Act with regard to computation of long term and short term capital gains in respect of transfer of certain capital  assets. This article aims to discuss such issues with more emphasis on its practical perspective.

1) Transfer Of Capital Assets

Section 45 of the Act is the charging section of capital receipts and the relevant section says that any profit or gain arising from the transfer of a capital asset  during the previous year is taxable  under the head “Capital Gains” in the immediately following assessment year unless such profits or gains are specifically exempted under the Act. Section 2(14) of the Act defines the term “Capital Asset” which includes property of any kind whether fixed or circulating, movable or immovable, tangible or intangible. Section 2(47) defines the term “Transfer of Capital Asset” which is an inclusive definition. It says that transfer with regard to a capital asset includes sale, exchange or relinquishment of the assets or extinguishment of  any rights therein or compulsory acquisition thereof under any law. It is evident from the above legal provisions that any profit or gain arising out of a transfer of a capital asset which is effected during a previous year has to be offered to tax in the return to be filed for the relevant assessment year.  Though the taxing provisions relating to capital gain lay down a broad basis as to how to compute the capital gains, both long term and short term,  it does not explicitly deal with certain practical difficulties or issues concerning the computation of such capital gains. Certain  issues which are practically faced at the time of computing the capital gains when  capital assets, especially land and buildings together, are transferred  are discussed hereunder.

2) Transfer Of  Building And The Land Appurtenant Thereto As A Single Lot

The land and building are two different identifiable, independent, distinct capital  assets and the provisions relating to capital gain permits their transfer independently and compute the capital gain or loss thereon for each asset accordingly. However in practice an  assessee acquires a vacant land  initially and later construct a building thereon or acquire both land and building at the same time. There may be situations wherein an assessee can also construct a building on a land owned by the assessee through inheritance or succession, gift or will etc. When the  assessee  wishes to transfer these assets thereafter for a monetary consideration, such assets have to be transferred as a single lot  (both land and building) to the  ultimate  transferee against which the capital gain implications have to be examined.

A) Land and Building whether short term or long term assets

The land and building being the immovable assets could either be  a short term capital asset or a long term capital asset depending upon the period of holding of such assets by the assessee. In respect of immovable property being land or building or both,if the assessee holds such assets for more than 24 months on after 1-4-2017, the same are classified as long term capital assets and the gain arising out of the transfer of such assets has to be considered  as long term capital gain. Prior to  1-4-2017, in order to claim these assets as long term assets, the assessee should have held these assets for more than  36 months. If the above  immovable property is held by an assessee for less than the above stipulated  period, then such assets have to be  classified as short term capital assets and the corresponding profits or gains arising out of the transfer of such assets will be regarded as short term capital gains. As per section 50 of the Income Tax Act 1961, a building has to be treated as a short term capital asset on  its transfer if depreciation is allowed to the assessee in the past.

B) Mode of computation of capital gains

As per section 48 of the Act, the income chargeable under the head “capital gains” shall be computed by deducting the following amounts from the full value of consideration received or accruing as a result of the transfer of the capital asset.

(i) Expenditure incurred wholly and exclusively in connection with such transfer,

(ii) the cost of acquisition of the asset and the cost  of any improvement thereto

As per the second proviso to section 48,  where long term capital gain arises from the transfer of a long term capital asset other than capital gain arising to a non resident from the transfer of shares in or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words “cost of acquisition” and “cost of any improvement” the words “indexed cost of acquisition” and “indexed cost of any improvement” had respectively been substituted.

In case of a transfer of land and building which are long term assets at the hands of the assessee, the indexed cost of acquisition as computed based on the Cost  Inflation Index notified is deductible from the full value of consideration received or accruing as a result of the transfer of capital asset.

With regard to the full value of consideration, it is the actual sale  consideration received or accruing to the transferor from the transferee at the time of transfer of  the asset. If the sale consideration declared in the conveyance deed for the transfer of land and building is less than the value adopted for the purpose of stamp duty by stamp valuation authority of the State Government, the value so adopted by the above authority for stamp duty purposes is deemed to be full value of consideration with regard to  computation of capital gains as per section 50C of the Act

C) How to compute the capital gains on transfer of building and land  together

In practice, a building and the land appurtenant thereto held by an assessee, as long term capital assets, could be transferred together to a transferee through a  single conveyance deed against a  lumpsum  monetary  consideration. In this case, the question on the method of  computing the long term capital gains arises (ie)  whether the long term capital gain could be computed  for land and building separately?  This question assumes paramount importance since the indexed cost of acquisition and improvement thereto in respect of these assets will vary depending upon the period of holding . The long term capital gains could be computed separately for land and building  as held by  the Hon’ble ITAT, Calcutta in the case of CIT vs Sri Sekhar Gupta[2001]114 Taxmann 122 wherein it was held that the land is an independent,identifiable asset and continues to remain as  an identifiable capital asset even after construction of a building thereon. Identical views were taken by the Hon’ble Rajasthan High Court in the case of CIT vs Vimal Chand Golecha reported in [1993]201 ITR 442 and by the Hon’ble Madras High Court in CIT vs Dr.D.L.Ramachandra Rao[1999]236 ITR 51.The only condition to be complied with in respect of long term capital gain in respect of the building is the assessee should not have claimed  any depreciation on the building in the past years prior to the transfer.

However in order to claim  the above capital gains separately for land and building, the assessee is required to maintain certain basic  details like the original cost of acquisition of land and building, the year acquisition  etc separately duly supported by necessary documentary evidences as they may be required at the time of scrutiny assessment. Based on the holding periods of these assets, the indexed cost of acquisition could be computed. Likewise in order to claim the indexed cost of improvement necessary documents in support of the improvements done and the  expenditure incurred thereon  have to be also maintained by the assessee.

The next question is how to appropriate the sale consideration for  the transfer of land and building if a  lumpsum monetary  consideration is received by the transferor from the transferee when the transfer is effected through a single conveyance deed. As per section  50C as amended by the Finance Act 2009, where the consideration received or accruing as a result of transfer of land and/  or building is less than the value adopted or assessed or assessable by an authority of the State Government for the purpose of payment of stamp duty in respect of such transfer, the value  so adopted or assessed or assessable shall be deemed to be the full value of consideration received or accruing as a result of such transfer for computing capital gains.

In all the registered  conveyance deeds, wherein  transfer of land and   building is involved,   an Annexure IA is appended wherein the market values  are furnished  for  the land and the building separately for the purpose of stamp duty valuation. The market value of the immovable property transferred as indicated in the sale deed will be equivalent to  the actual  sale consideration received by the transferor from the transferee. If this value exceeds the value adopted or assessable by the Registration Authority for stamp duty purposes, the said sale consideration as appropriated to land and building as per Annexure IA attached with the registered sale deed could be adopted for the purpose of computing the capital gains. If the sale consideration is lesser than the value adopted or assessable by the Registration Authority for stamp duty purposes, then such  value so adopted by the Registration  Authority as appropriated between the land and building  could  be adopted as deemed sale consideration for the respective assets for the purpose of computing the capital gains. This will be in line with the provisions contained in section 50C of the Income Tax Act 1961.

This can be illustrated by way of an example.

Mr. X acquired a vacant land during the year 2002  at a total  cost of Rs.6,00,000/ including  transfer and  development expenditure incurred during  the same year. Later he completed the construction of  a building on the above  land at a total cost of Rs.7,00,000/ during the year 2007.He sold the land and building together for a lumpsum consideration of Rs 60,00,000/ in the year 2018.The value adopted by the Registration Authority for stamp duty purposes for both land and building is  Rs.35,00,000/.The market value furnished in Annexure IA to the sale deed for land is 35,00,000 and the building  is Rs 25,00,000/.

Computation of long term Capital Gain for the transfer of land and Building separately

In the above example, as the actual sale consideration received by Mr.X from his transferee is more than the value adopted by the Registration Authority for the purpose of stamp duty, the same has been considered as the value of sale consideration for the purpose of computing the long term capital gains and as both the immovable assets have been held by the assessee for more than 24 months without claiming depreciation on the building, the same have been considered to be  long term assets.

For the purpose of computing the cost of acquisition, a different  method has to be adopted  if the relevant asset was acquired before 1^st April 2001.If the property became the asset of the assessee before 1^st April 2001,the cost of acquisition will be the  actual cost of acquisition or the fair market value of the property as on 1^st April 2001 whichever is higher. In respect of cases which were acquired after 1^st April 2001, the actual cost of acquisition to the assessee has to be considered at the time of computing the capital gain.

D) Computation of short term capital gain in respect of the building transferred along with the land

There are practical cases wherein  the assessee would have claimed depreciation on the building in the past years. In that event, when the building and the land appurtenant thereto are  transferred together, the gain arising out of the transfer of land will be a long term capital gain provided the assessee satisfies the holding period for more than 24 months after 1-4-2017 and 36 months prior to 1-4-2017. Though the assessee satisfies the same condition  in respect of the building, the assessee cannot claim it as a long term capital asset as depreciation has been allowed on the  building in the past years. In such a case, the capital gain arising out of the transfer of land will be a long term capital gain and the gain arising out of the transfer of building will be treated as short term capital gain.

With regard to depreciable assets covered under section 50 of the Act, the cost of acquisition has to be determined by taking into account the opening balance of the block of assets on the first day of the previous year plus actual cost of the assets acquired during the year which  falls in the same block of assets .With this, any expenditure incurred wholly or exclusively in connection with the above transfer may be added. If the sale consideration appropriated to the  building as per the guidelines indicated supra exceeds the above sum, the differential value constitutes short term capital gain and the same has to be offered to tax accordingly in the return of income.

E) Computing long term capital gains in case of revaluation of land and building

Section 43(1) of the Act defines the term “Actual Cost” as follows.

“In section 28 to 41 and in this section unless the context otherwise requires “actual cost” means the actual cost  of the assets to the  assessee  reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. Section 32 of the Act allows depreciation on various block of assets at prescribed rates  as per Rule 5(1)  read with Appendix I of the Income Tax Rules. A combined reading of the above two sections will reveal that the assets for the purpose of allowing depreciation under the Act have to be recognised only with  the historical cost of the assets and the relevant  block of assets including additions and deletions thereon have to be maintained  by the assessee as prescribed under the above Rules. For the purpose of computing capital gains, the relevant provisions also recognises only the cost of acquisition of the assets. The cost of acquisition of an asset is the cost against which the relevant asset was acquired by the assessee which will include expenses of capital nature for completing or acquiring the title to the assets.

The Accounting Standard 10 on “Accounting for Fixed Assets” permits the revaluation of fixed assets and any increase in the net book value arising on account of revaluation of fixed assets should be credited directly to owners interests under the head “Revaluation Reserve.” If the land and building are revalued and their revalued cost is reflected in the respective block of assets in the books of account, the assessee is required to adopt only the historical or original  cost of acquisition for the purpose of computing the long term capital gain. For the above purpose, the assessee is required to maintain the details containing various block of assets with their  historical or the original cost  including land and building , additions/deletions made thereon, and depreciation claimed on depreciable assets etc  for income tax purposes. This  is applicable even for computing the short term capital gain in respect of a building wherein the assessee had claimed depreciation in the past years.

E) Cost of Acquisition in certain cases

In respect of cases wherein the assessee acquires a land or building or construct a building on a land already owned  by him through a deed of conveyance, the cost of acquisition could be normally determined based on the value for which the property was acquired by the assessee. But there are other situations wherein the assessee gets the title or ownership of the property by succession or inheritance, will or gift etc  wherein there will be no actual cost of acquisition. For the purpose of computing the capital gains when such properties are transferred for a monetary consideration, the income tax law lays downs the circumstances under which an assessee gets the title or ownership of the property without a  sale deed and the method under which the cost of acquisition could be determined.

Section 49(1) of the Act says that  the  cost of acquisition in respect of an asset acquired by an assessee  through the following modes shall be deemed to be the cost for which the previous owner had acquired the property as increased by the cost of any improvement of the assets incurred or borne by the previous owner or the assessee as the case may be.

(i) on any distribution of assets on the total or partial partition of a Hindu undivided family

(ii)  under a gift or will

(iii) (a) by succession, inheritance or devolution or

(b) on any distribution of assets on the dissolution of a firm, body of individuals or other association of persons where such dissolution had taken place at any time before the  1^st day of April 1987 or

(c) on any distribution of assets on the liquidation of a company or

(d) under a transfer to a revocable or an irrevocable trust or

(e) under any such transfer as is referred to in clause(iv),[or clause (v),[or clause (vi)[or Clause (via),[ or clause (viaa), [or clause (vica) or [clause (vi cb) or clause (xiiib) of section of the Act.

(iv) such assessee being a Hindu undivided family, by the mode referred to in  section 64(2) at any time after the 31^st day of December 1969

 As per the Explanation to the above section,the “previous owner” of the property in relation to any capital asset owned by an assessee means the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to clause(i) or clause(ii) or clause (iii) or clause (iv) of this sub section.

In view of  the above provisions, the cost of acquisition of the land and building which were acquired by an assessee in any one of the modes explained above has to be computed based on the cost on which the previous owner has acquired the said property as increased by the  development expenditure incurred or borne by the previous owner or the  assessee.

However it should be noted that if the asset became the property of the assessee  before  1^st April 2001 by gift, will etc or by any mode specified in section 49(1), the cost of acquisition to the previous owner or the fair market  value as on 1^st April 2001 whichever is higher has to be taken as the cost of acquisition.  If it becomes the property of the assessee through the above modes specified after 1^st April 2001, then the cost of acquisition to the previous owner has to be taken as cost of acquisition for the purpose of computing the capital gains.

By virtue of section 55(3), where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner.

In this regard another question may arise on how to compute the holding period in order to determine whether the relevant asset is a long term or short term asset for cases dealt with in section 49(1)  and  to claim the indexation benefit. In order to find out whether a particular asset is  a short term or a long term asset in the above  cases, the period of holding of the previous owner shall be taken into consideration. With regard to indexation benefit, the Hon’ble Bombay High Court  in the case of CIT vs Manjula J.Shah [2002]204 Taxman 691 and the Hon’ble Delhi High Court in the case of Arun Shunhgloo Trust  vs CIT [2012]205 Taxman 456 have  held that indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not with regard to the year in which the assessee became the owner of the asset.

When an assessee becomes the owner of an asset through various modes specified in section 49(1) and later converts into a new asset, then the period of holding will commence only from the date of conversion. In CIT vs Debmalya Sur [1994]207 ITR 996/77  Taxman 313 (Cal), it was held that section 49(1) applies only in relation to a cost of asset which was received by the assessee as a gift. The converted new asset has no nexus with the gift and therefore section 49(1) has no application for the purpose of determination of cost of the converted asset.