Section 54F of the Income-tax Act, 1961 provides for exemption from capital gains arising from the transfer of a long-term capital asset (other than a residential house) if the net consideration is invested in the construction or purchase of a new residential house. A key area of contention has been whether cost incurred for purchase of land or commencement of construction before the date of transfer of the original asset is eligible for exemption under this section.
Recent judgments and interpretations, including CBDT Circular No. 667 dated 18-10-1993, have shed light on this issue, providing significant relief to taxpayers. This article analyses these developments with reference to two key judicial decisions.
Judicial Precedents Supporting Deduction of Pre-Sale Expenses
1. CIT v. K. Ramachandra Rao [2015] (Karnataka HC)
Facts:
- The assessee sold a parcel of land and claimed exemption under Section 54F.
- Prior to the sale, he had already started construction of a house on a plot he owned, using borrowed funds.
- He utilized the entire sale consideration within three years for the construction of the house but did not deposit the amount in the Capital Gains Account Scheme (CGAS).
Ruling:
- The Karnataka High Court held that investments made in construction of a residential house within one year prior to the date of transfer of the original asset are eligible for exemption under Section 54F(1).
- The Court further held that non-deposit of the amount in CGAS will not disqualify the exemption, provided the conditions of utilization are met within the stipulated period.
Key Takeaways:
- Expenditure on construction commenced one year before the date of transfer is valid for exemption.
- Use of borrowed funds is permitted.
- Utilization of capital gains within 3 years is the essence, not mere deposit in CGAS.
2. Sohanlal Mohanlal Bhandari v. ACIT [2019] (ITAT Pune)
Facts:
- The assessee purchased a plot before selling his original asset and started constructing a house thereon.
- He claimed exemption under Section 54F for the entire cost of the plot and construction.
Ruling:
- ITAT Pune held that as long as construction is completed within 3 years, the exemption must be allowed.
- It further clarified that the purchase of a plot and commencement of construction before the date of sale is permissible if it is done within a reasonable period and in contemplation of the new residential house.
Key Takeaways:
- Exemption under Section 54F is available for entire cost of land and construction, even if incurred before the sale.
- There is no mandate to use only the sale proceeds; own or borrowed funds are equally acceptable.
- Purchase/construction must relate to a reasonable timeline linked with the ultimate investment goal.
Supporting CBDT Circular
CBDT Circular No. 667 dated 18-10-1993 clarifies that if the construction of a residential house is commenced before the transfer of the original asset but completed within three years from the date of transfer, exemption under Section 54F shall be available.
This circular aligns with the judicial pronouncements and reinforces the principle that the substance of investment—i.e., actual use of sale proceeds within the prescribed time—is more important than rigid formality regarding timing.
Conclusion
The interpretation of Section 54F by various courts and the CBDT makes it evident that cost incurred for purchase of plot or commencement of construction prior to the transfer of original asset is not a bar to exemption, provided:
- Construction is completed within three years from the date of transfer;
- The house is constructed on a new asset (not pre-existing property);
- The investment can be from borrowed or personal funds;
- The expenditure is in contemplation of the new residential house.
These developments provide much-needed clarity and relief to genuine taxpayers and remove unnecessary procedural hardships.
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Author: Purshottam Mishra | Article Assistant, Tax & Regulatory Services
Chartered Accountancy Student | Contributor to Tax Interpretation and Practice
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