Commentary on section 54 of the Income-tax Act, 1961

Object of section 54 of the Income-tax Act, 1961

Object of section 54 is to give relief to individual or HUF who makes profit/gain on transfer of residential house and once again invest (whether purchase or construct) such capital gain amount in another residential house.

Think of situation where one person has sold his old house for any reason and he purchases another house from such sale proceed so in this if income-tax is levied then this will result into genuine hardship that is why there is section 54.

By this section amount of capital gain will go to real estate sector i.e. from where capital gain arose once again went to the same sector.

Analysis of Section 54(1) of the Income-tax Act, 1961

Assessee (transferor/seller) must be individual or HUF therefore persons like company, LLP, partnership firm etc. cannot claim exemption under section 54. Capital asset which is transferred (sold) must be building or land appurtenant thereto, income of which is chargeable under the head house property and such building or land appurtenant (you cannot claim benefit of section 54 in respect of capital gain on transfer of vacant land) residential house and this residential house has been held by assessee for more than 24 months. Earlier this period of 24 months was 36 months but Finance Act, 2017 reduced it to 24 months with a view to promote the real-estate sector and to make it more attractive for investment.

Property must be residential house therefore individual or HUF cannot claim exemption under section 54 in respect capital gain arising on transfer of commercial property.

To claim exemption under section 54, assessee must purchase new residential house in INDIA, within 1 year before (object is to allow relief to assessee where he undertakes purchase transaction before sale of his existing residential house) or 2 years after the date of transfer of old residential house i.e. original asset (object of 2 years is to allow enough time to purchase new residential house after transfer of his old residential house) or must construct new residential house in INDIA within period of 3 years after date of transfer of old residential house (3 years time period in case of construction of new residential house because construction takes time).

Finance Act, 2014 (No.2) made an amendment where Legislature provided that assessee can purchase or construct only one residential house (object was to restrict exemption of section 54 only in respect of one residential house earlier before this amendment it was possible to invest in more than one residential house) in INDIA, earlier what was happening that few assessees were investing capital gain amount in foreign countries so to stop this loophole where investment was moving out of India, Legislature made an amendment to section 54 where it has been provided that one residential house (purchased or constructed) must be in INDIA.

Amount of exemption under section 54 shall be lower of the following (section 54(1)(i) and 54(1)(ii))

(1) Capital gain amount or

(2) Cost of new asset (i.e. new residential house)

Legislature has also imposed one condition that when assessee purchases or constructs new asset i.e. residential house, then he has to hold such property for at least 3 years from its purchase or construction and if assessee transfers this new asset before 3 years then assessee will not be able to reap benefit of section 54 because in such case cost of new asset which is transferred within 3 years shall be nil (where full capital gain was utilised) or cost of new asset shall be reduced by the amount of capital gain (where capital gain was partly utilised for purchase or construction of new house).

Object of this provision is to stop speculation activity in real estate sector and through this Legislature intends that assessee must hold new asset for reasonable period of time i.e. at least 3 years.

Proviso to section 54(1) – when investment can be made in more than one residential house

Finance Act, 2014 (No.2) made it compulsory that to claim exemption under section 54 of the Income-tax Act, 1961 assessee must purchase or construct one residential house in India. But later on Finance Act, 2019 (No.1) gave a life time option which can be taken only once in lifetime of assessee where assessee can purchase or construction two residential house in India if capital gain amount is upto Rs.2 crore.

So if your capital gain exceeds Rs.2 crore then you will have to purchase or construct one residential house in India and if your capital gain is upto Rs.2 crore then you have to purchase or construct one residential house in India if you have not availed once in a life time opportunity as mentioned above and once you exercise once in a lifetime opportunity then you can purchase or construct 2 residential houses in India after exercising aforementioned option in any previous year and after exercising this, in your life time whenever you sell your residential house and want to claim exemption under section 54 then you have to purchase or construct one residential house in India.

Legislative history

Section 54(1) of the Income-tax Act, 1961 corresponds to section 12B(4) of the Indian Income-tax Act, 1922.

Section 54(2) of the Income-tax Act, 1961 – Capital Gain Account Scheme (CGAS)

Initially under Income-tax Act, 1961, there was no sub-section (2) of section 54 but Finance Act, 1987 inserted sub-section (2). Earlier before introduction of capital gain account scheme (CGAS) what was happening that assessee used to claim benefit of section 54 exemption but for any reason if he could not utilize capital gain amount within stipulated time period as given in section 54(1) then there was need of rectification of assessment therefore with a view to dispense with this rectification of assessment burden, Legislature introduced capital gain account scheme and. Now you have understood rationale of CGAS.

Central Government has framed Capital gain account scheme, 1988.

Under Capital gain account scheme there are two types of deposit account namely-

(1) Deposit account –A (saving deposit)

(2) Deposit account-B (term deposit)

This CGAS account can be opened with public sector bank e.g. State Bank of India (SB), Punjab National Bank (PNB) etc.

Section 54(2) comes into picture only when assessee could not appropriate full or partly capital gain amount for new asset till the due date of filing income tax return as given in section 139(1) of the Income-tax Act, 1961 and if before this due date assessee has fully utilised capital gain then capital gain account scheme will not come into picture.

If assessee could not utilize capital gain amount whether fully or partly then upto due date of income tax return filing as given in section 139(1) and assessee is bound to deposit capital gain amount in capital gain account scheme to claim exemption under section 54 and amount deposited in capital gain account scheme must be utilsed by assessee for purchase or construction of new house within stipulated time limit as provided in section 54(1) of the Income-tax Act, 1961.

If assessee could not utilise capital gain amount deposited in CGAS upto time limit as given in section 54(1) then unutilized capital gain shall be liable to income-tax in previous year in which period of 3 years from the date of the transfer of the original asset expire and assessee shall be entitled to withdraw capital gain amount from CGAS.

Text of Section 54 of the Income-tax Act, 1961 – Profit on sale of property used for residence

(1) Subject to the provisions of sub-section (2), where, in the case of an assessee being an individual or a Hindu undivided family, the capital gain arises from the transfer of a long-term capital asset, being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head “Income from house property” (hereafter in this section referred to as the original asset), and the assessee has within a period of one year before or two years after the date on which the transfer took place purchased, or has within a period of three years after that date constructed, one residential house in India, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,—

(i) if the amount of the capital gain is greater than the cost of the residential house so purchased or constructed (hereafter in this section referred to as the new asset), the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or

(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain:

Provided that where the amount of the capital gain does not exceed two crore rupees, the assessee may, at his option, purchase or construct two residential houses in India, and where such option has been exercised,—

(a) the provisions of this sub-section shall have effect as if for the words “one residential house in India”, the words “two residential houses in India” had been substituted;

(b) any reference in this sub-section and sub-section (2) to “new asset” shall be construed as a reference to the two residential houses in India:

Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.

(2) The amount of the capital gain which is not appropriated by the assessee towards the purchase of the new asset made within one year before the date on which the transfer of the original asset took place, or which is not utilised by him for the purchase or construction of the new asset before the date of furnishing the return of income under section 139, shall be deposited by him before furnishing such return [such deposit being made in any case not later than the due date applicable in the case of the assessee for furnishing the return of income under sub-section (1) of section 139 in an account in any such bank or institution as may be specified in, and utilised in accordance with, any scheme which the Central Government may, by notification in the Official Gazette, frame in this behalf and such return shall be accompanied by proof of such deposit; and, for the purposes of sub-section (1), the amount, if any, already utilised by the assessee for the purchase or construction of the new asset together with the amount so deposited shall be deemed to be the cost of the new asset :

Provided that if the amount deposited under this sub-section is not utilised wholly or partly for the purchase or construction of the new asset within the period specified in sub-section (1), then,—

(i) the amount not so utilised shall be charged under section 45 as the income of the previous year in which the period of three years from the date of the transfer of the original asset expires; and

(ii) the assessee shall be entitled to withdraw such amount in accordance with the scheme aforesaid.

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