Introduction:

Sections 54 and 54F of Income tax Act, 1961 contain the provisions for claiming the deduction relating to long-term capital gains on the sale of house property and other capital assets and reinvestment while purchasing of residential house property.

These provisions are not concise and clear and give more headroom for ambiguity. In order to decode these provisions, we need to rely on the precedents rendered by Courts and Tribunal. .

This article tries to decipher some of the core issues that arise while claiming the deduction under Sections 54 and 54F of the Act.  The issues arising therein can be understood in the light of the judicial pronouncements. These judgments will help us to understand the intention of the provisions and their usage. Various issues relating to claiming the deduction under Section 54 and 54F have been covered in this article along with relevant judicial pronouncements.

Profit on sale of property used for residence Section 54 of the Act:

As per Section 54 of the Act, if any individual or a HUF has transferred a long-term capital asset being a residential house property, within a period of one year before or two years after the date of transfer of the old house, the taxpayer should acquire another residential house or should construct a residential house in India within a period of three years from the date of transfer of the old house.

From AY 2021-22 the amendment made to Section 54, the eligible assessee can claim the exemption in respect of investment made in two residential house properties in India. The exemption for the investment made, by way of purchase or construction, in two residential house properties shall be available if the amount of long-term capital gains does not exceed Rs. 2 Crores. The assessee exercising this option once cannot exercise again for the same or any other assessment year.

In case, the assessee purchases/constructs a house and claims exemption under section 54 and then transfers the new house within a period of 3 years from the date of its acquisition/completion of construction, then the benefit granted under section 54 will be withdrawn. If the new house is sold before a period of 3 years from the date of its purchase/completion of construction, then at the time of computation of capital gain arising on transfer of the new house, the amount of capital gain claimed as exempt under section 54 will be deducted from the cost of acquisition of the new house.

If till the date of filing the return of income, the capital gain arising on the transfer of the house is not utilised (in whole or in part) by the assessee to purchase or construct another house property, then the benefit of exemption can be availed by depositing the unutilized amount in Capital Gains Deposit Account Scheme in any branch of public sector bank, in accordance with Capital Gains Deposit Accounts Scheme, 1988 (hereafter referred as Capital Gains Account Scheme (CGAS)). The new house can be purchased or constructed by withdrawing the amount from the said account within the specified time limit of 2 years or 3 years, as the case may be. If the assessee fails to utilize the amount deposited in the capital gains account to purchase or construct a residential house property within the specified timeline, the unspent amount will be treated as capital gains and taxed accordingly.

The provisions of Section 54 can be further enumerated with the help of various judgments pronounced by the judicial authorities. The judgments would facilitate us to understand the intricacies of the provision and its application in real life. The following are the various issues that arise while applying the provisions of Section 54:

I. Acquisition of a flat under construction will be treated as a purchase of a house or construction of a house for the purpose of Section 54 exemption?

II. Purchase of house property in assessee’s name alone to claim an exemption under Section 54?

III.  Whether it is mandatory to deposit the amount in the CGAS account?

IV. Completion of construction of the property within 3 years in order to claim an exemption under Section 54?

V. Whether the assessee is obliged to utilize the same sale proceeds of the old house in the purchase of a new house to claim the exemption?

Answers to the above issues to be found with the help of the various judicial pronouncements:

I. Acquisition of a flat under construction will be treated as a purchase of a house or construction of a house for the purpose of Section 54 exemption?

Acquisition of a flat under construction is considered as construction of a house property but not as a purchase of a house. This was concluded by the Mumbai ITATBench B in the case of Mustansir I Tehsildar vs. Income-tax Officer – 21(2)(3), Mumbai [2017] 88 taxmann.com 275 (Mumbai – Trib.).The ITAT has held that “We notice that the Hon’ble Bombay High Court has held in the case of Mrs Hilla J B Wadia (supra) has held that booking of flat in an apartment under construction must also be viewed as a method of constructing residential tenements. Accordingly, the co-ordinate bench has taken the view in the case of Sagar Nitin Parikh (supra) that booking of a flat in an apartment under construction is a case of “Construction”. In view of the above-said decision of the Hon’ble Bombay High Court and Tribunal, the acquisition of a new flat in an apartment under construction should be considered a case of “Construction” and not as “Purchase”.

II. Purchase of house property in assessee’s name alone to claim an exemption under Section 54?

Generally, the assessee who sold his old asset needs to purchase or construct a residential house property in order to claim an exemption under Section 54. However, there are some judgments pronounced by the judicial authorities that highlighted that the reinvestment in another property is important rather than the buyer’s name. These judgments provide insight into the provision:

a. The ITAT Bench Of Mumbai has held in the case of Jitendra V Faria v. Income-tax Officer, 18(2)(1), Mumbai [2017] 81 taxmann.com 16 (Mumbai – Trib.)  The appellant had sold a house property and purchased a house property by claiming exemption under Section 54. The appellant has registered the new house in his name along with his brother. During the assessment, the AO has disallowed 50% of the exemption for the reason that the new property is in joint names. The ITAT has held that “Since the assessee has incorporated the name of his brother, he is entitled to only 50 per cent of the investment so made in the new house. There is no justification in the Assessing Officer’s action, in so far entire investment was made by the assessee and only for the safety reason he has included the name of his brother. In the assessment order itself, the Assessing Officer has observed that the entire cost of the new property was borne by the assessee though the property is in the joint name with his brother. There is no merit in the action of Assessing Officer for restricting exemption under section 54 to the extent of 50 per cent of the value of the new house”.

b. In the case Shankar Lal Kumawat v. Income Tax Officer, Ward-7(2), Jaipur [2021] 125 taxmann.com 347 (Jaipur – Trib.) the Jaipur ITAT Bench A has relied upon the decision of Hon’ble Rajasthan High Court in case of Mahadev Balai (supra), in which the High Court has held that it is the assessee who has to invest and it is not specified in the legislation that the investment is to be in the name of the assessee and where the investment is made in the name of wife, the assessee shall be eligible for deduction. The ITAT Bench has relied on the various judgments relating to the same issue and thus decided the matter in favour of the assessee.

c. The assessee has sold residential property and invested entire sale consideration for the purchase of residential house property in the joint names of the assessee, her daughter and son-in-law and claimed exemption under Section 54. Chandigarh ITAT Bench B allowed the exemption under Section 54 in the case of Income-tax Officer, Ward-4(3), Chandigarh v. Smt. Rachna Arora [2021] 131 taxmann.com 307 (Chandigarh – Trib.).

III. Whether it is mandatory to deposit the amount in the CGAS account?

As per Section 54, if the assessee is unable to invest the capital gains on the sale of old house property in the purchase/construction of the new house, he has to deposit the unspent amount in CGAS account with an authorized bank in this regard in order to claim deduction under Section 54. However, not depositing in a CGAS account does not warrant claiming exemption under Section 54, provided the assessee fulfils other conditions specified in Section 54.

The following judgments highlight the situations in which exemptions are permissible u/s 54 in spite of no CGAS account opened or the amount not deposited by the assessee.

a. Chandigarh ITAT Bench B has held in the case of Mrs Seema Sabharwal Vs Income-tax Officer, Ward-4, Panchkula  [2018] 91 taxmann.com 2 (Chandigarh – Trib.) “The real purpose of the enabling provision is the compliance of the substantial provision of sub-section (1) to section 54 of the Act. Sub-section (2), in fact, regulates the procedure for the substantive rights of the exemption provisions u/s 54 of the Act. This enabling section, in our view, cannot abridge or modify the substantive rights given vide sub-section (1) of section 54 of the Act, otherwise, the real purpose of substantive provision i.e. sub-section (1) will get defeated. The primary goal of exemption provisions of section 54 is to promote housing. The procedural and enabling provisions of sub-section (2) thus cannot be strictly construed to impose strict limitations on the assessee and in default thereof to deny him the benefit of exemption provisions. In our view, if the assessee at the time of assessment proceedings proves that he has already invested the capital gains on the purchase/construction of the new residential house within the stipulated period, the benefit under the substantive provisions of section 54(1) cannot be denied to the assessee.

b. In the case of Venkata Dilip Kumar v. Commissioner of Income-tax, Chennai[2019] 111 taxmann.com 180 (Madras), the Madras High Court has held that “Section 54(2) cannot be read in isolation and on the other hand, application of section 54(2) should take place only when the assessee failed to satisfy the requirement under section 54(1). While the compliance of requirement under section 54(1) is mandatory and if complied with, has to be construed as substantial compliance to grant the benefit of the deduction, the compliance of requirement under section 54(2) could be treated only as a directory in nature. If the assessee with the material details and particulars satisfies that the amount for which deduction is sought under section 54 is utilised either for purchasing or constructing the residential house in India within the time prescribed under section 54(1), the deduction is bound to be granted without reference to section 54(2), which compliance would come into operation only in the event of failure on the part of the assessee to comply with the requirement under section 54(1). Mere non-compliance with a procedural requirement under section 54(2) itself cannot stand in the way of the assessee in getting the benefit under section 54 if he is, otherwise, in a position to satisfy the mandatory requirement under section 54 (1) is fully complied with within the time limit prescribed therein”.

IV. Completion of construction of the property within 3 years in order to claim an exemption under Section 54?

The objective of Section 54 is capital gains to reinvest in another residential house. The provision emphasizes the investment of amount in new property within the timelines as per Section 54, but not completion of the property.

The completion of the construction of new house property may not have happened due to various issues like disputes in the title of the lands, non-obtaining approvals from the government authorities etc. Hence, investing the capital gains amount in new house property within the time limits is more important for claiming exemption under Section 54 than the completion or taking possession of the new property.

a. The ITAT bench of Bangalore has held that in the case of Estate of Late Dr Zakaulla Masood v. Income Tax Officer, Ward 1(5)(4), Bangalore [2020] 122 taxmann.com 214 (Bangalore – Trib.) “We are satisfied on the basis of evidence produced by the assessee that a building had come up over the site purchased by the assessee and the purchase of site and cost of construction was much more than the capital gain arrived at by the assessee on sale of the ancestral house. The CIT (Appeals) has gone by the fact that there was the absence of an Occupation Certificate. In our opinion, this will not be a ground to deny the claim of the assessee for deduction u/s. 54 of the Act, as other evidence filed by the assessee sufficiently, demonstrates that the assessee has constructed a residential house within the period stipulated by law. The findings of the CIT (Appeals) in this regard are very vague and cannot be the basis to deny the claim of the assessee for deduction u/s. 54 of the Act. It was held that the assessee was entitled to deduction u/s. 54 of the Act and consequently no long-term capital gain was exigible to tax and accordingly the addition was deleted.

b. The Chennai bench of ITAT has held in the case of Kannan Chandrasekar v. Income-tax Officer, Corporate Ward-16(2), Chennai, [2017] 82 taxmann.com 284 (Chennai – Trib.) “The assessee had already appropriated the capital gains for the purpose of construction of the residential unit. However, construction was not completed within the stipulated period. Liberal interpretation to be considered while granting exemption under section 54, as it is a beneficial provision. The judgment of the Karnataka High Court in the case of CIT v. Smt. B.S. Shanthakumari [2015] 60 taxmann.com 74/233 Taxman 347 held that completion of construction within three years was not mandatory and was necessary that the construction should be commenced. That cannot be disputed. When the commencement of the construction of the residential unit which is evidenced by the construction agreement cited (supra) and also the sale deed cited (supra), the assessee over and above satisfied the conditions laid down by section 54 and demonstrated his intention to invest the capital gains in a residential house. The assessee ought not to have denied the claim of deduction under section 54. Accordingly, the assessee is entitled to exemption under section 54 and the same is to be granted.

c. In the case of Bhavna Cuccria v. Income-tax Officer, Ward 4 (1), Chandigarh [2017] 82 taxmann.com 306 (Chandigarh – Trib.) the Chandigarh Bench of ITAT has held that “It has been decided in the number of cases that for the purpose of claiming exemption under section 54, investment of substantial amount in the new asset, is sufficient compliance. It has been held by various courts that in such circumstances the assessee is entitled to claim exemption despite the fact that the construction is not completed within three years. This issue was addressed by the Delhi High Court in the case of CIT v. R.L. Sood [2000] 245 ITR 727/108 Taxman 227, wherein the Hon’ble High Court held that the assessee has invested a substantial amount in the purchase of a new asset, thus acquiring substantial domain over the new flat within the specified period, the assessee could be said to have complied with the requirement of section 54 and merely because possession of the Flat was not handed over to the assessee within the specified period the said benefit could not be denied.

V. Whether the assessee is obliged to utilize the same sale proceeds of the old house in the purchase of a new house to claim exemption u/s 54?

It is pertinent to invest in a new residential property to claim exemption u/s 54 but not to utilize the same sale proceeds of the old house. Various case laws discussed below demonstrate the same.

a. The ITAT Bench of Chandigarh held in the case of Keshav Dutt Shreedhar v. Deputy Commissioner of Income-tax, Circle Shimla [2019] 111 taxmann.com 70 (Chandigarh – Trib.) The law does not require the assessee to hold on to the very same money and demonstrate that the very same money is utilized in the acquisition of the asset. The requirement of the law is that the money so available to the assessee to that extent on which exemption under section 54 is sought to be claimed ought to be invested in the acquisition of the specific asset within the stipulated time.

b. Amit Parekh v. Income-tax Officer, Ward 30(2), Kolkata [2018] 92 taxmann.com 295 (Kolkata – Trib.) the Kolkata ITAT Bench has held that “We find that the facts of the case of the Hon’ble Punjab & Haryana High Court in the case of Kapil Kumar Agarwal v. Asstt. CIT [2013] 38 taxmann.com 384/ [2014] is identical to the facts of the present case. The Hon’ble High Court of Punjab & Haryana considered the decision of Hon’ble High Courts of Kerala & Gauhati in the case of ITO v. K.C. Gopalan [1999] 107 Taxman 591 respectively and held that section 54 of the Act provides that the assessee has to purchase a house property for the purpose of his own residence within the period of one year on or after the date on which the transfer of property took place or assessee should have constructed a house property within a period of 2 years after the date of transfer. We find that it is clear from the AO’s order that the assessee sold his residential units during the financial year 2009-10 and purchased a new residential flat, got its possession on 17-06-2010 and it is well within the time prescribed in the Act involving section 54 and thereby the assessee is entitled to claim exemption u/s. 54 of the Act. Merely because the assessee had availed house building loan of Rs. 82.50 lacs from the bank for purchasing a new residential unit, which cannot act as a disqualification for the claim of exemption u/s. 54 when the primary conditions imposed in Sec. 54 of the Act were satisfied.

c. The Mumbai Bench of ITAT has held in the case of Reji Easow v. Income-tax Officer [2022] 136 taxmann.com 111 (Mumbai – Trib)that the requirement of section 54 is that the assessee should purchase a residential house within the specified period and source of funds is quite irrelevant. Nowhere, it has been mentioned that the funds received as consideration from the sale of the original asset must be utilized for the purchase of the new residential house. Since the date of purchase falls within a period of 2 years from the sale of the original asset, the assessee is entitled to benefit under section 54.

Decoding Sections 54 and 54F of Income-Tax Act, 1961

Capital gain on transfer of certain capital assets not to be charged in case of investment in residential house under Section 54F of the Act

Section 54F specifies that if any individual or a HUF has transferred a long-term capital asset other than a residential house property, within a period of one year before or two years after the date of transfer of the old asset, the taxpayer should acquire another residential house or should construct a residential house in India within a period of three years from the date of transfer of the old asset.

The assessee has to invest net sale consideration in new house property to claim an exemption under Section 54F. Net consideration means the total sale consideration of the old asset sold less any expenditure incurred wholly and exclusively in connection with such transfer. In case, the assessee invests less than net sale consideration, he is eligible to get a proportionate amount as an exemption.

In order to claim the exemption u/s 54F, the assessee has to satisfy the conditions of (i) not owning more than one house property other than new property, (ii) not purchasing a house property other than a new house within a period of one year after the date of transfer of the original asset, (iii) Not to construct another house other than new house within three years from the date sale of the old asset.

If the assessee purchases/construct a house and claims exemption under section 54F and then transfers the new house within a period of 3 years from the date of its acquisition/completion of construction, then the benefit granted under section 54F will be withdrawn. If the new house is sold before a period of 3 years from the date of its purchase/completion of construction, then at the time of computation of capital gain arising on transfer of the new house, the amount of capital gain claimed as exempt under section 54F will be deducted from the cost of acquisition of the new house.

Until the date of filing the return of income, the capital gain arising on the transfer of the house is not utilised (in whole or in part) by the assessee to purchase or construct another house property, then the benefit of exemption can be availed by depositing the unutilized amount in Capital Gains Deposit Account Scheme in any branch of public sector bank, in accordance with Capital Gains Deposit Accounts Scheme, 1988 (hereafter referred as Capital Gains Account Scheme (CGAS)). The new house can be purchased or constructed by withdrawing the amount from the said account within the specified time limit of 2 years or 3 years, as the case may be. If the assessee fails to utilize the amount deposited in the capital gains account to purchase or construct a residential house property within the specified timeline, the unspent amount will be treated as capital gains and taxed accordingly. The assessee is allowed to withdraw the amount deposited in CGAS account after paying relevant taxes on the unspent amount.

Issues involved in application of the provisions of Section 54F are mentioned below:

I. Purchase of house property in assessee’s name alone to claim an exemption under Section 54F?

II. Completion of construction of the property before 3 years is necessary to claim an exemption under Section 54F?

III. Is it mandatorily utilizing the sale proceeds of the old house for purchasing a new property to claim an exemption under 54F?

I. Purchase of house property in assessee’s name alone to claim an exemption under Section 54F?

The answer is No. The provision insists on the purchase or construction of the residential house by the assessee. Nowhere it is mentioned in the section that it should be purchased in the name of the assessee alone. Hence, if it is purchased in the relative’s name of the assessee is also allowed as an exemption under Section 54 and 54F, provided it should comply with all other requirements of the section.

a. In the case of Krishnappa Jayaramaiah v. Income Tax Officer, Ward 6(3)(4) Bangalore, the ITAT of Bangalore has held that It was found that the assessee’s married widowed daughter was having no independent source of income and was fully dependent on the assessee. Hence the assessee has purchased the house in the name of her daughter. It is to be noted that a purposive consideration is to be preferred as against literal consideration, more so when even in calling the literal consideration, there is nothing in Section 54F of the Act to show that the house should be purchased in the name of the assessee only. Section 54F of the Act terms does not require that the new residential property shall be purchased in the name of the assessee, it merely says that the assessee should have purchased/constructed a residential house”. Accordingly, we direct the Assessing Officer to grant exemption u/s. 54F of the Act on the amount invested in the purchase of a residential house in his daughter’s name. This ground of appeal of the assessee is allowed.

II. Completion of construction of the property before 3 years is necessary to claim an exemption under Section 54F?

Investing the net sale consideration within the time limits is vital for claiming exemption under Section 54F. Taking possession of the house property or completing the construction is not pertinent for availing of the exemption under Section 54F.

If the assessee fails to utilize the net sale consideration within the time limits, he will be liable to pay taxes on the unspent amount in the previous year after the expiry of three years.

a. In the case of Income-tax Officer, Ward-2(3), Siliguri v. Smt. Saroj Rani Gupta [2019] 104 taxmann.com 132 (Kolkata – Trib.) the Calcutta ITAT has held that the assessee has not got the possession of the new house within stipulated period. The requirement for claiming exemption under section 54F was not satisfied. The Commissioner (Appeals) found that the entire amount was invested by the assessee in purchase of a new residential house within the stipulated period and the assessee, therefore, she had satisfied the requirement for claiming exemption under section 54F. There is no requirement that the construction of new house should be completed within that period and the assessee gets possession of the said flat.

b. The Bangalore High Court has held in the case of Professor P.N. Shetty v. Office of Income-tax Office, [2019] 112 taxmann.com 218 (Karnataka) it is very clear that if only a part of the amount deposited in the Capital Gains Account Scheme is utilized for the construction or purchase of a new asset within the specified time, income tax is chargeable on the unutilized amount.

III. Is it mandatorily utilizing the sale proceeds of the old house for purchasing a new property to claim an exemption under 54F?

The answer is no. The section has not mentioned that the same proceeds should be used for the purchase of a new property.  No colour is assigned to the money. Hence, the assessee needs to purchase house property within the time limits. Nowhere it is mentioned in the provision that the assessee should utilize the same money to purchasing new/constructing a new house to claim an exemption under Section 54F.

a. The Kolkata ITAT Bench has held in the case of Lalit Marda v. Assistant Commissioner of Income-tax, Circle-3, Siliguri [2008] 23 SOT 250 (Kolkata), the case of the present assessee is squarely covered by the case of K.C. Gopalan (supra) wherein it was held that Law does not insist that sale consideration obtained by the assessee itself should be utilised for purchase or construction of new house property. The assessee is entitled to exemption under section 54 even though for the construction of a new house, the amount received by way of selling his old property as such was not utilized. Keeping in view the facts and circumstances of the case, construction of sections 54 & 54F and the judicial pronouncements referred to above, we hold that the CIT(A) was not justified in sustaining addition on the ground that the net consideration was not invested in purchasing of house property. The ground raised by the department is, therefore, dismissed and that of the assessee is allowed.

Conclusion:

There are various practical issues which assessee may face while claiming deduction under Section 54 and Section 54F. These practical difficulties can be resolved with the help of judicial pronouncements. However, the tax authorities at the level of assessing officers may not readily accept these pronouncements while conducting assessments, which would defy judicial discipline. In such a case, the assessees need to approach appellate authorities/courts to get relief.

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