Introduction:
Computation of Capital gain has always been a complex provision under the Income-tax Act. New controversies are created dime a dozen merely because the amounts involved are usually large in case of capital gain assessments.
A controversy arises where the purchaser of the land makes payment to seller for the land and further makes payment for removal of encumbrance to various other parties. The revenue has been contending that the amount which has been paid by the purchaser to other parties for removal of encumbrance is actually a consideration in the hands of the seller and hence for calculation of capital gain the enhanced consideration should be considered.
Recently the Supreme Court in the case of Principal Commissioner of Income-tax-1 v. Lalitaben Govindbahi Patel [2019] 103 taxmann.com 10 (SC) dismissed the Special Leave Petition filed by revenue against the order of Gujarat High Court reported in [2018] 94 taxmann.com 396 (Guj.).
Facts of the Case:
In this case the assessee had earlier entered into an agreement to sell land to a party for a sale consideration of Rs. 38.74 lakhs. At time of execution of agreement, assessee received a sum of Rs. 1 lakh from such prospective buyer. Subsequently, assessee executed a sale deed in of the said land to another party being the new buyer for a sale consideration of Rs. 4.43 crores. The said sale deed was executed between the assessee as seller, the new buyer and the earlier prospective buyer who became the confirming party for releasing his rights. As per the said Sale deed the assessee received balance sale consideration of Rs. 37.74 lakhs, whereas remaining amount of Rs. 4.04 crores was received by earlier buyer for releasing his rights in the said land in favour of new buyer. In return of income, assessee claimed that cost of acquisition of land was Rs. 33.36 lakhs which was sold for Rs. 38.74 lakhs and, thus, difference was offered as short term capital gain. In the original assessment the Assessing Officer accepted the return of income. However, subsequently, the Commissioner invoked his revision jurisdiction under section 263 of the Act and passed order holding that sale consideration being Rs. 4.43 crores, assessee had to offer a sum of Rs. 4.09 crores by way of short term capital gain. In appeal the Tribunal set aside the revisional order of the CIT. The revenues appeal before the High Court was dismissed holding that since it was undisputed that out of total sale consideration, Rs. 4.04 crores was received by confirming party and assessee never received anything beyond Rs. 38.74 lakhs originally agreed, question of charging capital gain from assessee on a sum larger than said amount would not arise.
The above decision requires fair consideration of the facts but it unequivocally lays down that the sale consideration for the sale of a capital asset would be the amount actually received by the seller. The amount paid for the removal of encumbrance cannot be added to the sale consideration of the seller since the said amount is not received by the seller.
Deduction u/s 48(1):
One wonder why the said matter went upto the Supreme Court. Even if the revenue contended that the sale consideration is to be enhanced by the amount paid to the confirming party, yet under section 48(1) of the Act, the said amount was deductible from the sale consideration in the hands of the seller. Accordingly, there would be no impact on the final amount assessed as a capital gain. The Mumbai High Court has in the case of CIT v. Shakuntala Kantilal [1991] 190 ITR 56 (Bom.) on almost identical facts have held that the payments made to another party for settlement of claim / encumbrance is deductible under section 48(1) of the Act for arriving at the taxable capital gain. Similar view was once again taken by the Mumbai High Court in the case of CIT Vs. Abrar Alvi (2001) 247 ITR 312 (Bom.) held that removal of encumbrance is the deductible expenditure under section 48(1).
In a later decision the Madras High Court in the case of CIT Vs. M/s. Bradford Trading Company (P) Ltd. (2003) 261 ITR 222 (Madras) explained the concept in great detail. It held that where the amount is paid to a third party which is inextricably linked to the transfer of the capital asset, such payment is to be allowed as an expense under section 48(1). This is because if such expense is not incurred there would be no transfer. The court further distinguished the payment for discharge of self created mortgage vis a vis removal of encumbrance and held that the removal of mortgage is not for transfer of capital asset but an application of the sale consideration and hence not deductible.
Conclusion: in view of the above decisions broadly leading to the similar conclusion and the tax effect, it would be prudent that a proper circular is issued to the field officers so that unnecessary litigation could can be avoided. For the assessee it is important that documentation with the seller and the purchaser are so made so as to ensure that the amount paid for removal of encumbrance is an expense of the purchaser but not the income in the hands of the seller.
Author Bio
A crisp read and a very good synopsis of the caselaws on the issue