High Court rules on Advance Payment to claim section 54 Exemption

Madras High Court in Moturi Lakshmi vs ITO in Tax Case Appeal No.181 Of 2019 on 17 August 2020 issued its decision that where an investment is made in new residential property, prior to the sale of the original residential property, any gain on the sale of the original property is eligible for long-term capital gains (LTCG) tax exemption under section 54 of the Income-tax Act, 1961 (ITA).

Section 54 provides an exemption from LTCG tax on the sale of a residential property by an Indian resident individual who:

1. Purchases a new residential property in the period from one year before to two years after the date of the original transfer; or

2. Constructs a new residence in India within three years after the date of the original transfer.

(In certain cases an individual may purchase or construct two residential properties.)

Background and facts of the case

The taxpayer is an individual who claimed an exemption under section 54 of the ITA for the financial year 2012-13, corresponding to assessment year 2013-14.

In the current case, the taxpayer had paid an advance deposit for purchasing an apartment prior to the sale of her original apartment, against which she claimed an exemption under section 54. The Assessing Officer (AO) disallowed the exemption since the investment was made prior to the sale of the first apartment.

Both the Commissioner of Income-tax Appeals and the Income-tax Appellate Tribunal (ITAT) dismissed the taxpayer’s subsequent appeals and upheld the AO’s order.

The taxpayer appealed the ITAT’s order to the Madras High Court.

Observation of the High Court

The High Court noted that the following substantial question of law arose in the case under consideration, namely whether or not for the purposes of section 54, the advance payment made by the taxpayer for the purchase of the residential apartment constitutes part of the purchase price, where the advance payment is made to the seller of the apartment prior to the date of sale of the original capital asset.

The High Court noted that:

The Madras High Court in an earlier case had held that the investment in the new asset for the purposes of deduction under section 54F of the ITA (which provides a similar exemption for certain LTCG on the transfer of capital assets upon investment in a residential property) need not be out of the sale consideration received on the transfer of the original asset;

The Madras High Court in another case, when evaluating whether for the purpose of section 54 the cost of a new asset (which is eligible for set off against the capital gain) would include the cost of land purchased three years prior to the sale of the property on which the gains had arisen, had held that:

The interpretation of statutory provisions should, to the extent possible, be in accordance with the plain meaning of the language used in the provision; and

The condition precedent for claiming exemption under section 54 was that the new residential property should have been purchased or constructed within the specified period from the date of transfer of the original residential property giving rise to the capital gains.

The provisions did not contemplate that the same money received from the sale of the original residential property should be used for the acquisition of the new residential property;

In view of the above, the High Court held that:

The Supreme Court in an earlier case, in the context of section 54 had held that the intention of the legislature was to give relief to the taxpayer from the payment of tax on LTCG.

and

The intention of the legislature was to purchase the new residential property either before or after the date of sale of the original property.

In view of the above, the High Court allowed the benefit under section 54 with respect to the advance payment made by the taxpayer for the purchase of a residential apartment prior to the date of sale of the original apartment.

Learnings

Payments made for the purchase of new residential property prior to the sale of the original residential property qualify for the LTCG tax exemption under section 54 of the ITA, subject to the satisfaction of other conditions; and

The intention of the legislature with respect to section 54 was to give relief to the taxpayer from the payment of tax on LTCG.