Tax Planning Series 2.1 : Capital Gain (Exemption u/s 54: Profit on sale of residential house)

Exemption u/s 54 of Income tax Act, 1961  in respect of capital gains arising on sale of a residential house



1. Profit on sale of property used for residence [Section 54]

Section 54 provides for exemption in respect of capital gains arising on sale of a residential house. The exemption under section 54 can be claimed if the following conditions are satisfied :

The assessee is an individual or a HUF. Since a firm cannot use a building for its residence the exemption in section 54 is not available to it. [K.I. Viswambharan & Bros. v. CIT[1973] 91 ITR 588 (Ker.) (FB)].
The asset is a residential house property (building or lands appurtenant thereto) (one residential house in India with effect from 1-4-2015). The basic requirement of section 54 is that the capital gain should arise from the transfer of buildings or lands, the income of which is chargeable under the head ‘Income from house property’. If land alone is sold, the provisions of section 54 will have no application, inasmuch as the income from the land is not chargeable under the head ‘Income from house property’. [CIT v. Zaibunnisa Begum [1985] 151 ITR 320 (AP)].
The income from the house is chargeable under the head ‘Income from house property’ (even if the house is self-occupied and its annual value is taken as nil), the exemption can be claimed if the income or notional income, if charged to tax would be chargeable under this head – (Circular No. 538, dated 13-7-1989).
The transferred asset is a long-term capital asset (held by the assessee for more than 36 months/24 months w.e.f. 01 April 2017).
The assessee has within a period of 1 year before or 2 years after the date of transfer purchased, or has within a period of 3 years after that date constructed a residential house. In Mrs. Prema P. Shah v. ITO [2006] 100 ITD 60 (Mum. – Trib.) it was held that for the purpose of availing exemption under section 54, the residential house need not be in India. The new residential house could be in foreign country as well (Finance (No. 2) Act, 2014 has amended section 54(1) so as to provide that the exemption is available, if the investment is made in purchase or construction of one residential house situated in India).
The capital gain not utilised in purchase or construction of the new asset before furnishing the return of income is deposited in the Capital Gains Account Scheme in a bank before the due date for furnishing the return of income and proof of such deposit is furnished along with the return of income.
Under the present law the benefit under section 54 is not available to a co-operative society or firm – [South Kanara Central Co-operative Wholesale Stores v. CIT[1978] 114 ITR 298 (Kar.); K.I. Viswambharan & Bros. v. CIT [1973] 91 ITR 588 (Ker.)(FB) and CIT v. K. Gangiah Chetty & Sons [1995] 214 ITR 548 (Mad.). Neither the firm nor its partners are entitled to exemption under section 54 in respect of capital gain arising from sale of its building by the firm. [K.I. Viswambharan & Bros. v. CIT [1973] 91 ITR 588 (Ker.)(FB)]. A trust is also not entitled to exemption under section 54. [Rajneesh Foundation v. ITO [1983] 4 ITD 409 (Bom. – Trib.)]

However, where the relevant conditions are satisfied, the exemption under section 54 can be claimed by legal heirs also – [Mir Gulam Ali Khan v. CIT [1987] 165 ITR 228 (AP) and C.V. Ramanathan v. CIT [1980] 125 ITR 191 (Mad.)].

2.Quantum of deduction under section 54

The following points may be noted:

Where the amount of capital gain is equal to or less than the cost of the new residential house, the entire capital gain is free from tax.
Where the amount of the capital gain exceeds the cost of the new residential house, only the excess of the capital gain over the cost of the new asset is chargeable to tax under the head ‘Capital gains’. [The assessee can avoid paying tax on this excess capital gains if he invests in specified bonds under section 54EC.]
Where the capital gain is not used by the assessee in the purchase/construction of the new house before the due date for furnishing the return of income under section 139(1), he must, if he wishes to claim the exemption under section 54, deposit the unutilised amount in an account under the Capital Gains Accounts Scheme in any specified bank/institution by that date and utilise it in accordance with such notified scheme.
For the purpose of computing the exemption under section 54 the amount utilised in the purchase/construction of the new asset together with the amount deposited in the Capital Gains Accounts Scheme will be deemed to be the cost of the new asset. In other words, the exemption under section 54 will be the lower of —

the amount of the capital gains, and
the amount utilised in the purchase/construction of the new residential house plus the amount deposited under the Capital Gains Accounts Scheme by the due date for furnishing the return of income under section 139(1).
In CIT v. Rajesh Kumar Jalan [2006] 286 ITR 274 (Gau.) the assessee sold his share in residential property for Rs. 40 lakhs and the indexed cost of acquisition of the property was Rs. 10.27 lakhs. The assessee entered into an agreement for purchase of flat for total consideration of Rs. 30 lakhs. The Assessing Officer rejected exemption under section 54 on the reasoning that the assessee had taken only sublease of property and the sublease does not amount to purchase of property. Also, the assessee did not deposit the unappropriated amount in the capital gain deposit scheme within the time of furnishing the return prescribed in section 139(1) of the Act. The court held that the assessee had to deposit before furnishing the return under section 139 and it would not mean the ‘due date’ under section 139(1). With respect this decision requires reconsideration. When the condition for unappropriated amount is to be deposited in the capital gain account before the due date mentioned in section 139(1), the utilization even after that date could not be a proper compliance of statutory condition.

3.Illustration 

1. Dinesh acquired a residential flat in 2001-02 for Rs. 5,00,000. On 10-12-2007 he sold the flat for Rs. 25,00,000. On 22-3-2008, he acquired a new residential house for Rs. 12,00,000.
The exemption under section 54 will be worked out as under :
Rs.
Full value of consideration – sale proceeds 25,00,000
Less: Indexed cost of acquisition : 5,00,000 × 551/426 6,46,700
18,53,300
Less: Exemption under section 54 – in respect of new  residential house. 12,00,000
Taxable long-term capital gain 6,53,300
Since the investment in new house exceeds the amount of the capital gains the entire capital gains is eligible for exemption under section 54.

2. Tarun inherited a house from his father who had purchased it in 1962 for Rs. 15,000. The market value of the house on 1-4-1981 was Rs. 2,50,000. Tarun sold the house on 11-11-2007 for a sum of Rs. 27,00,000. He intends to construct another house within 3 years (i.e., by 10-11-2010). The estimated cost of construction is Rs. 9,00,000. By 31-3-2008, he spent Rs. 1,00,000 on the construction. On 15-6-2008 he deposits Rs. 8,00,000 in a bank under the Capital Gains Accounts Scheme. Compute capital gains.
Rs.
Full value of consideration – sale proceeds 27,00,000
Less: Indexed cost of acquisition : 2,50,000 × 551/100 13,77,500
13,22,500
Less: Exemption under section 54 (Rs. 1,00,000 spent on construction and Rs. 8,00,000 deposited in CGS account) 9,00,000
Taxable long term capital gain 4,22,500

3. Ashok provides following data regarding his transaction for sale of one of his two residential houses for assessment year 2008-09. :

Rs.
House purchased in March 1982 1,50,000
Sold in November 2007 17,80,000
Purchased another house in September 2007 7,50,000
Compute the amount of capital gain to be included in the total income for assessment year 2008-09.
Rs.
Full value of consideration – sale proceeds 17,80,000
Less: Indexed cost of acquisition : 1,50,000 × 551/100 8,26,500
Capital gains 9,53,500
Less: Deduction under section 54 : Acquisition of another residential house within one year before the date of transfer of residential house 7,50,000
Taxable long term capital gain 2,03,500

4. Narain is the owner of two residential houses. One house is let on rent and the other is self occupied. The self-occupied house was constructed by him in the year 1971 at a cost of Rs. 75,000. The fair market value of this house on 1-4-1981 was Rs. 90,000. In the year relevant to assessment year 2008-09, he sold the self-occupied house for Rs. 8,50,000. But within six months of this sale, he purchased for his residence, a new house costing Rs. 3,00,000. What is the amount of taxable capital gain? Would it make any difference if the cost of the new house is Rs. 3,25,000 ?

Case I Case II
Rs. Rs.
Full value of consideration – sale proceeds 8,50,000 8,50,000
Less: Indexed cost of acquisition : 90,000 × 551/100 4,95,900 4,95,900
Capital gains 3,54,100 3,54,100
Less: Exemption under section 54 in respect of new residential house 3,00,000 3,25,000
Taxable long term capital gain 54,100 29,100

5. Jayant sold his residential house in January 2008 resulting in long-term capital gain of Rs. 4.70 lakhs. Out of the sale proceeds he purchased a site for Rs. 4.00 lakhs in February 2008. He proposes to commence construction of a residential house after about six months.
In case Jayant deposits the balance of Rs. 70,000 before the due date for furnishing the return of income in a scheduled bank under Capital Gains Accounts Scheme, will he be entitled to exemption under section 54(2) ? Would the amount invested on purchase of site be taken as part utilisation for construction of a new asset or is it necessary for Jayant to invest the entire capital gain of Rs. 4.70 lakhs for construction excluding cost of site ?
If Jayant deposits Rs. 70,000 in capital gain account, then he is eligible for the full exemption. As regards acquisition of land and its eligibility for deduction under section 54 the CBDT Circular No. 667, dated 18-10-1993 provides the answer. It is the aggregate cost of land and building that should be considered for determining the quantum of exemption under section 54/54F provided the acquisition of the plot and the construction of the house are completed within the period specified in these sections. Therefore, Jayant should complete construction of the house on the site within the specified period of three years and he will be eligible for the exemption contained in section 54 of the Act.

6. Bimal purchased a residential flat on 1-4-1999 for Rs. 10,50,000. On 5-5-2007 it was sold for Rs. 45,00,000. He deposited Rs. 16,00,000 in an account under the CGA Scheme on 30-6-2007. He utilised Rs. 14,50,000 out of the amount deposited under the CGA Scheme in the construction which was completed on 12-9-2009. Compute the capital gains.
Rs.
Full value of consideration – sale proceeds 45,00,000
Less: Indexed cost of acquisition : 10,50,000 × 551/389 14,87,300
Capital gains 30,12,700
Less: Exemption under section 54 in respect of amount deposited in CGS account. 16,00,000
Taxable long term capital gain 14,12,700
Note : Since the assessee has utilized only Rs. 14,50,000 out of the CGS account for the construction of new residential house within the period of 3 years the balance of unutilized portion of deposit as the income of the previous year in which the time period of 3 years expires. Rs. 1.50 lakhs will be the income under the head long term capital gains for the previous year 2010-11 (assessment year 2011-12).

7. Rao acquired a vacant site for Rs. 2,00,000 in April, 1978 and constructed a residential building for Rs. 5,00,000 during the year 1990-91. The fair market value of the site as on 1-4-1981 is Rs. 3,00,000. The building was transferred by Rao to Chetan for Rs. 75,00,000 in October 2007. Rao deposited Rs. 10,00,000 in NHAI capital gain bond and acquired a residential building in January 2008 for Rs. 20,00,000. Discuss the issues involved in the transfer and reinvestment.

Rs. Rs.
Full value of consideration 75,00,000
Less : Indexed cost of acquisition
Land Rs. 3,00,000 × 551/100 16,53,000
Building Rs. 5,00,000 × 551/182 15,13,800
31,66,800
Long term capital gain 43,33,200
Less : Exemption u/s. 54 in respect of new residential house 20,00,000
23,33,200
Less : Exemption u/s. 54EC in respect of NHAI bonds 10,00,000
Taxable long term capital gain 13,33,200
Issues involved:
(1) Since the subject matter of transfer is land and building, provisions of section 50C is applicable. If the stamp valuation authority has adopted the asset value more than the apparent consideration then such value is to be adopted unless the assessee disputes the valuation before the State stamp valuation authority. Alternatively, the assessee (vendor) may dispute the valuation before the Assessing Officer in which case it would be referred to Valuation Officer.
(2) The subject matter of transfer consists of land and building. It would be advisable to specify in the sale deed the sale consideration towards land and building separately. For stamp duty purpose, the value of land may be increased nearer to State stamp valuation and the building value is determined normally by deducting depreciation towards wear and tear of the asset.
(3) Bifurcation of sale consideration towards land and building would reduce the difference in valuation as adopted by the State stamp valuation authority and the assessee as the subject matter of dispute would be more on land than on building value.


4. Amendments to section 54 by Finance (No. 2) Act, 2014 (applicable w.e.f. assessment year 2015-16)

Section 54 relates to profit on sale of property used for residence. The existing provisions contained in sub-section (1) of section 54 provide that where capital gain arises from the transfer of a long-term capital asset, being a residential house, and the assessee within a period of one year before or two years after the date of transfer purchases, or within a period of three years after the date of transfer constructs, a residential house then the amount of capital gains to the extent invested in the new residential house is exempted.

There was a dispute whether the house in which reinvestment should be within India in order to avail the exemption. In Leena J.Shah v. Asstt. CIT [2006] 6 SOT 721 (Ahd. – Trib.) it was held that for availing of exemption under section 54 the property acquired/constructed must be within India in Vinay Mishra v. Asstt. CIT [2013] 30 taxmann.com 341/141 ITD 301 (Bang. – Trib.) contrary view was taken that a residential property acquired outside India is also eligible for exemption under section 54.

Courts have interpreted provisions to hold that exemption is available even if investment is made in more than one house. In CIT v. D. Ananda Basappa [2009] 180 Taxman 4 (Kar.), it was held that exemption under section 54 is available when two flats are purchased and combined to make them one residential unit. Section 13 of the General Clauses Act was referred to which states that whenever the singular is used for a word, it is permissible to include the plural. The expression ‘a residential house’ should be understood in a sense that the building should be of residential nature and ‘a’ should not be understood to indicate a singular number – CIT v. Smt. K.G. Rukminiamma [2010] 8 taxmann.com 121/[2011] 196 Taxman 87 (Kar.). Four residential flats constituted ‘a residential house’ for the purpose of section 54 of the Act – Dr. Smt. P.K. Vasanthi Rangarajan v. CIT [2012] 23 taxmann.com 299/209 Taxman 628 (Mad.). The fact that residential house consists of several independent units cannot be permitted to act as an impediment to allowance of deduction under section 54/54F of the Income-tax Act – CIT v. Gita Duggal [2013] 30 taxmann.com 230/214 Taxman 51 (Delhi). Purchase of 2 flats adjacent to one another having a common meeting point would fulfil the requirement of exemption provisions of section 54 of the Income-tax Act – CIT v. Syed Ali Adil [2013] 33 taxmann.com 212/215 Taxman 283 (AP).

To overcome the above judicial decisions on allowing exemption for investment in multiple houses and also to resolve controversy as regards whether the investment should be in a house in India, the Finance (No. 2) Act, 2014 has amended section 54(1) so as to provide that the exemption is available, if the investment is made in purchase or construction of one residential house situated in India. This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to assessment year 2015-16 and subsequent years.

The Explanatory Memorandum explains the amendments as under:
Capital gains exemption in case of investment in a residential house property
The benefit was intended for investment in one residential house within India. Accordingly, it is proposed to amend the aforesaid sub-section (1) of section 54 so as to provide that the rollover relief under the said section is available if the investment is made in one residential house situated in India.
It is further proposed to amend the aforesaid sub-section (1) of section 54F so as to provide that the exemption is available if the investment is made in one residential house situated in India.
These amendments will take effect from 1st April, 2015 and will accordingly apply in relation to assessment year 2015-16 and subsequent assessment years. [Clauses 22 & 24]

5. Acquisition – Purchase or construction

In P.K. Datta v. ITO [2006] 100 TTJ (Pune – Trib.) 133 the assessee sold his residential property and the sale consideration was Rs. 3.75 lakhs and the capital gain thereon was Rs. 3.34 lakhs. The assessee entered into an agreement with a developer for construction of a row house and claimed exemption under section 54. The assessee paid Rs. 2.50 lakhs to the developer before the due date for filing the return prescribed in section 139(1). The assessee did not deposit any money in the capital gain account scheme. The new residential house possession was taken in February 1993. The Assessing Officer held that the transaction of the sale was made on 26th June, 1990 and the possession of new house was obtained in February 1993 and the transaction in the nature of purchase/acquisition was beyond 2 years after the date of sale of old residential house and hence not eligible for exemption under section 54. The Tribunal held the agreement with the builder/developer is in the nature of acquisition and the transfer of new house was given only in February 1993 and the agreement is not an agreement for construction but is an agreement for construction by the builder and sale of one row house to the assessee. However, it held legal formalities alone is not to be considered for exemption under section 54 but the test of domain and control over the property should be applied. It held that the assessee paid substantial part of the cost of new house within 2 years hence is entitled to exemption under section 54.
The Central Board of Direct Taxes has issued Circular No. 471, dated 15-10-1986, has clarified that for the purpose of capital gains tax, the cost of the new asset is the tentative cost of construction and the fact that the amount was allowed to be paid in instalments does not affect the legal position stated above and that cases of allotment of flats under the self-financing scheme of the Delhi Development Authority shall be treated as cases of construction for the purpose of capital gains.
Section 54 only says that within two years, the assessee should have constructed the house but that does not mean that the construction of the house should necessarily be completed within two years. What it means is that the construction of the house should be completed as far as possible within two years. In the modern days, it is not easy to construct a house within the time-limit of two years and under the Government schemes, construction takes years and years. Therefore, confining to two years’ period for construction and handing over possession thereof is impossible and unworkable under section 54. If substantial investment is made in the construction of the house, then it should be deemed that sufficient steps have been taken and this satisfies the requirements of section 54 [Smt. Shashi Varma v. CIT [1997] 224 ITR 106 (MP)].


Refer extract of Section 54 on link https://incometaxindia1.blogspot.in/p/profit-on-sale-of-property-used-for.html


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