Taxation can become a tricky affair if the laws are not clearly spelled in the Income Tax Act. In the absence of clarity, it’s always the discretion of an assessing officer to interpret the law and take a decision.
A case in point is Rahul Nanda’s. He recently sold his second house in Mumbai to reinvest the proceeds to buy another property. He is looking at under-construction projects that might take some time to complete. This will also give him time to arrange for additional money required to fund the new house. The rates of such flats are 25 per cent cheaper than a ready-to-move property.
Section 54 of the Income Tax Act says if a taxpayer invests the capital gains earned on sale of a house property in another one within two years from the date of sale or within one year before the date of sale, the amount of capital gains invested in the new house will be exempted from tax. If the person is constructing the house, the time period is further relaxed to three years from the date of sale. The Act has prescribed different time limits for ‘purchase of a new house‘ and for ‘construction of a new house‘.
The Act, however, does not define how an under-construction property from a builder should be treated – will it be considered a ‘purchase’ or ‘construction’. In one such case, the Bombay High Court has held that booking of a flat, which is going to be constructed by a builder should be classified as ‘construction of property‘ and accordingly exemption can be claimed under Section 54 of the Income Tax Act.
But if the taxpayer gives an advance to a builder and the realtor does not deliver the house within the prescribed period of three years, can a person still claim exemption under Section 54? There have been quite a few residential projects that have seen inordinate delays. In many cases, taxpayers use the money received from sale of a property towards buying a new one. If they are denied tax exemption for the amount advanced to the builder, it would lead to taxpayers getting penalised twice – for the delay in getting possession and by paying additional income-tax.
One such matter recently came up for hearing at the Mumbai Income Tax Tribunal. A taxpayer, in his return of income, had declared sale of a residential property for a total amount of Rs 1.02 crore. After considering the indexed cost of acquisition, the long-term capital gains worked out to be Rs 88 lakh. He claimed exemptions under Section 54 on the basis of the advance of Rs 1 crore given to a builder for a new house. The taxpayer had the necessary receipts for payments and an allotment letter to justify the acquisition of the new property.
During assessment, the tax officer noted that even two years after the date of transfer of old house, the construction of the new property was not completed and that the assessee had not gained possession of the new premises. Further, the tax officer was of the view that giving advance to a builder cannot be equated to purchase of a property for the purpose of Section 54 of the Income Tax Act, as no agreement was executed. Also, the builder can return the advance money to the buyer any time in the absence of an agreement. The tax officer disallowed the tax payer’s exemption claim. At the first appellate-level hearing, the tax payer did not get a favourable order.
The taxpayer moved the tribunal against the order of the appellate and submitted that he had duly invested the amount in acquisition of a new property and the delay by the builder was beyond his control. The taxpayer had also furnished the allotment letter for the flat. He also said since the complete amount of consideration was paid to the builder, there was no requirement to produce an agreement as the allotment letter along with proof of payment clearly establishes that he had invested the proceeds of the earlier house to buy a new one.
Relying on several past judgments, the tribunal noted that when substantial investment is made on a new property, it should be deemed that sufficient steps have been taken and the same should satisfy the requirements of Section 54. The basic purpose behind Section 54 is to ensure that the taxpayer is not taxed on the capital gains, if he buys a house within the stipulated period.
Addressing the objection raised by the tax officer about the absence of an agreement, and that the advance could be returned any time, the tribunal held that the mere possibility does not prevent the taxpayer’s claim for exemption and there is no evidence of the advance being returned. If this happens in the future, the person will need to pay capital gains for that relevant year.
The judgment sets precedence for allowing tax exemption on advances made for properties without registered agreements in place.