In this article, we delve into the joint appeal case filed by Sunil Amritlal Shah and Rita Sunil Shah (appellants) against the Income Tax Officer (ITO) for the Assessment Year (AY) 2011-12. The crux of the matter lies in interpreting Section 54 of the Income Tax Act, 1961 (ITA), specifically regarding the crucial date for claiming tax exemption on capital gains from selling residential property.

The decision of the Income Tax Appellate Tribunal (ITAT) "I" Bench, Mumbai, on May 13, 2024, explores the validity of considering the possession date compared to the purchase agreement date for the exemption claim.

Background: A Dispute Arises

The case centres on the sale of certain jointly-owned property by spouses, generating a disagreement over the computation of capital gains and eligibility for deduction under Section 54 of the ITA. Initially, the assessing officer (AO) categorized the gains as short-term capital gains but subsequently conceded that there were long-term capital gains. However, discrepancies arose regarding the indexed cost of acquisition. The crux of the dispute revolved around the eligibility for deduction under Section 54 of the ITA, with the AO deeming the date of the purchase agreement as relevant, while the appellants argued for considering the possession date of the new property.

Appeal Details: Challenging the Assessment

Sunil A Shah and Rita Sunil Shah filed appeals, numbered ITA No. 4069/M/2023 and ITA No. 4070/M/2023, respectively, against the assessment order dated October 3, 2023, for the AY 2011-12. Both appeals cite identical grounds, particularly disputing the assessment officer's refusal to recognise the possession date as the relevant date for exemption purposes.

Grounds of Appeal: Contesting Tax Treatment

In ITA No. 4069/MUM/2023, Mr. Sunil A Shah challenged several aspects of the assessment order:

(i) Disallowance of Deduction under Section 54

The assessing officer (AO) disallowed the deduction under Section 54 for a long-term capital gain from the sale of a property dated February 10, 2011. The AO argued that the purchase agreement, dated July 25, 2009, exceeded the one-year period. However, the assessee (Mr. Shah) argued that the possession date (February 10, 2011) should be considered instead of the agreement date (July 25, 2009).

(ii) Penalty Actions

The AO initiated penalty proceedings for disallowing the deduction under Section 54, considering it as concealment or furnishing inaccurate income details.

(iii) Penalty Proceedings for Variance in Indexed Cost of Acquisition

Additionally, penalty proceedings were initiated for a variance in the calculation of the indexed cost of acquisition. The assessee calculated a higher indexed cost of acquisition than the AO, who treated this variance as concealment or furnishing inaccurate particulars of income.

(iv) Right to Amend Grounds of Appeal

The assessee reserved the right to add further grounds or amend the existing grounds of appeal before the hearing date.

Identical Grounds in ITA No. 4070/M/2023

Identical grounds of appeal are raised in ITA No. 4070/M/2023 for Mrs. Rita Sunil Shah, indicating a parallel challenge to the assessment order.

Unlocking Section 54: A Guide to Tax Exemption

Section 54 of the ITA provides tax exemptions on capital gains from the sale of a residential property if certain conditions are met. This section applies to individuals and Hindu Undivided Families (HUFs).

Conditions for Exemption

(i) Purchase of New Property

The taxpayer must purchase a new residential house within one year before or two years after the sale of the original property.

(ii) Construction of New Property

Alternatively, the taxpayer can construct a new residential house within three years after the sale of the original property.

Calculation of Exemption

(i) If the capital gain is less than or equal to the cost of the new property:

(a) The entire capital gain is exempt from tax.

(b) If the new property is sold within three years, the cost of the new property will be reduced by the amount of the exempted capital gain.

(ii) If the capital gain is more than the cost of the new property

(a) The exemption is limited to the cost of the new property.

(b) Any remaining capital gain is taxed.

Special Provisions

(i) Multiple Residential Houses

If the capital gain is up to two crore rupees, the taxpayer can purchase or construct two residential houses in India. This option can only be exercised once in a lifetime.

(ii) Cost Limitation

If the cost of the new property exceeds ten crore rupees, the excess amount will not be considered for the exemption.

(iii) Deposit Scheme

(a) If the capital gain is not immediately used to purchase or construct a new property, it must be deposited in a Capital Gains Account Scheme before filing the income tax return.

(b) The deposited amount should be used to purchase or construct the new property within the specified period.

(c) If not utilized within three years, the unutilized amount will be taxed as capital gains in the year when the three-year period ends.

Judicial Precedents

In the case of Principal Commissioner of Income Tax & Ors. vs. Akshay Sobti & Ors. (2020), the Delhi High Court decided that a particular provision is beneficial for taxpayers who replace the  original long-term capital asset with a new asset. The Court held that booking an unfinished flat is considered as constructing a house, not buying it. Therefore, the important date is when construction is completed. In this case, the taxpayer had booked an under-construction flat, and possession of the flat was handed over on completion of construction.

In the case of Beena K. Jain [217 ITR 363 (Bombay)], the Bombay High Court examined Section 54F, which is similar to Section 54 but has different computation rules. The Court determined that Section 54F provides a tax exemption for individuals who sell a long-term capital asset (excluding residential houses) and then purchase a residential house within a year before or two years after the sale. The tax department argued that a taxpayer did not meet this requirement because a purchase agreement for a new flat was entered into more than a year before selling the original asset. However, the Tribunal disagreed, stating that the relevant date is when the taxpayer paid the full consideration and took possession of the flat, which was July 29, 1988. The Tribunal considered this as the purchase date, emphasizing that the substance of the transaction, not just the agreement date, determines eligibility for the exemption.

Further in the case of Bastimal K Jain vs. ITO [2016], the Coordinate Bench determined that the taxpayer's eligibility for deduction under Section 54 should commence from the day the builder transferred possession of the flat to the taxpayer, namely, September 11, 2009. Based on this timeline, the taxpayer met the criteria for deduction under Section 54, as the residential flat was sold on February 24, 2010.

Tribunal's Decision

The Tribunal considered the allotment date as the acquisition date for computing the capital gain. It ruled that the deduction under Section 54 is valid based on the possession date, not the purchase agreement date. This decision aligns with the well-recognized judicial rulings that emphasize the possession date for determining eligibility for exemptions under Section 54 of the ITA.

Conclusion

The ITAT's decision to allow the appeals partly by recognizing the possession date for claiming the Section 54 exemption stresses the significance of the actual transfer of property ownership in tax exemption cases.

This ruling reinforces the precedent that the possession date, when the property is completed and ready for occupancy, is the critical date for tax exemption under Section 54, instead of the date of the agreement to purchase. This interpretation supports taxpayers in similar situations, providing clarity and consistency in applying tax laws to property transactions.