The Hindu Business Line : Capital gains — planning beyond investments

Often, the direct expenses incurred in connection with transfer of an asset can be substantial and have to be properly documented and captured to reduce the incidence of capital gains.

R. Anand

Planning for capital gains tax is tricky as the amounts in question are significant. Sale of properties at current market rates have posed enormous challenges to assessees and professionals to plan for capital gains.

Reinvestment options are getting curtailed on account of the ceiling imposed on bonds which is now Rs 50 lakh for a financial year.

Similarly, reinvestment in another residential house has its own share of problems on account of various conditions in the law coupled with rising prices of property in city limits.

This is also tempting adventurous assessees to now look beyond the shores of this country and deploy capital gains on sale of shares in residential property abroad subject to, of course, FEMA regulations.

In our anxiety to focus only on reinvestment as a means for capital gains planning, sometimes we lose sight of claiming direct expenses incurred in connection with transfer of the asset.

More often than not such expenditure can be substantial and has to be properly documented and captured to reduce the incidence of capital gains.

In this connection an interesting case came up before the Karnataka High Court in the Mrs June Perrett vs ITO 298 ITR 268 Karnataka).

Facts, decision

The assessee was the daughter of ‘B’ who had died leaving behind a Will. The executors of the Will, who resided in the UK, were required to obtain the probate and the letter of administration in respect of a house property owned by B in India and, thereafter, sell the said property and divide the sale proceeds between ’B’s sons and the assessee.

The executors incurred certain expenditures to obtain the probate and the letter of administration and also for eviction of maid-servant who had illegally occupied the house. The house was sold and the assessee received one-fourth of the sale proceeds.

While computing capital gains, the assessee claimed deduction of expenditures incurred by the executors towards litigation expenses, and the court fee expenses. The assessing officer (AO) rejected the assessee’s claim. On appeal, the Commissioner (Appeals) partially allowed the claim.

The Tribunal also rejected the assessee’s appeal and the matter reached the Karnataka High Court.

The court held that the amount paid by the executors as court fee has to be treated as expenditure incurred in connection with the transfer. The court reasoned that “the executors of the Will, who resided in London, were required to obtain the probate and the letter of administration and any expenditures incurred by the executors in that respect were to be treated as expenses incurred by them in connection with the transfer of property in question, since the executors could not sell the property to any party without a letter of administration.”

The Nexus factor

For computing capital gains from the sale of a capital asset, Section 48 of the Income-Tax Act, 1961 prescribes the method, by which the full value of the consideration has to be reduced by the expenditure incurred wholly and exclusively in connection with such transfer and the cost of acquisition and the cost of improvement thereto.

The question here is what are the types of expenditure envisaged that qualify for deduction from the full value of consideration. While it would be impossible to list out an exhaustive list of expenditure, over a period of time courts have adjudicated on the allowability or otherwise of various types of expenditure.

The key issue is the nexus between the expenditure incurred and its intimate connection with the transfer of the asset. The language in Section 48 is so strict that the expenditure has to be wholly and exclusively incurred for the transfer.

The common expenses for deductible expenses are brokerage or commission paid for the transaction, stamp charges and registration fees borne by the seller. If carefully documented, travelling and associated expenses can also be claimed.

It was held in CIT vs P. Rajendran (1981127 ITR 810 Karnataka) that in the case of capital gains on property transaction the expenditure incurred in connection with the transfer need not necessarily have to be incurred prior to passing of title.

Since there a marked similarity between Sections 37 and 48 one cannot claim the expenditure under Section 48 if it has already been claimed in any other head on income like business income.

This proposition has been laid down in CIT vs Maithreyi Pai (1985 152 ITR 247 Karnataka).

An allied issue on the subject relates to the amounts spent on the discharge of mortgage on the property which is the subject matter of transfer.

(The author is Partner, Global Tax and Advisory Services, Ernst & Young.)

The Madras High Court in the CIT vs N.Vajrapani Naidu (1999 241 ITR 560) case held that where the property has been mortgaged by the vendor and the amounts spent for discharging the burden whether prior to or at the time of sale by payment to the mortgagees cannot be treated as an expenditure in connection with the transfer and does not qualify for deduction from the sale consideration.

Complex process

Computation of capital gains is a fairly complex process. Legal and consultancy fees paid particularly in private equity deals are heavy and can be claimed against the value of consideration received.

In the case of several individuals, these costs have to be shared in proportion to the shares sold to arrive at the correct capital gains. The question of reinvestment of the proceeds would arise only after claiming the expenditure incurred on the transfer.

At the end of it, planning for capital gains is not only about investments but covers capturing and claiming the right expenditure from the sale proceeds.

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