The Hindu Business Line : Taxing times after tenant eviction

REINVESTMENT either in residential property or specified bonds is a key factor in determining the capital gains tax. Assessees often take the reinvestment route to mitigate the liability and get a reasonable rate of return for the reinvested assets.

Lately, however, with the tax slab on long-term capital gains falling to 20 per cent, 10 per cent and nil, respectively, depending on the type of asset, there is a tendency to pay the tax rather than seek the reinvestment route.

A common feature of capital gains taxation relates to sale of long-term capital asset other than residential property and reinvesting the net consideration in a residential property. This is contained in Section 54F of the Income-tax Act, 1961.

In a recent case (DCIT vs Uday S. Kotak — 278 ITR AT 171 Mumbai), the Bombay Bench of the Tribunal had to deal with the issue of sale of shares and reinvesting in a residential house. The case assumed significance as the assessee paid huge sums to tenants for getting the premises vacated.

Facts, issues

The assessee sold shares and earned long-term capital gains of Rs 5,87,48,102 during the assessment year (AY) 1995-96. He invested the sale consideration for acquisition of a residential house, comprising ground plus two floors. He purchased half of the undivided share of the second floor on `as is where is' basis from his brother, who owned the legal title, for Rs 6 lakh.

After purchase, the assessee paid Rs 1.60 crore and Rs 2.85 crore to the tenants on the ground and first floors, respectively, in lieu of the tenancy rights owned by them. He claimed exemption under Section 54F in respect of the purchase consideration of Rs 6 lakh and for the amounts paid to the erstwhile tenants against the said long-term capital gain.

The assessee's claim was that the payment made to the tenants was purchase price for the residential house and, therefore, it qualified for exemption under Section 54F.

The assessing officer (AO) did not accept this claim. According to him, the claims were to be restricted only to the Rs 6 lakh and the payments made to the tenants were only after the assessee became the legal owner of the house, which could not be said to be acquisition or improvement cost and the tenancy right was a separate asset in itself.

Accordingly, he allowed the assessee's claim under Section 54F only to the extent of Rs 6 lakh. The Commissioner (Appeals) held that the payments made to the tenants were also cost of acquisition of residential house and qualified for exemption under Section 54F. The Department precipitated the issue to the Tribunal.

Tribunal decision

On the payments made to vacate the tenants, aggregating Rs 4.45 crore, the Tribunal reasoned that "the terms `cost of acquisition' and `cost of improvement' were not mentioned in Section 54F; therefore, Section 54F could not confer the benefit sought for by the assessee. Even by a liberal interpretation, the benefit sought for by the assessee could not be conferred upon him.

Admittedly, the legal title vested in the brother of the assessee who sold his half share in the residential house to the assessee on `as is where is' basis.

"The erstwhile tenants of the residential house did not have ownership rights in the residential house. Thus, any payment made to them after the completion of sale did not amount to purchase money paid for `purchase' of residential house. Such payment may be cost of acquisition within the meaning of Section 48, which was relevant only for computing capital gain."

The Tribunal accordingly allowed the Department's appeal.

Rules of interpretation

The core issue in this case is how one interprets the provisions granting exemptions. While the computation provision of capital gains requires that from the sale consideration the cost of acquisition of the asset is to be reduced, the provision dealing with exemption deals with purchase of a residential property.

In property matters, particularly in Mumbai, the term `purchase' extends to paying off tenants to avoid litigation. Should not the scope of the term be extended rather than restricted to payment to the seller alone?

While it is not possible for the court to give an elastic interpretation and enlarge the scope of the provisions, the provisions must be construed reasonably in the context of the purpose for which the Section has been introduced.

The fact is payments are made for reinvestment in a residential property. How does it matter to whom they are paid as long as they are properly accounted for and are relatable to the end-use, which is the objective of Section 54F? If there are wrinkles in the Section, then it is time the lawmakers ironed them out.

(The author is a Chennai-based chartered accountant.)

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