 "Gift a house on which capital gains benefit has been claimed")
Section 54 of the Income Tax Act says income tax on capital gains accruing to an individual from the sale of his house property, owned and held by him for more than three years, can be saved by reinvesting capital gain amount in another residential property. Most tax payers are conversant with this provision. It is also one of the most widely used tax planning measures.
However, a lesser known restrictive provision in Section 54 is that the new property acquired should not be sold within three years from its date of acquisition. The section further provides that if the property is sold within three years, the capital gain for the new property will be calculated by taking its acquisition cost as nil in the year of sale. There are other nuances to this section, as the cases below highlight.
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High tax liability on early sale
Take Amit Kumar's case, who sold his residential property in Mumbai in July 2014 for Rs 1.25 crore and there were long-term capital gains of Rs 75 lakh. His tax liability at the rate of 20 per cent on these gains would have been Rs 15 lakh. He invested the proceeds into another residential property for Rs 1.40 crore in January 2015 and claimed exemption under Section 54 of the Act.
Now, if he sells the new property say, in March 2016, for Rs 1.6 crore, he is liable to pay short-term capital gains tax on the entire amount. While calculating the short-term capital gain, he will not be allowed to adjust the cost of acquisition of Rs 1.4 crore against the sale proceeds. Thus, his tax liability will be calculated at the rate on the sale price of Rs 1.6 crore, which would amount to Rs 48 lakh.
Thus, if the restrictive provision under Section 54 is violated, the tax liabilities can go up several times.
What if the property is gifted?
Recently, an interesting case came up for decision before the Chennai Income Tax Tribunal. A tax payer had filed his income tax return for assessment year 2011-12 offering income from house property and business. The tax payer had earned long-term capital gain on the sale of a residential house property in April 2010 and purchased another residential property in August 2010, and had claimed exemption under Section 54 of the Act.
While assessing his return, the income tax officer observed the tax payer had settled the property in favour of his daughter in November 2010 out of love and affection.
The income tax officer arrived at the conclusion that the property had been sold within three years. He rejected the tax payer's claim for deduction under Section 54. He relied on the 2008 decision of the Bombay High Court, which had held that to qualify for long-term capital gains exemption under the Act, it is obligatory for the tax payer to make the investment in a residential house in his own name and not in the name of any other person. The income tax officer was of the view that in this case the tax payer was circumventing the exemption provisions by making the investment in his own name and immediately settling it in favour of his daughter.
At the first level of appeal, the tax payer argued the income tax officer was not right in rejecting the exemption claim under Section 54, as all the conditions laid down for claiming it had been duly honoured by the tax payer.
The tax payer argued that even if the restrictive provisions of Section 54 are invoked, capital gains need to be computed in the manner laid down for sale of the new property within three years, but it does not speak of withdrawal of exemption claimed. As the property was settled in favour of his daughter by means of a settlement deed out of love and affection and without any consideration, the tax payer was neither liable to any capital gains nor taxes under the relevant provisions of the Act.
Under the provisions of the Act, gifts do not attract capital gains and settlements are excluded from the purview of exemption. The tax payer maintained that the settlement was made out of love and affection and hence partakes the character of a gift, as there was no consideration involved in the transaction.
Further, he pointed out that 'gift' is not defined under the Act but is defined under the Transfer of Property Act as follows: "Gift is the transfer of certain existing movable and immovable property made voluntarily without consideration of one person called donor to another the donee and accepted by donee." Relying on this definition, the tax payer insisted that the gift should not attract capital gains tax.
The first level appellate authority was convinced and accordingly directed the income tax officer to allow the exemption. The tax officer, not convinced, made an appeal to the Tribunal.
The final judgement
The Tribunal observed that the tax payer, being the father, had settled the property in favour of his daughter out of love and affection and without any consideration. It held that as far as the settlement is concerned, it is akin to a gift under the Act and hence does not attract capital gains.
With reference to the exemption claim made under Section 54, the Tribunal held the tax payer had complied with the provisions and conditions laid down. Hence, it allowed the exemption. However, the authority put in a rider that the daughter should hold the property for three years from the date of acquisition to comply with the provisions of Section 54.
This ruling serves as a good precedent for genuine cases where tax payers, as part of their estate planning, want to transfer their property during their lifetime without invoking tax liabilities.
The author is a chartered accountant and financial planner
