SECTION 54 and 54F - SALE PROCEEDS VS INVESTMENT IN RESIDENTIAL HOUSE - liberal approach to achieve purpose of investment in residential houses is required.

[C.A. DEV KUMAR KOTHARI]

Links: Section 54, 54F

CIT  Vs.  D. ANANDA BASAPPA  2009 -TMI - 32481

Section 54

Section 54 is an old provision and it apply when a residential house is sold and another residential house is purchased.  Such reinvestment, on compliance of other requirement leads to exemption from capital gains tax in respect of residential house sold to the extent of investment made in new house computed as per provisions. 

Section 54F

Section 54F was inserted in the Income-tax Act, 1961 vide the Finance Act, 1982 w.e.f. 01.04.1983(A.Y.1983-84). Initially the benefit was given only to individuals however, it was extended to Hindu Un-divided Families w.e.f. 01.04.1988 vide the F.A. 1987. The benefit is available when sale proceeds of long-term capital asset ( other than a residential house) are reinvested in residential house. Earlier the assessee was not eligible to avail benefit if a residential house, income from which was chargeable under the head income from house property was owned by him at the  time of transfer of the original asset or if  he purchased within two years  or constructed  within three years another such house. Thus, earlier only one residential house income from which is chargeable under the head income from house property could be held without loosing the benefit. However, vide the F.A. 2000 w.e.f. 01.04.2001 it is provided that the disentitlement will be in case if the assessee owns more than one such house on the date of transfer of the original asset or purchases or construct another house within stipulated period. That means assessee can have up to two houses without loosing the benefit.

A disincentive has been provided to check restrictions on sale of new house within a period of three years from its purchase or construction. In case of sale within three years from its purchase / construction , the long term capital gains exempted earlier becomes taxable in the year of such sale.

The scheme of section provides that in case amount has not at all been used or has not been fully used for purchase / construction of residential house the assessee may deposit the balance or part of balance in designated Capital gain Deposit scheme before the due date for filing of the return. A check and disincentive is also  provided to the effect that if the amount kept in notified capital gain deposit scheme, during intervening period  is  not invested in purchase or construction of residential house the gain becomes taxable in the year  in which the period of three years from the sale of original asset is completed.

Section 54 and 54F both are incentives to promote investment in housing

Section 54 as well as 54 F of the Income Tax Act, 1961 are beneficial provisions designed with a view to promote re-investment of sale proceeds of long-term capital assets ( residential house in case of S. 54 and capital assets other than residential house in case of S. 54F) in residential House properties. The benefits of these section are available only to Individuals and Hindu un-divided families and not to companies, co-operative societies or firms. 

The purpose of the benefit can be gathered from the Speech of the Finance Minister and Memorandum explaining the proposal in the Finance Bill, 1982. The Honourable Finance Minister told the house  (See (1982)  134 ITR (St.) at page 28) as follows:

"There is an acute shortage of housing, and house building activity has to be given impetus. With a view to providing an incentive to taxpayers who do not own a residential house, I propose to exempt from tax long-term capital gains arising from the transfer of other assets where the net consideration is invested by the tax payer in a residential house. 

 At present, capital gains arising from the transfer of a house used for personal residence by the tax payer are exempt from income-tax to the extent that such gains are utilized by the tax payer for construction or purchasing a house for personal residence within a specified period. These conditions often lead to hardship. I, therefore, propose to remove these restrictive conditions." 

The first paragraph  of the above speech pertain to section 54F and the second paragraph is relevant to section 54 ( exemption of  long-term capital gains on sale of residential house). From the Memorandum explaining the provisions of the Finance Bill, 1982 also vide paragraph 42 (134 ITR 138 (St.) it is clear that the purpose of section 54F is to encourage house construction.  

Permissible time limits: 

To avail the benefit the assessee can make investment within the following time limits:

A. In case of purchase of residential house:

(a) one year before the sale of Long-term capital asset,  

(b) two years after  the sale of Long-term capital asset. 

B. In case of construction of residential house:

(a) three years from sale of Long-term capital asset.  

Thus in case of purchase a prior investment is permitted whereas in case of construction prior investment is not permitted. Therefore, in case of construction, even investment in land must be afterwards. If land is purchased before the sale of original asset, the cost of land will not be eligible. 

In this regard important point to be cared is that the purchase or construction must be completed within the above time frame. In case purchase or construction is not completed within the specified period the benefit will not be available. 

It is also advisable to complete the purchase or construction well before the dead line in case it is afterwards sale of the original long-term capital asset. In case of prior purchase (before sale of original asset) the purchase should not be one year before. This is because in case of boarder line transactions the Assessing Officer may try to establish that the purchase or construction was beyond the permissible time frame.  

Permissible mode of parking funds in intervening period: 

It is not permissible to keep money any where the assessee may choose. If the assessee has not been able to fully utilize amount of  net sale proceeds of original long-term capital asset for the purpose of purchase / construction of residential house, before the due date for filing of the return under section 139(1), (for the previous year in which original long-term capital asset has been sold), the assessee can only make deposit in notified  long-term capital gains deposit scheme accounts as prescribed in sub-section (4) of section 54F. If the amount utilized for purchase / construction of the residential house and deposit made within LTCG deposit account (before the due date) is less than the net consideration on sale of original long-term capital asset, the deduction shall be allowed on proportionate basis.       

Purposive approach is required:

As discussed earlier the purpose of S. 54F if to promote investment in residential houses. This is also clear from the fact that now the law   has allowed such investment even if one has already own residential house. Being the beneficial provision the benefit must be allowed when the purpose is achieved. 

Merely because the assessee want to take benefit of S. 54F he cannot keep the funds ideal for some time similarly if the assessee had funds available with him he can purchase the residential house even prior to selling the original assets. In two situations the steps required may be summarized as follows: 

1.  Purchase of residential house prior to selling the original asset.

     a) Making the decision as to purchase of the residential house.

     b) Making the decision as to selling of certain other assets.

     c) Arranging funds for purchase of residential house may be own funds, or borrowed funds. In this case funds obtained on sale of original asset cannot be used except in rare circumstances of receiving advance payment from the buyer against sale of some other asset.  

     d) Finalizing for purchase of residential house.  

     e) Making payment and receiving possession of residential house.  

     f) Selling out certain original assets for mobilization of funds and also booking long term capital gain and availing exemption.

 In the above case certain steps required towards the purchase of residential house and disposal of other assets may take place simultaneously but fact is that the assessee purchases the residential house before selling of original assets. The investment has been made in a new assets - residential house has been acquired the purpose of S. 54F has been achieved.  

2.  Selling original assets before and then purchase of residential house

     a) Assessee make a decision as to depose-off certain assets he identify the assets to be sold and then steps for selling the original assets are taken.

     b) He finds out buyers and negotiates terms and conditions and sells the original assets.

     c) Receiving payment for original assets and deposit in to bank account.

     d) Identify property to be purchased and negotiate the terms and conditions.

     e) Makes payment for the residential house and take possession.

In the above case the assessee may prefer to use the funds received on selling of original asset before re-investment is made in residential house. To increase his income he may choose different   ways to utilize the money off course these choices are available only up to the due date for filing of the return which falls after the selling of the original assets because if he is unable to use funds for residential house he has to be deposit the balance amount of sale proceeds in long term capital again deposit account.  If the deposit is not made then the amount out of sale proceeds of original assets to the extent not used for the purpose of purchase / construction of residential house will become taxable. 

CONTROVERSY AS TO APPROPRIATION OF SALE PROCEEDS

Sub-section (4) speaks about the 'amount not appropriated', in the following manner:

  (4) The amount of the net consideration which is not appropriated by the assessee towards the purchase of the new asset made within one year before the date on which the transfer of the original asset took place, or which is not utilized by him for the purpose of construction of the new asset before the date of furnishing such return [such deposit being made in any case not later than the due date applicable in the case of the assessee for return of income under sub-section(1) of section 139] in any account in any such bank or institution as may be specified in, and utilized in accordance with, any scheme which the Central Government may, by notification in the Official Gazette, fame in this behalf…..   

The word appropriation of sale proceeds cannot be taken in the sales that the amount received from the buyers of the original assets should only be used for purchasing/ construction of new residential house.  The law itself permit that if the full amount of sale proceeds permit is not used for purchase/construction of new residential house the assessee can make deposit in capital gain deposit account before the due date for filling of the return. Suppose the amount is deposited in capital gain deposit account the assessee will have to withdrawn the money from that account for making investment in residential house. 

Appropriations - if construed in its literal sense it can only mean that if the assessee has received cash payment on sale of original assists, he must use the same currency notes for purchasing /construction of residential house. In case payment is received from buyer by cheques the strict meaning of appropriations may mean that the buyer of the old assets should issue cheques to the vendor of the new residential house if a cheques is received and deposited with bank account and then the funds are used for reinvestment in residential house it may not amount to appropriation of the sale proceeds in residential house because by depositing the cheques amount of sale proceeds had been appropriated towards making a deposit into the bank account and not towards reinvestment  in residential house. 

Recent case law u/s 54- two flats used as one unit are eligible as one house:

In CIT  Vs. D. ANANDA BASAPPA  2009 -TMI - 32481 [2009] 309 ITR 329 (Karn) decided on 20 October 2008 matter us/ 54 was under consideration. Assessee purchased two residential flats which were adjacent to each other and claimed the same as one residential house  and accordingly treated cost of both flats as eligible for deduction u/s 54.  A.O.  allowed exemption for capital gains to the extent of cost of one residential flat on ground that section 54(1) does not permit exemption for the purchasers for more than one residential premises. The court held that  Purchase of two flats which were combined to make one residential unit are one unit  of residential house and that the assessee is entitled for deduction for full amount of cost of two flats. The mere fact that the two flats are purchased vide two different purchase deeds will also not make difference because both the flats are used as one unit. The Tribunal also relied on provisions of  S. 54F, as amended and applied the same in relation to S. 54 also.  The questions of law were framed as follows:

        (a) Whether the Tribunal was correct in holding that out of the sale proceeds of the property bearing No. 9, Brunton Road, Bangalore, owned by the assessee he could invest the same in two residential flats bearing No. G-01 and G-02, and claim deduction in respect of both these flats in accordance with section 54 read with section 54F of the Act for the assessment year 1996-97?

       (b) Whether the proviso to section 54F of the Act, as it stood prior to the amendment brought about by the Finance Act, 2000, can be read to mean that for the assessment year 1996-97 the assessee would be entitled to relief in respect, of more than one dwelling unit for the purpose of claiming exemption under the head 'Capital Gains'?"

Facts in brief:

The assessee a HUF sold a residential house for Rs. 2,12,50,000 in the year October, 1995 and purchased two residential flats adjacent to each other from M/s. Ormonde Private Developers Ltd vide two separate registered sale deeds in respect of the two flats situate side by side purchased on the same day. The vendor of flats has certified that he has effected necessary modifications to the two flats to make them as one residential apartment. As the original asset sold was a residential house, the assessee sought benefit of section 54 of the Income-tax Act.

The A.O. taking view that two flats means tow housesgave exemption for capital gains to the extent of cost of one residential flat. It was found in the inspection by the inspector that the residential flats were in occupation of two different tenants disclosing separate enjoyment. Therefore, it is held that section 54(1) of the Income-tax Act does not permit exemption for the purchasers for more than one residential premises. The Commissioner of Income-tax confirmed the order of the assessing authority. The Tribunal in appeal set aside the order of the Commissioner of Income-tax and held that the purchase of the two flats made by the assessee has to be treated as one single residential unit and that the assessee is entitled for full exemption.

The court noticed relevnt provisions as follows:In the provision of section 54(1) of the Income-tax Act, the relevant portion is extracted herein for convenient reference:

"Subject to the provisions of sub-section (2), where, in the case of an assessee being an individual or a Hindu undivided family, the capital gain arises from the transfer of a long-term capital asset, being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head 'Income from house property' (hereafter in this section referred to as the original asset), and the assessee has within a period of one year before or two years after the date on which the transfer took place purchased or has within a period of three years after that date constructed a residential house, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall, be dealt with in accordance with the following provisions of this section", that is to say,—

Then the court held that a plain reading of the provision of section 54(1) of the Income-tax Act discloses that when an individual-assessee or Hindu undivided family-assessee sells a residential building or lands appurtenant thereto, he can invest capital gains for purchase of residential building to seek exemption of the capital gains tax. Section 13 of the General Clauses Act declares that whenever the singular is used for a word, it is permissible to include the plural.

The contention of the Revenue that the phrase "a" residential house would mean one residential house does not appear to the correct understanding. The expression "a" residential house should be understood in a sense that building should be of residential in nature and "a" should not be understood to indicate a singular number. The combined reading of sections 54(1) and 54F of the Income-tax Act discloses that, a non residential building can be sold, the capital gain of which can be invested in a residential building to seek exemption of capital gain tax. However, the proviso to section 54 of the Income-tax Act, lays down that if the assessee has already one residential building, he is not entitled to exemption of capital gains tax, when he invests the capital gain in purchase of additional residential building.

Considering case of a HUF court considered that when a Hindu undivided family's residential house is sold, the capital gain should be invested for the purchase of only one residential house is an incorrect proposition. After all, the Hindu undivided family property is held by the members as joint tenants. The members, keeping in view the future needs in event of separation, purchase more than one residential building, it cannot be said that the benefit of exemption is to be denied under section 54(1) of the Income-tax Act.

The two apartments are situated side by side. The builder has also stated that he has effected modification of the flats to make it as one unit by opening the door in between two apartments. The fact that at the time when the inspector inspected the premises, the flats were occupied by two different tenants is not the ground to hold that the apartment is not a one residential unit. The fact that the assessee could have purchased both the flats in one single sale deed or could have narrated the purchase of two premises as one unit in the sale deed is not the ground to hold that the assessee had no intention to purchase the two flats as one unit.

In view of the above facts, reasons and discussion, the court answered substantial questions of law in favour of the assessee and dismissed the appeal of revenue.

Conclusion:

Considering the purpose of S. 54 and S.54F, it appears that the provisions should be interpreted liberally in a purpose seeking approach. Strict and literal interpretation may render the section non-workable in many circumstances for example: 

i) Prior purchase with other funds (Before sale of original asset)

ii)) Use of other funds for temporary period in purchase of residential house

iii) Investment of sale proceeds (even deposit the bank account) may disentitle for benefit.

iv) The expression 'One residential' house should be interpreted in a meaning full and purpose seeking manner.

v) the expression 'residential house' should also be viewed from practical manner. Because a residential house can be a hut, flat, a house ,a bungalow or a palace or it can be a group of huts, flats, houses, bungalows or palaces depending on the nature of residential requirement of the assessee his family guests according to his status.

One residential house means a unit of residential house. It can be a small one room flat or a large flat or a big bungalow. In some cases it can be very large bungalow like a palace. For example for a newly qualified professional initially he may purchase a small flat and then after few years he can purchase a big flat or bungalow. In case of a very rich person a large bungalow with service quarters will be a house consisting of several units but used as one house for a family, guests and servants. A person may purchase two or more flats and use as one residential unit.  

Suppose a person purchase a big flat it is considered as one unit. Another person purchases two flats which are adjacent, and he combines tow flats and use them as one residential unit then both flats will constitute one unit.

Discussions to this article

[Baalu Radhakrishna]

Though I have no touch in Income Tax act, for my own purpose of managing my Capital Gains I just gone through Section 54 and 54F and relevant case laws,notificatiions, and Circulars and this nice article. But the following doubts needs clarification. At first in the case of construction of a residential house, the time limit is 3 years. The doubt is this three years include bying the plot/land and construction or else is it compulsory that the plot/land should be purchased before 2 years and construction be completed in the next year or can purchase and construction be effected in the third year and completion off cousre before the end of 3rd year! 2. Is there any restriction in apportionment of the capital gains to be invested in plot/land and towards construction of the house? 3. Is there any restriction of the proposed construction of the house to meet the requirement such as a minimum plinth area or minimum of bed rooms or first floor or duplex like? My doubt is can i invest 80% of my gains in land and just 20% in the house built over there? If the author could clarify these doubts I shall be grateful Regards RK/25-07-2009