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September 11, 2020

Benefit from scrapped flat deal is taxable as capital gains – Mumbai ITAT

by CA Shivam Jaiswal in Income Tax, Legal Court Judgement

Benefit from scrapped flat deal is taxable as capital gains – Mumbai ITAT

Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price.

The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act. To save tax on these capital gains, a few capital gains exemption/deductions are available under sections 54, 54B, 54D, 54F etc. As per the provisions of these sections, the amount is required to be reinvested in specified investment types before the specified period. However, if the due date of filing income tax returns falls before the expiry of the specified period, the amount of capital gains is required to be invested temporarily in the Capital Gains Account Scheme which can be easily withdrawn at the time of investment in the specified instrument.

Let us refer to the case of Mukesh Sohanraj Vardhan, Mumbai vs Income Tax Officer (2020) (Mumbai ITAT) where an appeal filed by the assessee directed against the order of the Commissioner of Income Tax (Appeals) [CIT(A)] on the ground that the CIT(A) had wrongly denied  exemption under Section 54 of the Income Tax Act and consequently adding LTCG and treating the same as “Income from Other Sources”

Facts of the Case and Assessment Proceedings:-

  • During 2005, the appellant had acquired a flat for a total consideration of Rs.30,00,000 from M/s Vardhaman Estate Corporation (Builder).
  • The said Builder had issued an allotment letter stating therein the terms and conditions for sale of the said flat to the appellant.
  • At the time of the allotment letter issued by the said builder, the appellant had paid earnest money of Rs.10,00,000 and Rs.20,00,000 towards purchase of the said flat.
  • Thereafter in 2011, the appellant cancelled the booking of the aforesaid flat and treated the same as a sale for a total consideration of Rs.48,75,000.
  • He invested Rs.75,53,469 in purchase of new flat, claiming exemption u/s 54, after availing indexation benefit for cost of the flat paid in installments.
  • During the course of assessment proceedings, the Assessing Officer (AO) asked the appellant to explain why the benefit received on cancellation of deal with the builder should not be treated as income from other sources, instead of long term capital gains, as no purchase as well as sale agreement has been entered into by the assessee with the builder.
  • In response to it, the appellant explained to the AO that a capital asset in the form of interest in the flat came into existence by virtue of allotment letter issued by the builders, when payment was made
  • However, the AO was not convinced with the above explanation of the assessee and came to a finding that the gain which the appellant received from the builder on cancellation of deal has resulted in benefit of compensation of Rs.18,75,000 and the same was nothing but income from other sources.
  • Further on analysis of the bank account of the appellant, the AO noticed that the assessee had actually received from the builder total amount of Rs.52,75,000.
  • Thus the AO brought to tax Rs.22,75,000 (Rs.52,75,000 – Rs.30,00,000) on account of benefit of compensation received by the appellant from the builder in respect of the property under the head “Income from other sources”.

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Proceedings of CIT(A)

Aggrieved by the order of the AO, the appellant filed an appeal before the CIT(A).

The CIT(A) observed that the allotment letter cannot be called as an allotment letter as:-

  • the same is a plain letter with no details of commencement certificate issued by the Municipal Corporation
  • the land details are not recorded
  • authenticity of address of builder not established – telephone number/PAN/Registration Number etc. not recorded in the document
  • paragraph 3 of the allotment letter spells out certain conditions, it is not met which includes execution of agreement
  • in the course of hearing details of such agreement arising out of paragraph 3 of the purported allotment letter was sought to which it was stated as not available
  • the details of flat (area, amenities, specifications etc. are not recorded, (vii) the total sum payable is not mentioned
  • the document is not registered; there is no registration of any allotment agreement at any time
  • the assessee has not signed the purported letter of allotment
  • it is the assessee who signed in his capacity as partner of the builder firm.

Thus the CIT(A) arrived at a finding that the incomplete, non- registered “letter of allotment” cannot be treated as an “allotment letter” for deciding ownership of capital assets. Further, it was observed that the above documentary evidence did not establish ownership of capital assets and hence the question of assessment of capital gains did not arise.

Further, the CIT(A) held that the AO has rightly brought to tax the incremental receipt as income from other sources. Aggrieved with the order of the CIT(A), assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT)

Reference to earlier case by ITAT

  • Similar issue arose before the Tribunal in Ashwin S. Bhalekar (supra).
  • In that case, the assessee was allotted a flat vide allotment letter.
  • The assessee had paid advance amounting to Rs.50,00,000 on the allotment of the said flat.
  • By virtue of the said allotment, the assessee had acquired right to the proposed flat.
  • The construction of the building was yet to commence on the date of allotment.
  • Due to various delay in regulatory approvals, the builder could not obtain permission to construct the building upto 17th floor.
  • The assessee surrendered the right to receive the flats and the builder cancelled the allotment of the above flats and agreed to pay the compensation for an amount of Rs.1,10,00,000 on account of surrender of such flats.
  • In addition to the above, the builder transferred the initial advance of Rs.50,00,000 to the new flat in the same project which the assessee agreed to buy.
  • The assessee then invested the said money to acquire a flat in the same project for Rs.1,53,03,800 vide an agreement registered on 29.02.2012.
  • The AO did not accept the claim of the assessee and treated the compensation on surrender of flats amounting to Rs.1,10,00,000 as income from other sources.
  • On appeal by the assessee, the CIT(A) accepted his claim.
  • Appellant had relied on CBDT Circular No.471 dated 15.10.1986 where it was held that property acquired by allotment letter was considered as capital asset for the purpose of exemption from capital gains.
  • It was held that surrendering of allotment of flat had to be considered as a right in property which was a capital asset and any capital gain arising from that capital asset and if appellant purchases new flat then appellant is eligible for exemption u/s 54.
  • Therefore, the appellant was eligible for claiming of exemption u/s 54 of the Act.
  • AO was directed to compute the surplus amount received from surrender of flat as capital gain and also allow exemption claimed by the appellant u/s 54.
  • Hence, AO’s addition of Rs.1,10,00,000 is deleted and the appeal of the assessee was allowed.
  • Aggrieved with the order of the CIT(A), Revenue appealed before the ITAT
  • ITAT noted that the above narrated facts were undisputed.
  • The facts clearly showed that the extinguishment of assessee’s right in the proposed building known allotted vide allotment letter was actually extinguishment of any right in relation to capital asset in view of the provisions of section 47  which fell in the definition of transfer and hence, resulting in capital gain chargeable under section 45.
  • ITAT found that the CIT(A) had rightly deleted addition made by the AO in regard to disallowance of the claim of the assessee disallowing deduction of long term capital gain under section 54 of the Act on the premise that the compensation received is income from other sources.

The facts of the present case being identical, ITAT followed the above order of the Co-ordinate Bench and allowed the appeal.  In conclusion, in an assessee books a flat and then cancels the deal with the builder and benefits by receiving a sum higher than the earnest amount paid, the excess will not be treated as a tax-free income. The excess consideration received will be taxed as capital gains.

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