Is Section 54F deduction allowable where an independent building having multiple residential units is treated as ‘one residential unit’?

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amount of capital gains is required to be invested temporarily in the Capital Gains Account Scheme which can be easily withdrawn at the time of investment in the specified instrument.

What is Section 54F of the Income Tax Act?

The income tax law provides for certain situations where such capital gains will not be subject to tax. Section 54F provides one such exemption. In the case of an assessee being an individual or a HUF, if the capital gain arises from the transfer of any long-term capital asset, not being a residential house (original asset) and the assessee has within a period of 1 year before or 2 years after the date on which the transfer took place purchased, or has within a period of 3 years after that date constructed, one residential house in India (new asset), the capital gain shall be dealt with in accordance with the following provisions of this section:

if the cost of the new asset is not less than the net consideration in respect of the original asset, the whole of such capital gain shall not be charged under section 45
if the cost of the new asset is less than the net consideration in respect of the original asset, so much of the capital gain as bears to the whole of the capital gain the same proportion as the cost of the new asset bears to the net consideration, shall not be charged under section 45

Let us refer to the case of Halesh K.C. Vs ITO (ITAT Bangalore) where the issue raised was whether benefit of Section 54F is allowable where an independent building having multiple residential units is treated as ‘one residential unit’

Facts of the Case:

The assessee along with other family members had sold an immovable property located in Bangalore on 20-08-2015.
The assessee worked out long term capital gain of Rs.1,50,20,000 and claimed deduction of entire amount u/s 54F.
The AO noticed that the assessee had received a building by way of gift on 13.8.2015 and the said building consisted of ground floor, first floor and second floor.
The AO also deputed his inspector to physically inspect the property.
The Inspector reported that the Ground floor was having a garage and one residential unit; first floor was having two 1BHK flats and second floor was having 2 single (with bath) units.
The AO, accordingly, took the view that each of the unit was a separate house.
Since deduction u/s 54F was not permitted, if the assessee was having more than one house property, the AO rejected the claim for deduction u/s 54F.

Order of Commissioner of Income Tax (Appeals) [CIT(A)]

The CIT(A) also confirmed the same and took support of decision rendered by Bangalore bench of Tribunal in the case of Ramaiah Harish. Aggrieved with the order of the CIT(A), assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT)

Observations of ITAT on decisions of earlier cases:

ITAT noticed that the decision rendered by the Tribunal in the case of Ramaiah Harish (supra) was an ex-parte order and the same was recalled by the Tribunal later. Hence the CIT(A) could not have placed his reliance on the above said decision.

The question, whether each floor of a single standalone building should be considered as separate house was examined by the coordinate bench in the case of Shri Bhatkal Ramarao Prakash vs. ITO. According to the said case:

As far as the case of the AO that assessee has purchased two properties under Sale Deed.
Actually, this was a single piece of property owned by Smt. Janaki Iyengar.
She constructed a residential house in ground floor in the year 1937 and the first floor in the year 1962-63.
Janaki Iyengar died and the legatees under the will sold their respective shares in one property to the Assessee.
The entire property constituted single house but was bifurcated with two door numbers for the ground and first floor with common entrance in the ground floor only to earmark the share of each beneficiaries.
The property otherwise constituted a single property, though they have two different door nos.
In such circumstances, the assessee has purchased only one property and not two properties.
In this regard, the decisions cited by the Counsel for the assessee supported the plea of the assessee viz., the decision of the Delhi High Court in the case of CIT Vs. Gita Duggal (Delhi).
In the aforesaid decision, the facts were that the assessee entered into a development agreement pursuant to which the developer demolished the property and constructed a new building comprising of three floors.
In consideration of granting the development rights, the assessee received Rs. 4 crores and two floors of the new building.
The AO held that in computing capital gains, the cost of construction of Rs. 3.43 crores incurred by the developer on the development of the property had to be added to the sum of Rs. 4 crores received by the assessee.
The assessee claimed that as the said capital gains was invested in the said two floors, she was eligible for exemption u/s 54.
The AO rejected the claim on the basis that the units on the said floors were independent & self-contained and not “a residential house” and granted exemption for only one unit.
The CIT(A) and Tribunal upheld the assessee’s claim by relying on B.Ananda Basappa (Kar) and K.G. Rukminiamma (Kar).
On appeal by the department, the High Court dismissed the appeal of the revenue.
The Court observed that as held in B.Ananda Bassappa (SLP dismissed) & K G Rukminiamma, the Revenue’s contention that the phrase “a” residential house would mean “one” residential house was not correct.
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.
Also, section 54/54F uses the expression “a residential house” and not “a residential unit”.

Section 54/54F requires the assessee to acquire a “residential house” and so long as the assessee acquires a building, which may be constructed, for the sake of convenience, in such a manner as to consist of several units which can, if the need arises, be conveniently and independently used as an independent residence, the requirement of the Section should be taken to have been satisfied.
There was nothing in these sections which required the residential house to be constructed in a particular manner.
The only requirement was that it should be for the residential use and not for commercial use.
If there was nothing in the section which required that the residential house should be built in a particular manner.
According to ITAT, the income tax authorities could not insist upon that requirement.
A person may construct a house according to his plans, requirements and compulsions.
A person may construct a residential house in such a manner that he may use the ground floor for his own residence and let out the first floor having an independent entry so that his income was augmented.
It was quite common to find such arrangements, particularly post-retirement.
There may be several considerations for a person while constructing a residential house.
The physical structuring of the new residential house, whether it is lateral or vertical, could not come in the way of considering the building as a residential house.
The fact that the residential house consists of several independent units could not be permitted to act as an impediment to the allowance of the deduction u/s 54/54F.
It was neither expressly nor by necessary implication prohibited.
ITAT was therefore of the view that the Assessee was entitled to claim deduction u/s.54F in respect of investment in the property.

Observations of ITAT on miscellaneous application by Revenue

ITAT also noticed that the revenue had filed a miscellaneous application against the said order passed by the Tribunal and the same was rejected by the order passed by the co-ordinate bench with the following observations:

In this miscellaneous petition, the revenue has contended that since the Tribunal has placed reliance on the decision of the High Court of Karnataka rendered in the case of B. Ananda Bassappa (supra) and K G Rukminiamma (supra) and since by the Finance Act, 2014, section 54F was amended by substituting the words “a residential house” with “one residential house” and since the assessment year in this appeal is after the aforesaid amendment, the conclusions drawn by the Tribunal were incorrect and suffered from an apparent mistake on the face of record and should be rectified suitably.
ITAT was of the view that there was no mistake, much less an apparent mistake, in the order of the Tribunal.
The Tribunal had clearly given a finding that the property at N.R. Colony belonged to one owner, Smt. Janaki Iyengar.
As per the Will of Smt. Janaki Iyengar, the Ground Floor of the premises which was numbered as Door No.37 was given to Smt. Janaki’s sister, Dr. M. Vaidehi and the 1st Floor numbered as Door No.37/1 was given to Smt. Janaki’s nephew, Shri P. Ramanuja Chari.
Both these owners of Ground Floor and 1st Floor sold the property to the assessee.
ITAT clearly observed that the entire property constituted one residential house, but was bifurcated with two Door Nos. for Ground Floor and 1st Floor with common entrance in Ground Floor only to earmark the share of each beneficiary and that otherwise the property constitutes a single property, though it had two different Door Nos.
ITAT had reached the conclusion that assessee had purchased only one property and not two properties.

The view taken was that an independent building can have a number of residential units and it would not lose the character of “one residential house”. Accordingly, ITAT was unable to agree with the view taken by the tax authorities that each floor of the individual house/each portion in a floor was separate house property. Accordingly, ITAT set aside the order passed by CIT(A) on this issue and held that the house property received by the assessee was “one residential house” only within the meaning of sec.54F of the Act. Accordingly, ITAT was of the view that the reasoning given by the AO to reject the claim for deduction u/s 54F was not justified. With these observations, ITAT restored this issue to the file of the AO for allowing the deduction u/s 54F of the Act in compliance with the above decision.

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