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Both residents and NRIs can benefit from the tax rules to this effect

For long-term capital gains earned on sale of property, the tax rate is 20%. If the value is above Rs 10 lakh, the tax rate climbs to 22.66%. This applies both to residents as well as non-resident Indians (NRIs).

Sec. 54 of the Income Tax Act offers a way out of paying such tax. If the capital gain amount is invested in a residential house within one year before to two years after the sale, then the capital gains earned are fully exempted from tax. In case the investor intends to construct a house, the time limit is extended to within three years of the date of sale. Of course, if only a part of the capital gain is used, the exemption would be proportional and the excess will be chargeable to tax.

So far, so good. Now comes the interesting part, especially for NRIs.

Nowhere does Sec. 54 specify that the new house purchased should be within India. This means, to save capital gains earned in India, the NRI can even purchase a house in his or her own host country abroad and yet claim exemption. Why just NRIs, now even resident Indians can benefit from this rule. RBI allows an Indian resident up to $1,00,000 per annum to be invested abroad. Such investment could be even in property.

So far, this was just a theoretical possibility based on a plain reading of the law. However, in a recent judgment, the Income Tax Tribunal in the case of Prema P Shah (Citation 282 ITR 211) has ruled that the exemption offered by Sec. 54 can indeed be extended to a property purchased in a foreign country.

The brief facts of the case were that the assessee claimed the capital gains on sale of house property situated in India as exempt. To support her claim, she filed a photocopy of a lease agreement for a house in London. The assessing officer disallowed the claim noting that Sec. 54 speaks of purchase of residential property or construction thereof. In this case, Shah had purchased only tenancy rights and hence exemption under Sec. 54 would not be available to her.

This argument was rejected by the Tribunal based on the facts of the case. In the UK, property belongs to the Sovereign; citizens, instead of being allowed to purchase, are granted long-term leases. In the instant case, the lease was valid for 150 years -- in other words, it was in perpetuity and for all practical purposes, the assessee was the owner of the property.

It's not even necessary that the same amount of capital gains be used to buy the property. The assessee can very well buy the property even on mortgage (housing finance) -- as long as the conditions specified in Sec. 54 are satisfied, the exemption is available. This is because, even for properties bought using mortgage, the borrower instantly becomes the owner of the property.

That he is paying his EMIs (mortgage) on the loan taken is an agreement between the lender and the borrower inter se. It has no bearing on the ownership of the property. In other words, as far as Sec. 54 is concerned, an investment has indeed been made in property. Whether it's through the mechanism of mortgage or otherwise is immaterial.

This judgment will have far reaching impact, especially on NRI investments and taxation. No one is born an NRI. Indian residents become NRIs when they go abroad for employment or business. More often than not, such persons own property in India, either the one they left behind when they went abroad and became NRIs, or one that is inherited.

A number of such persons, who have set up a new life abroad definitely don't need a new property just to save on tax. Now, such persons can actually consider buying property abroad and claiming tax benefits in India.

sandeep.shanbhag@gmail.com