Duck capital gains tax; avoid immediate sale after possession

Kamal, a close friend, called to inform me that at long last, he was about to get possession of a 2 BHK flat from the builder after a delay of close to five years. He told me he has already found a buyer and would complete the sale of the flat as soon as he got possession. Also, as he had booked the flat in March 2010, the indexation benefit would ensure that there were only minimal taxable capital gains on the flat on which the tax payment would not be very high. He wanted to check how the indexation benefit would be applied in this case since booking and initial payment had been made in 2010, and payment had been made in installments thereafter over the next seven years, with the last instalment to be paid against possession in March 2017.

I told him there was a chance that the tax department might seek to tax the transaction of the sale of the flat as a short-term capital gain rather than tax it as a long-term capital gain. Kamal was incredulous. “I have booked this flat seven years ago, how can this asset be considered as a short-term capital asset?"

I explained to him that the department would argue the asset he acquired in 2010 was only a right to acquire a residential flat not the residential flat itself. This right got converted into acquisition of the actual residential flat in March 2017 only. So, the asset will remain a short-term capital asset if it is sold at any time within two years from March 2017.

Once the asset is considered as a short-term capital asset, any capital gain from its sale will be taxed as normal income. In such case, no indexation benefit would be available while calculating the capital gains. Also, none of the exemptions such as buying another house or buying capital gains bonds will be available to save on capital gains tax.

Kamal asked why more people were not aware of this serious issue. I mentioned to him that there were two major reasons for this : a) Even within the tax department, not many officers were aware of this issue and hence, (fortunately) not many cases had been raised by the department itself. But now, the revenue-hungry department is raising this issue more often and b) Most cases on this issue had been decided against the tax department as courts had mainly ruled in favour of the tax payer though there were a couple of court rulings that were in favour of the tax department's stand.

I informed Kamal that the department's stand in this matter was illogical. If there stand was considered logically correct, there is a “transfer” of asset at the time when possession was taken. The “right to acquire a flat” would be extinguished and an actual flat would be acquired by him. It follows then that capital gains should be payable at that stage also. Fortunately, I have yet to come across a single case where the department has tried to charge capital gains at the stage when possession is handed over to the buyer.

I told Kamal that in any case, at least in his case, he had a risk-free way to make sure that the tax department did not create any problems for him. He should sell the flat before taking possession. At that time, the asset that he sells is only the “right to acquire” a flat and not a flat. This is clearly long term as that was acquired in 2010. Also, the wordings on cost indexation are clear. He will get the indexation on the full cost of the flat from 2010 itself irrespective of the date of the actual payment of the cost and also without considering the fact that a part of the cost was still to be paid to the builder. This will ensure that was minimal long-term capital gains tax in his case. Kamal was happy to hear this solution and has decided to implement it.

My suggestion to readers is to take professional opinion in case you are planning to sell an under construction flat within two years of taking possession. It can save you a lot of heartburn and a lot of taxes.

Harsh Roongta is a CA and Sebi-registered investment advisor. Send your queries to personalfinance@dnaindia.net or tweet them to @AskHarshdna