PERSONAL TAX: Tax benefit given on multiple houses' sale

An amendment in Budget 2014 put to rest an issue related to long-term capital gains (LTCG) exemption under Section 54 of the Income Tax Act, 1961 ('the Act'). The relevant provision was amended to provide that the capital gains exemption shall be restricted to investment made in one residential house, out of sale proceeds received from sale of a residential house property, within the prescribed time period. Prior to the amendment, the section referred to a residential house instead of one; in which case courts took a liberal interpretation that 'a' need not be one but can also be multiple properties.

In this week's case; a taxpayer sold three of his flats in Mumbai and claimed exemption u/s 54 of the Act. At the time of purchase, all three flats were located on the same floor and later on, the taxpayer converted them into one flat. The tax officer argued that as there were three flats with three separate agreements, the taxpayer was not entitled to exemption u/s 54 which entails that a ratio of 1:1 for properties sold and bought has to be maintained. The taxpayer submitted that due to legal formalities involved, the flats were purchased by three separate agreements and when sold, he had to enter into three agreements again. The tax officer was not convinced and accordingly allowed the deduction in respect of only one flat which was shown as residential address in the electricity bill of the taxpayer and disallowed deduction of Rs 1.88 crore in respect of the other two flats.

At the first appellate level, the taxpayer argued that he has used the properties as one residential house. Further, there has been only one single electricity meter in respect of all three flats. The appellate authority commented that it may not be generally possible to find a bigger residential unit and thus it requires combining two or more adjoining flats into one unit. The fact whether the adjoining flats are actually united and used as a common single unit has to be examined. Plain execution of separate agreements cannot be the sole deciding factor in this issue. The acquisition of flats may be done independently, but eventually there is a single unit and house for the purpose of residence.

The authority relied on a Bombay High Court decision which held that where the flats are constructed in such a way that they can be combined into one unit and for the purpose of residence, deduction u/s 54 cannot be denied.

Further, the authority observed that there is no restriction placed in Section 54 that exemption is allowable only in respect of sale of one residential house. There is no restriction that capital gain arising from sale of more than residential flat cannot be invested in one residential house. Decisions by Mumbai Tribunals in previous cases have supported this proposition, as long all the other conditions of Section 54 are fulfilled. Accordingly, the appellate authority ruled in favor of the taxpayer and directed the tax officer to delete the addition of Rs 1.88 crore made in the assessment order.

The tax officer preferred an appeal against the said order before the Mumbai Tribunal, which agreed with the appellate authority's conclusion.

This decision thus reiterates the principle that the benefit of Section 54 cannot be denied merely because the LTCG has arisen on transfer of more than one residential house, while all other conditions of Section 54 are fulfilled.

The writer is a Sebi-registered investment advisor