PERSONAL TAX: Tenancy rights buy not exempted under Section 54F

In cities like Mumbai, 'Pagadi' properties – where the buyer basically buys in tenancy rights of the flat, rather than ownership – are quite common. If a taxpayer invests his long-term capital gains (LTCG) to buy tenancy rights, will it qualify for exemption under section 54/54F of the Income Tax Act ('the Act')?

A taxpayer sold an agricultural land situated in Gujarat during the assessment year 2009-10. He had inherited the property from his father, who had purchased it prior to 1.4.1981 (being the start date on which the cost indexation starts under the provisions of the Act). The taxpayer was one of the four legal heirs to the property that was transferred in his name during financial year 2000-01 upon the death of his father. The taxpayer worked out the long-term capital gains at Rs 3.32 lakh against his share in the property by indexing the cost of the property since 1981-82. Further, he claimed deduction under Section 54 for Rs 3.55 lakh towards the amount spent in acquiring tenancy rights in a certain property. 

During the course of assessment, the tax officer, after adopting the sale consideration at higher of market value and agreement value, assessed the long-term capital gains at Rs 8.04 lakh. The tax officer raised two issues in the said case: First, he disallowed the indexation claimed by the taxpayer since 1981 and was of the opinion that is should be allowed only from 2000-01, being the first year in which the asset was first owned by the taxpayer. Second, the tax officer denied the benefit of deduction under Section 54 on account of his opinion that the said deduction was not available to acquire tenancy rights in a rented property. 

The first level appellate authority confirmed the tax officer's stand on both these points and refused to grant any relief to the taxpayer. 

Before the Mumbai tax Tribunal, the taxpayer argued that the honorable Mumbai High Court in an earlier decision has held that the indexed cost of acquisition has to be determined with reference to the cost inflation index for the first year in which a capital asset is held by the taxpayer. The terms 'held by the taxpayer' is not clearly defined under the Act and hence it can be liberally interpreted to mean that indexation has to be applied from the date the asset was held by the previous owner. This holds true in cases where the ownership of capital assets is passed on from one previous owner to another. Relying on this decision of the High Court, the Tribunal ruled in favour that the benefit of indexation would be available to taxpayer from FY1981-82. 

Based on the facts of the case in relation to the second ground, the Tribunal observed that in relation to the deduction u/s 54, the taxpayer has not acquired the ownership rights in the new property but merely acquired tenancy rights which could not be equated with ownership rights. The conditions prescribed under section 54/section 54F are that the taxpayer must purchase or construct a new property within the specified time. The acquisition of tenancy rights, in the Tribunal's opinion, does not amount to purchase or construction of a new property in any manner. The Tribunal thereby ruled that the taxpayer would not be eligible to claim the deduction u/s 54F of the Act. 

The writer is a Sebi-registered investment advisor