Put LTCG money in MFs and get tax exemption

Long-term capital gains need to be reinvested in specified assets like a residential house, bonds, etc within the time stipulated under the Income Tax Act ('the Act'). But is it necessary that the capital gains so realised should be directly reinvested in these specified assets? Can a taxpayer park the capital gains money for a short period in other investments like say mutual funds and then withdraw to invest in the specified assets? Will the exemption still be available? Lets find out.

A taxpayer had filed his return of income for assessment year 2011-12 by declaring a total income of Rs 35.60 lakh, which included long-term capital gains of Rs 10.69 lakh. During the said assessment year, the tax payer had sold a residential property for Rs 2.29 crore. Out of these proceeds, he invested Rs 10 lakh on February 24, 2011, and Rs 2 crore on March 4 the same year in mutual funds. Further on March 31, 2011, the tax payer withdrew these amounts and invested Rs 1.99 crore with a developer for construction of a villa. He also invested another Rs 5 lakh in the capital gains account scheme with a nationalised bank on July 19, 2011, and claimed exemption for Rs 2.04 crore u/s 54F of the Act. The balance long-term capital gains of Rs 10.69 lakh was offered to tax in the return of income.

During the course of assessment, the tax officer objected to the fact that the sale proceeds were first invested in mutual funds. He was of the view that the tax payer had deviated from the provisions under the Act and diverted the sale proceeds by investing in mutual funds, and accordingly denied the exemption of Rs 2.04 crore u/s 54F of the Act.

When the taxpayer appealed against this order, the first level appellate authority examined the issue and allowed exemption of Rs 1.99 crore (basically towards the investment made in the villa) as against the claim of Rs 2.04 crore.

The tax officer filed an appeal with the Bangalore tax tribunal against the said decision. The tax officer argued that the sale consideration was not directly invested by the tax payer into purchasing of the property, but was first invested in mutual funds. So, the taxpayer should not be entitled to exemption u/s 54F.

In his defense, the taxpayer submitted that both the amounts – for the villa and the bank FD, were invested in accordance with the provisions of section 54F and within the period provided under the said section. Thus, the claim for exemption is fair.

On the basis of facts of the case, the Tribunal observed that the residential property was sold on February 26, 2011, and the new capital asset was purchased on March 31, 2011. Before the purchase of the asset, the available money was invested in mutual funds. Further, the Tribunal observed that under the provisions of section 54F of the Act, the taxpayer had not only purchased the new asset within time but had also deposited the money in the capital gains account scheme before the due date of filing of returns. The taxpayer, had thus, fulfilled all the conditions required u/s 54F for the purpose of claiming the exemption. The Tribunal held that in their view, deposit of money inter-alia in mutual funds prior to purchase of residential house albeit will not make any difference as long as he has invested the money in the new capital asset within time provided under the Act.

The Bangalore Tribunal accordingly ruled the case in favor of the taxpayer.

The writer is a Sebi registered investment advisor