Budget 2019 has left the stake-holders perplexed as to applicability of some of the proposed amendments. Mr. J V Kodhandapani, FCA and CWA (Pani & Associates), in this article, evaluates one such amendments viz., benefit of re-investment of capital gains in two residential houses. Probing into some of the moot questions in the stake-holders’ minds, the author evaluates the retrospective application or otherwise of the amendment and opines that “The amendment being a substantive amendment and takes effect from AY 2020-21 and cannot be treated as procedural amendment giving retro effect replacing the earlier provisions of law allowing investment in one property only”. Further, in case where a person chooses to buy one house and construct another, the author warns that care should be taken to adhere to the separate time limits specified for purchase and construction. Another interesting scenario that author discusses is when there is increase in capital gains amount beyond Rs 2 Cr  in the course of assessment owing to disallowance of expenses etc.In such situation, the author cites various implications like huge capital gains tax liability, consequential interest u/s 234B, etc.

Expert Column:

Hon'ble Finance Minister has introduced The Finance Bill on 1-2-2019 proposing an amendment to section 54 of the Income tax Act, 1961 proposing to increase the number of residential houses to two for the purpose of exemption from capital gains.

A finer reading of the existing provision, amendments, budget speech, memorandum of objects and reasoning reveal the following issues for discussions, analysis and drawing relevant conclusions:

Q 1. As per the speech and the amendments, it takes effect from the AY 2020-21 onwards.  The point for consideration is whether the amendment is prospective or retrospective. Whether an assessee, who derived long term eligible capital gains in the earlier assessment years can exercise this option in AY 2020-21?   In other words, whether this option is with reference to capital gains arising from AY 2020-21 onwards or with reference to option of investment irrespective of the year in which the capital gains arises.

The probable answer is that the investment into 2 houses is a relief amendment as per the speech of the Finance Minister and it is a case of exemption provision being enlarged to cover 2 houses and the such investment option for exemption is available for from AY 2020-21.  The amendment being a substantive amendment and takes effect from AY 2020-21 and cannot be treated as procedural amendment giving retro effect replacing the earlier provisions of law allowing investment in one property only.

Further the proviso as introduced should be read in conjunction with the main subsection (1) of section 54 and hence the enhanced exemption is available for the capital gains arising under sub-section (1) from AY 2020-21 onwards.  

If an assessee say had LTCG in FY 2016-17 and invested in Capital Gains Account Scheme to acquire a house within 3 years and the amount is not utilized, the time limit to use the funds in CG A/c expires in FY 2019-20. Consequently it is chargeable to tax u/s 45 as the income (LTCG) of the previous year relevant to AY 2020-21.

Once the same LTCG is chargeable to tax AY 2020-21 as above, the question for consideration is whether beneficial provision under the option now brought-in can be exercised.   In other words, whether the LTCG for default under proviso to subsection 2 of section 54 is equivalent to LTCG as contemplated under subsection 1 of section 54.  The amendment does not clarify whether exemption is available or not. It is not possible to extend the same benefit under the newly introduced proviso to Sec 54(1) to capital gain as arising under proviso to section 54(2).

Q 2. In the FM Speech, in para 93, he has stated that the benefit of rollover of capital gains under section 54 of the Income Tax Act will be increased from investment in one residential house to two residential houses.

He has used the word roll over.  Roll over means …… should also be continued or allowed, extended, pass on.   In the context of the amendment brought in, there is no provision for or context of roll over.  The new proviso is a one time exemption provision as in Sec 54(1), but not a roll over provision.  Roll over provision means that that the exemption is postponed, allowed in subsequent periods, or continued in subsequent years, which may not be the intent of law makers.  

Q 3. As per the amendment, purchase or construct of two residential houses in India covers the following cases:

Purchase option for 2 houses or

Construction option for 2 houses or

Purchase 1 house and construct 1 house.

Care should be taken to adhere to the time limits periods specified for purchase separately and construction separately as per the time limits set u/s 54(1) - purchase within a period of 1 year before or 2 years later or construct within a period of 3 years, though there is no specific reference to this.

Q 4. The amendment is limited to the assesses who have capital gains not in excess of Rs 2 crore. The capital gains for this purpose is from the qualifying long term capital asset of buildings or lands appurtenant thereto being residential property under sec 54 only. The capital gain arising from other long term capital assets such as gold, shares, vacant land etc., are not to be considered and aggregated to check the eligibility of an assessee.  This is for the reason that the amendment by way of proviso is added to Sec 54(1) only, not under other exemption provisions for different assets separately stated.

Q 5. Whether the capital gain referred to in the amendment is aggregate of all capital gains from all residential properties sold or limited to one asset at a time.  For example in respect of capital from one asset, the capital gains may be less than 2 cr and the assessee will be allowed to avail this option of investment in 2 houses.  Whereas in respect of another residential property, the assessee may have capital gains exceeding 2 cr in respect of which he is not eligible to claim the benefit of investment of 2 properties, he is eligible to invest in one property.  As per the scheme of computation of capital gains, it needs to be computed asset wise.  Such computation needs to be done asset wise and exemption is to be claimed for each asset. On this principle basis, an assessee is eligible to purchase 2 houses for sale of one asset having capital gains upto Rs 2 crore and in respect of other asset having capital gains of over 2 crore, he is eligible to acquire one asset only.  The result of computation is completely different if it is taken on the principle of aggregation of capital gains of all residential basis. The aggregation principle is sounded on the basis of reference to the word used as capital gain in the proviso. Because the wording used is 'Provided that where the amount of the capital gain does not exceed two crore rupees.  There is a difference between capital gain vs income from capital gains.  The later one is after exemptions under sec 54. Therefore, unless the law is made clear, whether the option is available for asset wise individually or on aggregation basis, there are going to be uncertainties and tax disputes.

It was held that the exemption will be available in relation to each set of sale and corresponding investment in the residential house and the combination which is beneficial to the assessee has to be allowed as decided in [TS-5665-ITAT-2010(Mumbai)-O].

Q 6. The FM has said in his speech vide Para 93 that the benefit of rollover of capital gains under section 54 of the Income Tax Act will be increased from investment in one residential house to two residential houses for a tax payer having  capital gains up to Rs 2 crore. This benefit can be availed once in a life time.

The objects of amendment are not stated in clear terms, but the reasons and objects could be with reference to:

a) Tax payer being small or middle income person, having capital gain upto 2 crore.

b) To give the benefit of investment in 2 houses to promote the real estate industry.

c) To give the flexibility of each tax payer owning 2 properties one for self and one for parents or other family members, which object is clear from the amendment brought out in sec 23, where the two properties are allowed for self occupation purpose and the annual value of both such house properties will be NIL.  Taking the principle and rationale from the amendment to section 23, if the objects were to allow 2 house properties, then there is no rationale to fix the cap of capital gain of 2 crore.  It should have been open to all so that the investment would have flown in 2 properties, giving an encouragement to the real estate business, employment opportunities and also boost to the other industries depending on real estate business.  The State Governments are equally benefitted by way of stamp duty.  Taking a clue from the wordings used, the Finance Minister limited to benefit only to an assessee having capital gain upto 2 cr meaning that the large tax prayers can not take advantage of the amendment and will have to contribute by way of capital gains tax.  This way, only small tax payers are benefitted and spared, which is within the legislative powers of the law makers to differentiate and discriminate, what to tax, whom to tax and at what rate to tax and when to tax.

d) If the option is permitted for capital gain so computed for each of the properties, it is possible to interpret that an assessee is able to invest into 2 properties for each of the asset and thus 4 properties for 2 assets sold, 6 properties for 3 assets sold and so on as long as the capital gain for each asset is under 2 cr.

e) From the plain reading of the beginning portion of section 54, the legislature has used plural such as buildings or lands appurtenant thereto.  It is possible to draw inference that capital gain need to be computed first for all properties and then allow the exemption under section 54 to arrive at Income from capital gains. In this case, asset wise exemption is not available.

f) In order to set the matter to rest, the Legislature should bring an amendment covering all aspects and issues arising from such different interpretations.

Q 7. Another question for consideration is when an assessee is required to indicate his option and when an option need to be exercised and when the option needs to be implemented in view of the time gap between the date of exercising the option vs actual date of fulfillment of /investment since investment is deferred to a date within 3 years. However, in 3rd year, the actual scenario would be:

a) Investing 1 property only instead of 2 houses planned and option exercised.

b) Decided to pay up the capital gains tax and withdraws amount deposited in CG a/c.

c) Invests in 2 properties as planned.

In such cases in (a) and (b) above, the assessee though opted to invest in 2 properties, but unable to do so and utilize the opportunity.  Can it mean that he lost an opportunity in his life time.   The law will have to have sufficient clarificatory provisions to overcome and deal with such situations.

Q 8. An assessee having exercised his option under to invest in 2 properties, is it compulsory that the assessee must full the condition of investing in 2 properties. Supposing, he finally invests in 1 property only.  Does it mean that he has not fulfilled the conditions of the proviso,  this is for the reason that the law says that the assessee, may at his option, purchase or construct two residential houses in India.  The word used is the assessee purchase or construct two residential houses in India.  The wordings should have been upto 2 residential house properties.

Q 9. The amendment provides that the assessee, may at his option, purchase or construct two residential houses in India.  The word used is may is equal to may not be.  If he wants to invest in 1 property only, he should not exercise the option proposed through this amendment.  It is a matter of caution and once the option is exercised, the assessee does not get such an opportunity. We will have to wait for new ITR forms, how such an option can be exercised, whether the information relevant to choosing an option need to be filled in the pages relevant to CG capital gains.

Q 10.  For the purpose of exercising such an option, the amount of capital gain should not exceed Rs 2 crore.  It is pertinent to note that the capital gain of Rs 2 crore should be as computed by the assessee and as returned by the assessee.  For various reasons such as disallowance of expenses incurred in connection with sale and claimed u/s 48, reference to the valuation officer, higher stamp duty valuation, certain costs of acquisition and costs of improvements not allowed at the time of assessment by the AO, the assessed capital gains will go up.  In such cases, the capital gain as assessed might cross the limit of Rs 2 crore. Once the capital gain crosses Rs 2 crore, the assessee will not be eligible for exemption and the exemption for having invested in 2 properties hitherto claimed will be disallowed, causing huge capital gains tax liability and further consequences of interest u/s 234B and C, penalties etc.,

Q 11. It is not understandable why similar exemption for investment into 2 residential house is not being extended for capital gains arising on sale of other than residential properties to which the provisions of section 54F apply.  Ideally, such differentiation and discrimination should be avoided.

Q 12. Care should be taken while exercising the option to invest in 2 properties as amended u/s 54.  Assessees who had capital gains in the past and availed exemption under section 54F should not acquire another house property within a period of 1 year or construct within 3 years vide proviso to Sec 54F(1). The assessee will have to be careful not to get disqualified for the capital gains hither to claimed as exemption by virtue of reinvestment made in 1 or 2 properties under section 54(1).

Q 13. The maximum number of properties that can be owned by an assessee under section 54F is limited to two, while there is no such ceiling on the aggregate number of properties that can be acquired and owned to claim exemption u/s 54.

Q 14. It is interesting to read the language used in the proviso with reference to the words for the same.  Relevant para is extracted.

Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.'

What is the meaning of the word FOR THE SAME?  

What is the meaning of the word OR. ?

Is it with reference to the option? or

is it with reference to the assessment year?

If it is with reference to the option, then there is no meaning attached, since it is this option and same option is referred to in the later part.

If the same is with reference to the option, the repositioned language of the amendment would read as follows:

Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same option or any other assessment year.  (same is replaced by option).

If he word same is with reference to the assessment year, the object of the entire amendment becomes null and redundant as the language repositioned below:

Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.'

If the language of the word same is with reference to option, the readjusted language of the amendment is as given below:

Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same option or any other assessment year.  (same is replaced by option).  If this were to be objective or intent, the meaning of the word OR is not correct.  It should have been IN or FOR meaning IN any other assessment year or FOR any other assessment year.

Q 15.  The provisions as contained in taxation of capital gains arising on transfer of new residential house (new asset) within a period of 3 years as per 54(1)(i) and 54(1)(ii) shall apply mutatis mutandis to the new two new residential house properties under the exemption proviso.  As per 54(1)(i) and 54(1)(ii) where the new capital asset so acquired out of the exempted capital gains, if sold or transferred, and for the purpose of computing the capital gains of the said new asset, the cost is considered as NIL.

Under the new exemption vide Proviso for 2 house properties as being amended, if he new house property(ies) are sold, for the purpose of computing the capital gains for new properties, there is no clarity how much of the capital gains is to be reduced from which asset.  This is explained in the following example:

Thus if the newly exempted properties are sold within 3 years, there is no clarity as to from which property thee exempted Capital Gain to be reduced to arrive at net cost.  Problems get compounded, if the sales take place over different years.