Under section 54 of the Act, an individual or a Hindu Undivided Family is allowed to reinvest long term capital gains arising from the sale of residential house ("the original asset") for purchase or construction of another residential house("the new asset"). The purchase of the new asset could be one year before or two years after the sale of the original asset and the construction could be within three years of sale of the original asset. The capital gain is required to be reinvested. If only a part of the capital gain is reinvested, only pro-rata exemption is made available.
With effect from 1.4.1988 there is a requirement that, if the capital gain or any part thereof has not been used for purchase or construction of a new house before the due date for furnishing the return of income under section 139, it is required to be deposited in a special deposit account under the Capital Gains Account Scheme ("CGAS").
These provisions were being interpreted in the Gujarat case, supra, except that the requirement of deposit under the CGAS was not existing at that time.
The facts are that the original residential house property of the assessee was sold by him on March, 16, 1979, for Rs.71,000 and he had earned long-term capital gain of Rs.19,018 thereon. He had then purchased a house on March 23, 1979 for Rs.45,000 and had claimed that the capital gain of Rs.19,018 was not taxable in the AY 1980-81 . He had filed a copy of the sale deed of the original asset as well as the purchase deed of the new property. The Income-tax Officer accepted the claim and the capital gain of Rs.19,018 was treated as exempt from tax in the AY 1980-81.
The assessee spent Rs.9,650 on the house purchased on March 23, 1979, and sold it on May 14, 1980, for Rs.55,000 showing a short-term capital gain of Rs.350/- in his return for the assessment year 1981-82. The assessee had in the meantime completed construction of another property on May 25,1980 which he was occupying after having sold on May 14,1980 the property which was purchased by him on March 29, 1979.
The dispute centred around whether a property which has been purchased initially for a temporary period need not be the basis for the claim of the exemption and this property therefore could be sold without losing the benefit of the exemption as a result of another house having been constructed.
The Appellate Commissioner held in favour of the assessee, but the Tribunal favoured the Departmental stand. The High Court after tracing the provisions of the Act including the old provisions under the section 12B(4)(b) of the 1922 Act,stated that unlike under the 1922 Act there was no requirement under the 1961 Act that the assessee had to elect in writing before the assessment was made about the claim of the exemption and in respect of which property.
Such was not the case under the 1961 Act. The Court pointed out that under section 54(1) capital gains is not to be charged to tax to the extent it has been utilised for the purchase or construction of the new asset within the period stipulated.
The words "then, instead of the capital gain being charged to income-tax as income of the previous year in which transfer took place, it shall be dealt with as provided in clauses (i) and (ii)", would mean that even if the capital gain arises in the previous year in which transfer of original asset took place it will not be deemed to be income of previous year in which transfer took place.
They held that the provisions of section 54(1) would prevail over the deeming fiction of section 45 of the Act which treats capital gain as the deemed income of the previous year.
They further stated that under section 54(1) the assessee has an option to purchase house property within one year of the transfer of his residential property or to construct his own residential property within two years of such transfer. The ascertainment of the difference between the cost of the house property so purchased within one year or constructed within two years of the transfer of the original asset and the amount of capital gain arising from the original asset can take place only when the new asset is purchased or constructed,as the case may be.
The Court said that it, therefore, followed that the assessee cannot be subjected to pay income-tax on his capital gain which is not to be treated as his deemed income of the previous year in which the transfer took place until the expiry of the outer limit of one and two years in case of purchase and construction, respectively, at the end of which alone, it could be possible to compute the difference between the amount of capital gain and the cost of the new asset, and it is, at that stage, that the question of charging such difference under section 45 as income of the previous year can arise.
The AO, unless the transfer or purchase or construction of the new asset has already taken place in the previous year, must wait till such purchase or construction takes place within the stipulated outer time limit when he can work out the difference under the special provisions of section 54(1).
The Court also relied on Circular No.495 reported at 168 ITR (St.) 87, dated September 22, 1987 where, while elaborating the provisions for the new scheme for deposits under the CGAS in respect of exemptions from capital gain the CBDT observed that capital gains arising from the transfer of the original asset, inter alia, under provisions of section 54, exempt from Income-tax if such gains are reinvested in new assets within the time allowed for the purpose.
In my own view the new provisions requiring deposit under the CGAS on or before the due date of the filing of the return are merely directory as sub-section (2) which requires the deposit to be made under the CGAS does not anywhere state that if the deposit is not made, the benefit of the provisions of section 54(1), which allows the exemption, would not be available if the provisions of deposit under the CGAS are not met.
Secondly, it is now clear by this decision that there is no requirement that the actual amount of the gain itself should be reinvested in another residential house. In other words, the source for investment could also be something other than the capital gain itself, such as, a borrowing or an encashment of other investments.
Thirdly, capital gains arising on the sale of the original asset can be used for purchase of a temporary residence till the permanent residence is ready within the stipulated period.