He plans to build 12 apartments of about 1,000 square feet each. He has already entered into an agreement with a builder-developer of the city, under which he will be compensated at the rate of Rs 500 per sq ft of the redeveloped area. He has already received Rs 20,00,000 as payment from the builder. This is to ensure that the builder completes the reconstruction of the building within the agreed time period of two years. The period is to be computed from the date the landlord hands over physical possession of the vacant premises to him. Meanwhile, we tenants have been contacted by the builder with the offer to rebuild our areas in the new building at the rate of Rs 400 per sq ft. He has also made an alternate offer under which should we choose to either surrender the entire area currently occupied by us or a part thereof, then he will pay us Rs 900 per sq ft for the surrendered area.

As the area currently occupied by me is 2,000 sq ft, I would like to understand the income tax implications in the event that I opt to exercise any of these options:

In lieu of the present tenancy, I receive the entire area of 2,000 sq ft on an ownership basis,

Accept the new apartment with an area of 1,400 sq ft and surrender the balance area,

Surrender the entire area under my occupation and collect cash compensation of Rs 18,00,000 in lieu of it.

Please also indicate the most effective manner in which I should invest my capital gain receipts to reduce my income tax liability.

-- Hiteshwar Desai, MUMBAI

In the scheme outlined by you, it would seem that you are contemplating conversion of your tenancy rights into an apartment that you have been offered on an ownership basis. Under the inheritance covenants prescribed under the Bombay Rent Control Act, the ownership of tenancy rights in Mumbai is deemed to be a capital asset. Therefore, your I-T authority would treat the benefit derived from surrender or conversion of such rights as a capital gain in your hands, provided you do not own another house in your own name (Section 54F of the Income-Tax Act).

Therefore, assuming that you satisfy this condition, the financial implications of the proposal you have outlined would be as follows:

In the first case, you will only have to pay the builder Rs 8,00,000 to provide you with an alternate apartment in the reconstructed building on an ownership basis. The income-tax officer may not levy any capital gains tax because even the notional gain that you will be making in kind will stand re-invested into the purchase of a residential apartment and that too within the time period prescribed under the Income-Tax Act and hence exempt from capital gains tax payment.

In the second case, you will receive Rs 5,40,000 as surrender consideration and pay the builder Rs 5,60,000 for providing you with a 1,400 sq ft apartment on ownership basis in lieu of your current 2,000 sq ft leaseheld apartment. In this case, the income tax officer is likely to consider the Rs 5,40,000 as a capital gain, but as you are using the amount to buy an apartment for Rs 5,60,000, no capital gains tax liability will devolve upon you. This is because here again, the entire component of capital gains earned by you is being invested in the purchase of a residential property and that too within the time limit prescribed under the Income Tax Act.

In the third case, the entire receipt of Rs 18,00,000 will be treated as capital gains unless, of course, you can establish to the satisfaction of the income tax officer that some amount was legally paid by you as a pugree.

If you can do this, the income tax officer will not only reduce your tax liability to the extent of the amount paid by you at the time when you initially leased your accommodation, but also permit you to avail of the benefit of indexation on the amount.

To avoid tax, you can either invest the entire sum received in a scheme falling under the purview of Section 54 EC of the Income-Tax Act for a period of three years or utilise it to buy another dwelling unit.