2025 (5) TMI 24 - AT - Income Tax

LTCG - claim of deduction u/s 54 - sale of an inherited property particularly considering the cost of acquisition and cost of improvement claimed by the assessee - CIT(A) disallowing the indexed cost of improvement claimed by the assessee - HELD THAT - The circumstantial evidence; such as the Wealth Tax Return of the assessee s mother for the AY 1992-93 and municipal tax etc. support the assessee s claim. Unless the old property was not demolished or remodified/reconstructed/refurbished the new property would have not come. Therefore the entire facts and circumstances of the case have to be taken into account. We are of the considered view that the part of demolition/recodification/reconstruction/ refurbishing cost would have been met out of the sale of old building material also. Whether netting of the same has been claimed by the assessee as cost of improvement. The indexed cost of land and building as disclosed by the assessee has to be allowed while computing the LTCG. Ordered accordingly. After giving a thoughtful consideration on merit of the case facts and circumstances of the case we are of the considered view that the 5% of cost of improvements would have been met out of sale of old building material. Therefore the claim of 5% of cost of improvements (other than the cost of acquisition as on 01.04.1981) required to be disallowed while computing the LTCG. Deduction of the mortgage charge - Here in the present case the business concern which kept the above referred property on mortgage is different person that the assessee. This issue of claim of deduction of mortgage charges as deduction while computing the LTCG is held squarely covered by the decision of Roshan babu Mohammed Hussein Merchant 2005 (1) TMI 53 - BOMBAY HIGH COURT Thus CIT(A) is justified in upholding the disallowance of claim of deduction of the mortgage charge. Appeal of the assessee is partly allowed

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this appeal are:

(a) Whether the assessee is entitled to exemption under section 54 of the Income Tax Act, 1961, in respect of the capital gains arising from the sale of an inherited property, particularly considering the cost of acquisition and cost of improvement claimed by the assessee;

(b) Whether the Assessing Officer (AO) and Commissioner of Income Tax (Appeals) [CIT(A)] erred in disallowing the indexed cost of improvement claimed by the assessee on the ground of lack of corroboratory evidence;

(c) Whether the expenses incurred by the assessee on commission (Rs. 2,50,000/-) should be allowed as deduction while computing capital gains;

(d) Whether the mortgage charges of Rs. 43,75,000/- paid by the assessee to release the property from mortgage should be allowed as cost of improvement or deduction while computing capital gains;

(e) The correctness of the indexed cost of improvement calculation, including the treatment of improvement costs incurred in earlier years (1982-83, 1989-90, and 1999-2000) and the valuation of the property;

(f) The correctness of the relief amount granted by the CIT(A) and whether it aligns with the orders passed;

(g) The general question of whether the expenditure incurred to release a mortgage created by a third party (different from the assessee) on the property can be allowed as deduction under the Income Tax Act.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) and (b): Entitlement to exemption under section 54 and allowance of cost of acquisition and improvement

Relevant legal framework and precedents: Section 54 of the Income Tax Act provides exemption from capital gains tax on sale of a long-term capital asset if the capital gains are invested in acquiring or constructing a residential house property. The cost of acquisition and cost of improvement are critical components in computing taxable capital gains under sections 48 and 55.

Court's interpretation and reasoning: The Court noted that the property sold by the assessee was different from the original inherited property, as the old property was demolished and reconstructed into a new residential building in 1999-2000. The AO disallowed the indexed cost of construction and improvement claimed by the assessee due to lack of corroboratory evidence. However, the assessee produced circumstantial evidence such as the Wealth Tax Return of the mother (late Smt. Murti Devi) and municipal tax records supporting the claim of improvements.

The Court acknowledged that the demolition and reconstruction costs would partly be offset by the sale of old building materials, and therefore allowed the indexed cost of land and building as disclosed by the assessee, but disallowed 5% of the cost of improvements as likely offset by sale proceeds of old materials.

Key evidence and findings: The valuation report, sale deed, Wealth Tax Returns, and municipal tax records were examined. The AO's observation that the property sold was not the same as inherited was accepted, but the Court found the assessee's evidence sufficient to allow most of the claimed cost of acquisition and improvement.

Application of law to facts: The Court applied the principles of cost of acquisition and improvement under sections 48 and 55, considering the reconstructed nature of the property and supporting evidence, to partially allow the claimed deductions.

Treatment of competing arguments: The AO's strict requirement of corroboratory evidence was relaxed in view of circumstantial evidence and the factual scenario of reconstruction. The Court balanced the interests by disallowing 5% of improvement cost to account for sale of old materials.

Conclusions: The Court held that the indexed cost of land and building as claimed by the assessee must be allowed, subject to disallowance of 5% of the improvement cost, while computing Long Term Capital Gains (LTCG).

Issue (c): Deduction of commission expenses of Rs. 2,50,000/-

Relevant legal framework: Commission expenses incurred in connection with sale of capital assets are generally allowable as deduction under section 48 for computing capital gains.

Court's reasoning: The grounds raised by the assessee included disallowance of commission expenses, but the judgment does not elaborate on this issue specifically, indicating that the CIT(A) and AO did not dispute or address this point in detail.

Conclusion: Since the issue was raised but not specifically dealt with by the authorities, and the Court does not overturn the CIT(A) order on this ground, it implies no relief was granted for this claim.

Issue (d) and (g): Deduction of mortgage charges paid to release the property from mortgage

Relevant legal framework and precedents: Section 48 of the Income Tax Act allows deduction of expenditure incurred wholly and exclusively in connection with the transfer of a capital asset. The Court relied heavily on the decision of the Hon'ble Bombay High Court in Roshanbabu Mohammed Hussein Merchant, which interprets the treatment of mortgage repayments in capital gains computation.

The Apex Court decisions cited include RM Arunachalam, V.S.M.R. Jagdishchandran, and CIT v. Attili N. Rao, which distinguish between mortgages created by the previous owner and those created by the assessee himself. The principle established is that repayment of mortgage debt created by the previous owner is allowable as cost of acquisition, but repayment of mortgage debt created by the assessee himself is not allowable as deduction under section 48.

Court's interpretation and reasoning: In the present case, the mortgage was created by a business concern different from the assessee. The AO disallowed the deduction of Rs. 43,75,000/- paid to release the mortgage, reasoning that it did not add to the value of the property. The Court followed the Bombay High Court's reasoning that where the mortgage is created by a person other than the assessee, and the mortgage is released by the assessee, such expenditure is not allowable as deduction under section 48.

The Court rejected the assessee's contention that the mortgage payment should be allowed as it was necessary to enable the sale, holding that capital gains tax must be computed on the full sale consideration regardless of the mortgage discharge.

Key evidence and findings: The mortgage was created by a third party (business concern other than the assessee). The payment to release the mortgage was made by the assessee during the sale proceedings. The sale deed indicated the property was mortgaged and subsequently released.

Application of law to facts: Applying the precedents, the Court held that the expenditure on mortgage repayment was not an allowable deduction since the mortgage was not created by the assessee and did not constitute cost of acquisition or improvement.

Treatment of competing arguments: The Court considered and rejected the assessee's reliance on earlier High Court decisions which were overruled or distinguished by subsequent Apex Court rulings. The Court found the more recent and authoritative decisions binding.

Conclusions: The Court upheld the disallowance of Rs. 43,75,000/- mortgage charges paid by the assessee as deduction while computing capital gains.

Issue (e): Correctness of indexed cost of improvement calculation and valuation of property

Relevant legal framework: Indexed cost of improvement is computed by applying the Cost Inflation Index (CII) as per section 48 and section 55 of the Income Tax Act.

Court's reasoning: The AO disallowed a significant portion of the improvement cost due to lack of corroboration. The CIT(A) allowed partial relief. The Court examined the evidence and held that the indexed cost of land and building should be allowed, but 5% of the improvement cost should be disallowed to account for sale of old building materials.

Key evidence and findings: The valuation report, sale deed, and other documentary evidence supported the assessee's claim of improvement costs in various years. The Court accepted the reconstruction and improvement history but adjusted the claimed amount to reflect realistic costs.

Application of law to facts: The Court applied the indexing methodology and allowed the cost of improvements except for a nominal portion disallowed.

Conclusions: The Court corrected the indexed cost of improvement to Rs. 99,42,844/- instead of Rs. 85,61,215/- as taken by CIT(A), but disallowed 5% of the improvement cost to reflect netting of sale proceeds of old materials.

Issue (f): Correctness of relief amount granted by CIT(A)

Court's reasoning: The assessee contended that the relief granted by CIT(A) was factually incorrect and did not accord with the substance of the order. The Court noted discrepancies in relief amounts mentioned by the AO and CIT(A) but did not find grounds to disturb the CIT(A)'s order except to clarify the correct indexed cost of improvement and disallow 5% of improvement cost.

Conclusions: The Court partly allowed the appeal and modified the relief accordingly.

3. SIGNIFICANT HOLDINGS

(i) On the issue of cost of acquisition and improvement, the Court held:

"Keeping in view the above, it is held that the indexed cost of land and building as disclosed by the assessee has to be allowed while computing the LTCG. Ordered accordingly. Further, after giving a thoughtful consideration on merit of the case, facts and circumstances of the case, we are of the considered view that the 5% of cost of improvements would have been met out of sale of old building material. Therefore, the claim of 5% of cost of improvements (other than the cost of acquisition as on 01.04.1981) required to be disallowed while computing the LTCG."

(ii) On the issue of mortgage charges, the Court relying on the Hon'ble Bombay High Court's decision in Roshanbabu Mohammed Hussein Merchant held:

"There is a distinction between the obligation to discharge the mortgage debt created by the previous owner and the obligation to discharge the mortgage debt created by the assessee himself. Where the property acquired by the assessee is subject to the mortgage created by the previous owner, the assessee acquires absolute interest in that property only after the interest created in the property in favour of the mortgage is transferred to the assessee, that is after the discharge of mortgage debt. In such a case, the expenditure incurred by the assessee to discharge the mortgage debt created by the previous owner to acquire absolute interest in the property is treated as 'cost of acquisition' and is deductible from the full value of consideration received by the assessee on transfer of that property. However, where the assessee acquires a property which is unencumbered, then, the assessee gets absolute interest in that property on acquisition. When the assessee transfers that property, the assessee is liable for capital gains tax on the full value (less admitted deductions) realised, even if an encumbrance is created by the assessee himself on that property and the assessee is under an obligation to remove that encumbrance for effectively transferring the property. In other words, the expenditure incurred by the assessee to remove the encumbrance created by the assessee himself on the property which was acquired by the assessee without any encumbrance is not an allowable deduction under Section 48 of the Income Tax Act."

"The contention that the assessee has not received a pie from the transfer and the entire sale proceeds realised on transfer of the mortgaged asset has been appropriated towards discharge of mortgage is also without any merit."

(iii) The Court upheld the disallowance of mortgage charges paid by the assessee amounting to Rs. 43,75,000/-.

(iv) The Court partly allowed the appeal, allowing indexed cost of acquisition and improvement (subject to 5% disallowance of improvement cost) and disallowing mortgage charges as deduction.