The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that exemption under Section 54 of the Income-tax Act, 1961, cannot be denied merely because a taxpayer invested in two adjoining residential flats intended to serve as a single residential house, under the provisions applicable to Assessment Year 2012–13.

The bench of Beena Pillai (Judicial Member) and Arun Khodpia (Accountant Member) directed the Assessing Officer to allow the claim relating to the aggregate investment of ₹3,35,36,982 in both flats, subject to verification of the actual investment, fulfilment of the other statutory conditions and computation of the eligible capital gains in accordance with law and directed the Assessing Officer to account for the accepted cost of the building while recomputing indexed acquisition cost. 

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The dispute concerned the computation of capital gains arising from the transfer of a property comprising land and a structure in Sindh Co-operative Housing Society at Aundh, Pune.

The taxpayer had originally filed her income tax return for Assessment Year 2012–13 on July 31, 2012, declaring total income of approximately ₹3.43 crore. The assessment was subsequently reopened through a notice under Section 148 dated March 22, 2019, following information concerning the property transaction and its historical valuation.

The taxpayer had invested ₹3,35,36,982 in two adjoining residential flats. Although the original return claimed Section 54 exemption of ₹1,76,21,954 in respect of one flat, the return filed in response to the reassessment notice claimed exemption for the investment in both flats.

She maintained that the flats had been acquired together and were intended to constitute a single residential accommodation.

The Assessing Officer restricted the exemption to ₹1,76,21,954, taking the view that Section 54 permitted relief for only one residential house. This excluded the investment of ₹1,59,15,028 attributable to the second flat from the exemption claim.

The Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, upheld the restriction.

The appellate authority observed that the taxpayer had not furnished sufficient documentary evidence establishing that the two flats constituted one residential unit. It referred to the absence of material such as a sanctioned combined layout, municipal assessment as a single unit, common utility connections, an architect’s certificate or photographs showing internal connectivity.

The taxpayer challenged that decision before the Tribunal.

The taxpayer submitted that she had previously lived in a bungalow with a built-up area of approximately 300 square metres on a plot measuring 877.93 square metres.

It was explained that she belonged to a joint family and needed larger residential accommodation. Following the transfer of the earlier property, she purchased two adjoining flats on the same date, with a combined area of approximately 530 square metres, intending to use them as one residential house.

Her representative further argued that the statutory language applicable to Assessment Year 2012–13 did not expressly restrict the investment to “one residential house in India”. The amendment introducing that wording took effect from April 1, 2015, and could not govern the assessment year in dispute.

The department supported the orders restricting the exemption to one flat.

The Tribunal accepted the taxpayer’s principal contention.

It observed that Section 54, as applicable to the relevant assessment year, did not contain the express restriction requiring investment in “one residential house in India”.

The Bench relied on the Karnataka High Court’s decision in CIT v. D. Ananda Basappa, reported in (2009) 309 ITR 329, and the Delhi High Court’s decision in CIT v. Geeta Duggal, reported in (2013) 357 ITR 153.

As explained in the order, these decisions recognised that the expression “a residential house” was not necessarily confined to one independent physical unit. The nature and use of the accommodation had to be examined in the circumstances of the case.

The Tribunal also held that the amendment introduced by the Finance (No. 2) Act, 2014, effective from April 1, 2015, did not apply to Assessment Year 2012–13.

The Tribunal noted that the Revenue had not disputed that the flats were adjoining.

The purchase of both flats on the same date, the taxpayer’s joint-family circumstances and the explanation that they were intended to provide one residential accommodation supported the claim.

The Bench held that the exemption could not be rejected merely because the investment involved two adjoining flats, without examining the nature of the accommodation acquired and the taxpayer’s intention to use it as one residential house.

It accordingly directed the Assessing Officer to allow the Section 54 deduction in respect of the investment in both flats, subject to the specified verification and statutory requirements.

The direction concerns the eligibility of the investment for exemption; the final allowable amount remains subject to the eligible capital gains and other conditions under the law.

The Tribunal separately considered the omission of the building’s indexed acquisition cost.

The taxpayer submitted that the Assessing Officer had accepted the historical valuation of both the land and the building as on April 1, 1981, but had included only the land component while computing indexed acquisition cost.

The Tribunal found that the transferred property comprised both the land and the structure. The existence of the building was not disputed, and the Revenue had not produced material showing that its accepted cost should be excluded.

Once the building’s cost had been accepted as part of the acquisition cost, leaving it out of the indexed computation without a stated basis resulted in an internally inconsistent calculation, the Bench held.

It further explained that separate valuation of the land and structure did not justify excluding the structure’s cost when both components formed part of the transferred property.

The Assessing Officer was directed to include the building’s cost as on April 1, 1981, to the extent accepted and legally allowable, and grant indexation under the applicable provisions. The officer must verify the arithmetic, prevent duplication and give the taxpayer an opportunity of being heard during this limited exercise.

The Tribunal also condoned the delay in filing the appeal.

The taxpayer, approximately 80 years old and residing with her husband, approximately 85, explained that age-related limitations and difficulty tracking electronic communications prevented her from becoming aware of the appellate order in time.

She stated that her chartered accountant discovered the order on the portal shortly before the appeal was filed, following which she promptly sought professional assistance.

The Tribunal found sufficient cause for condonation and no evidence of mala fide conduct. Relying on Collector, Land Acquisition v. Mst. Katiji & Others, reported in (1987) 167 ITR 471, it emphasised the need to advance substantial justice when considering such procedural delays.

An additional challenge to the validity of the Section 148 notice was dismissed as not pressed. The Tribunal therefore did not decide the legality of the reopening on that ground.

Allowing the appeal, the Bench directed the Assessing Officer to recompute capital gains after accounting for the allowable indexed acquisition cost of the land and building and the Section 54 deduction for the investment in both adjoining flats, subject to its directions.

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