Redevelopment Woes

Source: The Hitavada      Date: 12 Nov 2018 15:20:33



These days many builders offer to buy a flat of the existing owner in exchange for one larger flat after completion of the redevelopment of the building. In addition some money is also paid as additional compensation to enable the owner shift to a new place and pay rent thereon until the new flat is ready for occupation and also for the inconveniences caused.

This is a win-win situation for both the builder and the flat owner. The builder can use the FSI and sell the new flats at a good (often stiff) price. On the other hand, the tenant or the owner of the old flat gets brand new more spacious ownership flat having a higher fair market value.

Obviously, the original owner will earn Long-term Capital Gains (LTCG) on the sale or transfer of his original property to the builder. This becomes exempt since he is reinvesting the capital gains in the new flat. This amount of reinvestment can be arrived at by ascertaining the price at which the builder sells other flats in the same building. Surely, this would be far in excess of the LTCG on the original housing property plus the cash, received. Incidentally, the reimbursement of rent paid by the builder to the tenant or the owner until the redeveloped flat is transferred by the builder to him is tax neutral and any extra sum paid for the inconveniences caused or mental agony is a capital receipt and therefore not taxable.

Provisions of Sec 54 (house to house) are attracted where the person owns the old flat. On the other hand, in the case of a tenant, Sec. 54F is applicable (tenancy rights to house). The cost of acquisition is required to be taken as nil. Moreover, the person should not be an owner of more than one residential house other than the rental premises on the date when the property is handed over to the builder. The fact that the builder is interested only in the land and is going to demolish the superstructure is immaterial and inconsequential.

Now, under this background, let us examine an interesting real life case of one Mr Mehta (name changed) whose building also similarly underwent redevelopment. Mehta was residing as a tenant in an old dilapidated flat. A builder entered into a contract with him to redevelop it. Mehta agreed and the builder finished the job within the specified period and handed over the redeveloped flat to Mehta. After 3 years, Mehta sold this redeveloped flat and purchased a new smaller flat.

There is no dispute over the fact that there is no tax liability arising out of the surrender of the dilapidated flat to the builder since the entire amount of the long-term capital gain (computed after taking the cost of acquisition of the tenancy flat as nil), has been invested in the redeveloped flat. Therefore, this gain is exempt u/s 54F. Mehta has also earned long-term capital gain by selling the redeveloped flat after the lock-in period of 3 years. This second transaction is covered by Sec. 54.

The CA of Mehta is of the opinion that the cost of acquisition of the redeveloped flat for the purpose of computing long-term capital gain, even on this second transaction should be taken as nil, since he has not paid any money to acquire it.

We do not agree with this opinion for the following reasons -
1. As per Sec 54F(3), if the new house is sold before 3 years from the date of its acquisition, the amount of capital gain arising from the transfer of the original asset not charged u/s 45 shall be deemed to be income chargeable as long-term capital gains of the previous year in which such new asset is transferred. Since the original asset was a rental flat, its cost has to be taken as nil by the fiction created by Sec. 55(2). This comes into picture in two situations -
(i) when an asset other than a residential property gets sold or transferred, and
(ii) where a residential property is purchased or constructed within specified periods resulting in a part or the entire long-term capital gain becoming exempt and this residential property is sold or transferred within 3 years from the date of its purchase. Mehta has sold the redeveloped flat after 3 years.

2. The second transaction is covered by Sec 54. The fiction created by Sec. 55(2) cannot travel to Sec 54. Both these sections are independent of each other. Sec 54 has also an embargo on sale of the new flat within 3 years. If an assessee does so, he will be required to reduce the cost of acquisition of the flat by the amount of capital gain claimed as exempt earlier.

3. It is not true that Mehta has not paid anything for acquisition of the redeveloped flat. He has surrendered his tenancy rights which certainly has a value attached to it. Mehta can take the cost of its acquisition as the value on which stamp duty has been paid. If the stamp duty is not ascertainable, he can take recourse to Sec. 50D and get the new flat assessed for its value on the date of its possession from a Chartered Valuer.

4. Finally, and most importantly, notwithstanding all observed above, note that -
Supreme Court had held in the case of B C Srinivasa Shetty, 128 ITR 294 that no capital gain arises on transfer of capital assets in respect of which there is no cost of acquisition.

This decision is being negated steadily u/s 55 by ordaining that capital gains shall be computed and charged to tax by taking the cost of acquisition as nil in the following cases -

(a) Goodwill of a business (not of a profession).
(b) Trademark or brand name associated with the business.
(c) Patent, copyright, formula, design, etc.
(d) Right to carry on any business.
(e) Route permits.
(f) Loom hours. And finally,
(g) Tenancy rights.

This implies that where the cost of acquisition of an asset is nil, no capital gain arises on transfer of capital assets, unless the asset belongs to the categories as stated above.
The redeveloped flat is not covered by any of the items listed above, including the item ‘g’. Consequently it can be opined that Mehta is not liable to pay any tax either on the first transaction or on the second.

(The authors may be contacted at [email protected])