Tenancy rights as capital asset affect composite estate capital gains when merged ownership and tenancy are sold together.

Tenancy rights constitute property and therefore a capital asset under section 2(14) of the Income-tax Act, 1961. Where a tenant later acquires the landlord's remaining rights and the smaller and larger estates merge into a composite estate that is then sold as a single asset, the sale consideration cannot be legally split between the two components. The capital gains computation must instead proceed on the basis of the main estate, with the tenancy right recognised in the cost of acquisition or related computation. In this matter, the taxable surplus was required to be recomputed by taking the value of the tenancy right into account, and the assessment was sent back for fresh computation.

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Issues: Whether the assessee's tenancy right was a capital asset and, on sale of the flat after merger of tenancy and ownership rights, the correct method of computing capital gains required treating the tenancy right as part of the cost of the composite estate and recomputing the short-term capital gain.

Analysis: The right of occupation as a tenant was held to be property and therefore a capital asset within the meaning of section 2(14) of the Income-tax Act, 1961. After the assessee purchased the landlord's remaining rights, the smaller estate and the bigger estate merged, producing a composite or full estate that was sold as such. The sale consideration of that composite estate could not be legally apportioned between the separate components. The proper approach was to treat either the smaller estate or the bigger estate as the main estate and to compute the surplus on that basis. Since the revenue had proceeded on the footing that the bigger estate was the main estate, fairness required that the value of the tenancy right as on the date of acquisition of the bigger estate be taken into account while recomputing the short-term capital gain.

Conclusion: The assessee succeeded to the extent that the tenancy right had to be recognised in the computation, and the assessment was set aside for fresh recomputation of the taxable surplus.

Final Conclusion: The appeal was allowed in a limited sense, with the matter sent back for fresh computation of capital gains after giving effect to the value of the tenancy right.

Ratio Decidendi: Where a tenancy right and the remaining ownership rights merge into a composite estate that is later sold as a single asset, the tenancy right remains relevant in determining the cost of acquisition and the capital gains computation, even though the sale consideration of the composite estate is not separately apportionable in law.

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