Interest on borrowed funds for property purchase allowed as acquisition cost for LTCG computation with indexation benefits

The ITAT Mumbai held that interest paid on borrowed funds for property purchase constitutes cost of acquisition/improvement for LTCG computation, with indexation benefits applicable. The tribunal followed the consistency rule, noting revenue authorities previously allowed similar deductions without double deduction. The court emphasized that prior to Finance Act 2023 amendments (effective 01.04.2024), no statutory restriction existed excluding interest deductions under section 24(b) from acquisition costs. Following jurisdictional precedents and applying the principle that favorable taxpayer construction should be adopted when two reasonable interpretations exist, the tribunal allowed the assessee's claim for interest deduction in capital gains computation.

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Issues Involved:

1. Whether the interest paid on borrowed funds for the purchase of property can be considered as a cost of acquisition/improvement for the purpose of calculating Long Term Capital Gains (LTCG).
2. Whether the benefit of indexation is to be allowed to the interest cost.
3. The possibility of a double deduction of interest under different sections of the Income Tax Act.

Detailed Analysis:

Issue 1: Interest as Cost of Acquisition/Improvement

The primary issue was whether the interest paid on borrowed funds used to acquire property can be considered as part of the cost of acquisition or improvement for the purpose of computing LTCG. The Assessing Officer (AO) disallowed the interest amount of Rs. 3,95,42,739/- claimed by the Assessee on the grounds that interest on housing loans does not constitute capital expenditure incurred in making any additions or alterations to the capital asset after it became the Assessee's property, as per Section 55 of the Income Tax Act. The AO relied on previous judgments, such as V. Mahesh and Harish Krishnakant Bhatt, to support this view.

Contrarily, the Ld. Commissioner allowed the Assessee's claim by considering various judgments that supported the inclusion of interest as part of the cost of acquisition. The Commissioner cited cases like CIT v. K. Raja Gopala Rao and CIT v. Sri Hariram Hotels, which recognized interest on borrowed funds for property acquisition as part of the acquisition cost. The Commissioner emphasized the absence of a specific prohibition in the law against such a deduction prior to the amendment by the Finance Act, 2023.

Issue 2: Indexation of Interest Cost

The AO questioned whether the benefit of indexation should be allowed on the interest cost. The Assessee claimed that the interest paid should be indexed as part of the cost of acquisition/improvement. The Ld. Commissioner, however, allowed this claim, noting that the explicit provisions of Section 48, which govern the computation of capital gains, did not exclude such interest from being considered as a cost of acquisition before the amendment effective from April 1, 2024.

Issue 3: Double Deduction of Interest

The Revenue Department argued that the Assessee claimed a double deduction of interest, once under Section 24(b) as a deduction from income from house property, and again as part of the cost of acquisition/improvement while computing capital gains. The Assessee countered this by stating that the deduction under Section 24(b) was limited to Rs. 1,50,000/- and the remaining interest was claimed as a cost of acquisition/improvement. The Ld. Commissioner supported the Assessee's position, citing the rule of consistency, as similar deductions had been allowed in previous years.

The Tribunal upheld the Ld. Commissioner's decision, affirming that before the amendment by the Finance Act, 2023, there was no restriction on claiming interest as part of the acquisition cost for capital gains computation. The Tribunal cited the principle from CIT vs. Vegetable Products Ltd., favoring a taxpayer-friendly interpretation when multiple reasonable interpretations exist.

In conclusion, the Tribunal dismissed the Revenue Department's appeal, affirming that the interest paid on borrowed funds for property acquisition, over and above the amount claimed under Section 24(b), was deductible while computing capital gains for the period before the 2023 amendment. The appeal was dismissed, and the Assessee's claim was upheld.

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