ITAT allows LTCG exemption under section 54 for pre-sale construction payments to builder

ITAT Delhi allowed assessee's appeal regarding LTCG exemption u/s 54. Revenue denied exemption claiming construction completion and possession occurred before property sale date. ITAT followed coordinate bench precedent and Delhi HC ruling in Bharati Mishra case, holding section 54 doesn't require construction to begin after sale of old asset. Tribunal ruled expenditure to make flat habitable within three years from sale date, including pre-sale payments to builder, qualifies for section 54 benefit. AO directed to delete addition.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Appellate Tribunal (AT) in this appeal are:

• Whether the assessing officer's (AO) order passed beyond the statutory time limit under section 153(1) of the Income Tax Act, 1961 (the Act) is valid or barred by limitation (ground 1.1, though not pressed).
• Whether the AO erred in completing the assessment at an income of Rs. 1,90,91,566 as against the returned income of Rs. 41,88,818 (grounds 1 and 1.2, general in nature).
• Whether exemption under section 54 of the Act, claimed on long-term capital gains arising from sale of a residential house by investment in construction of a new residential flat, was rightly denied by the AO and Dispute Resolution Panel (DRP) (ground 2 and sub-grounds 2.1, 2.2, 2.3).
• Whether the AO erred in levying and computing interest under section 234D of the Act (ground 3, consequential in nature).

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Validity of assessment order and income determination (Grounds 1, 1.1, 1.2)

The appeal raised general objections to the assessment order dated 10.12.2024, including alleged limitation under section 153(1) and the quantum of income assessed. However, ground 1.1 (limitation) was not pressed by the assessee's counsel and was accordingly dismissed. Grounds 1 and 1.2 were general in nature and not specifically argued before the Tribunal. Hence, the Tribunal did not elaborate further on these points and proceeded to focus on the substantive issue relating to exemption under section 54.

Issue: Eligibility for exemption under section 54 of the Income Tax Act on long-term capital gains (Ground 2 and sub-grounds)

Relevant Legal Framework and Precedents:

Section 54 of the Income Tax Act provides exemption from long-term capital gains arising from the sale of a residential house if the gains are invested in the purchase or construction of another residential house within prescribed timelines - specifically, the new house must be purchased within two years or constructed within three years from the date of sale of the original asset.

The key condition under scrutiny is whether the construction of the new residential house was completed within three years from the date of sale of the old residential house.

Precedent relied upon by the assessee includes a coordinate bench decision of the ITAT, Delhi for the Assessment Year (AY) 2020-21, which was upheld by the Hon'ble Delhi High Court. The decision, citing the High Court's ruling in CIT vs. Bharati Mishra (2014) 265 CTR 374 (Del), held that section 54 does not mandate that the construction must commence only after the date of sale of the old asset. It further held that expenditure incurred to make the flat habitable within the three-year period, as well as payments made to the builder prior to the sale date, qualify for exemption under section 54.

Court's Interpretation and Reasoning:

The AO and DRP denied exemption on three grounds:

1. The date of purchase of the new property (18.02.2016) was outside the permissible period for purchase or construction under section 54.
2. The possession of the flat was handed over on 01.03.2021, which was before the date of sale of the original asset (05.07.2021), thus allegedly violating the three-year construction period condition.
3. The payment of Rs. 37,56,748 towards the cost of the flat was made prior to the sale of the original asset and hence was not eligible for exemption.

The Tribunal found that the AO/DRP erroneously treated the possession of a bare-shell flat handed over on 01.03.2021 as completion of construction. The facts revealed that the flat was not habitable at the time of possession and that the assessee incurred substantial expenditure (Rs. 1,11,46,000) subsequently to make the flat habitable. The final occupation and use certificate was obtained on 01.04.2022, which is within three years from the date of sale of the original asset.

Therefore, the Tribunal held the possession date of 01.03.2021 to be only of an incomplete bare flat and not the completion of construction as contemplated under section 54. The relevant date for completion was the date when the flat became habitable and possession was effectively received, i.e., 01.04.2022.

Regarding payments made prior to the sale of the original asset, the Tribunal relied on the coordinate bench decision and the High Court ruling to hold that such payments do not disqualify the exemption claim under section 54.

Key Evidence and Findings:

• Sale of original residential house on 05.07.2021.
• Possession of bare-shell flat from builder on 01.03.2021.
• Expenditure of Rs. 1,11,46,000 incurred to make flat habitable.
• Final occupation and use certificate obtained on 01.04.2022.
• Payments of Rs. 37,50,748 towards cost of flat made prior to sale of original asset.
• Previous ITAT order in assessee's own case for AY 2020-21 and its approval by the Delhi High Court.

Application of Law to Facts:

The Tribunal applied the legal principle that the construction of the new residential house under section 54 must be completed within three years from the date of sale of the original asset. It interpreted "construction" to mean completion of the house in a habitable condition and not mere possession of an unfinished or bare-shell flat. The expenditure incurred to render the flat habitable and the date of receipt of occupation certificate were taken as the relevant markers for completion of construction.

It further applied the precedent that payments made before the sale of the original asset do not disentitle the assessee from claiming exemption under section 54.

Treatment of Competing Arguments:

The AO/DRP's argument that possession of the flat before the sale date disqualified the claim was rejected as a misinterpretation of the statutory conditions. The Tribunal distinguished the bare possession from completion of construction and emphasized the importance of the flat being habitable within the three-year period.

The Tribunal also rejected the AO's view that pre-sale payments towards the flat cost were ineligible, relying on binding precedent to the contrary.

Conclusions:

The Tribunal concluded that the exemption under section 54 was rightly claimed by the assessee on the expenses incurred to make the flat habitable and the payments made towards the cost of the flat, despite possession of the bare flat being handed over before the sale of the original asset. The AO's disallowance was therefore set aside and the exemption was allowed.

Issue: Levy of interest under section 234D (Ground 3)

This ground was treated as consequential. Since the exemption under section 54 was allowed, the addition to income was deleted, which in turn affected the levy of interest under section 234D. The Tribunal did not elaborate separately but allowed the ground in consequence of the main relief granted.

3. SIGNIFICANT HOLDINGS

"We find from the facts of the case that the AO/DRP has mistakenly considered that the one residential House was constructed and possession given on 01.03.2021. The facts of the case shows that the assessee earned capital gains from sale of the old property on 05.07.2021 for which she is claiming deduction u/s 54 of the IT Act. The builder handed over the possession of bare flat to the assessee, which was not habitable, on 01.03.2021. The assessee had to further incur an amount of Rs. 1,11,46,000 to make the flat habitable and also to make a further payment of Rs. 37,50,748 towards the cost of the residential flat prior to the sale of old property. Upon such payments, the assessee received the possession of the completed habitable flat on 1.4.2022 which is within three years of sale of old property."

"In section 54 there is no stipulation that the construction must begin after the date of sale of old assets. The assessee can not be denied the benefit of deduction under section 54 on the ground that construction of house had commenced before the sale of old assets."

Core principles established include:

• Possession of a bare-shell flat prior to sale of original asset does not amount to completion of construction under section 54.
• Expenditure incurred to make the flat habitable within three years from date of sale qualifies for exemption under section 54.
• Payments made towards the cost of the new residential property prior to sale of the original asset are eligible for exemption under section 54.
• The statutory timeline under section 54 is to be interpreted with regard to completion of construction and habitability, not mere possession of unfinished property.

Final determinations:

• The AO's disallowance of exemption under section 54 was set aside.
• The exemption claimed on Rs. 1,49,02,748 (comprising cost and construction expenses) was allowed.
• The interest levied under section 234D was consequentially deleted.
• The appeal was partly allowed in favor of the assessee.

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