Compensation for relinquishing settled possession and beneficial interest in property constitutes long-term capital gains under Sections 2(14) and 2(47)

ITAT Chandigarh held that compensation received by assessee for relinquishing settled possession and beneficial interest in property constitutes long-term capital gains, not income from other sources. The tribunal ruled that possessory and beneficial rights over prolonged period qualify as capital asset under Section 2(14), and relinquishment constitutes transfer under Section 2(47). AO's treatment as gift under Section 56(2) was incorrect as receipt was not gratuitous but consideration for relinquishing acknowledged rights. Assessee entitled to deductions under Sections 54 and 54EC. Appeal allowed, capital gains declared in return accepted.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal were:

• Whether the initiation of reassessment proceedings under Section 148 was valid, given the absence of escapement of income and reason to believe.
• Whether the Assessing Officer (AO) was justified in treating the amount received by the assessee as "income from other sources" under Section 56(2), rather than as long-term capital gains, given the assessee's lack of legal title but possession and beneficial interest in the property.
• Whether the extinguishment of possessory and beneficial rights in the property constituted a "transfer" of a capital asset under Sections 2(14) and 2(47) of the Income Tax Act, 1961.
• Whether the assessee was entitled to claim deductions under Sections 54 and 54EC for reinvestment of capital gains.
• Whether the assessee's failure to produce documentary evidence of possession justified denial of capital gains treatment.
• Whether payments made in the context of a family settlement for relinquishment of rights could be treated as capital receipts or gifts exempt from tax.

2. ISSUE-WISE DETAILED ANALYSIS

Validity of Reassessment Proceedings under Section 148

The assessee challenged the reopening of assessment on grounds that there was no escapement of income or reason to believe such escapement existed. The Tribunal noted that this issue was raised but did not form the primary basis for the decision. The order of the National Faceless Appeal Centre (NFAC) was challenged, but the Tribunal focused on substantive taxability of the receipt rather than procedural validity. The grounds relating to reopening were not upheld as the Tribunal did not find the reassessment to be illegal or arbitrary on the facts presented.

Treatment of Amount Received as Capital Gains vs. Income from Other Sources

The AO treated Rs. 1.75 crore received by the assessee as income from other sources under Section 56(2), reasoning that the assessee lacked legal ownership of the property and thus the amount could not be consideration for transfer of a capital asset. The CIT(A) upheld this view, citing absence of conclusive documentary evidence of possession or ownership and the unregistered nature of the agreement.

The Tribunal, however, examined the legal framework defining "capital asset" under Section 2(14) and "transfer" under Section 2(47), which include beneficial and possessory rights. It relied on judicial precedents recognizing that possession and beneficial interest, even without registered ownership, can constitute capital assets. Notably, the decisions in CIT v. Neba Ram Hansraj and ACIT v. G.C. Shah & Co. were cited to support that surrender or relinquishment of tenancy or possessory rights amounts to transfer of capital asset.

The Tribunal found the assessee had been in settled possession since the 1960s, had asserted rights through civil litigation, and received compensation as part of a family settlement for relinquishing these rights. The fact that the amount was received in consideration of extinguishing possessory and beneficial rights brought the transaction within the ambit of capital gains.

The Tribunal also noted that the Revenue had accepted capital gains treatment for the assessee's sister, who received Rs. 25 lakhs under identical circumstances and claimed deductions under Section 54. This inconsistency undermined the Revenue's stance.

The Tribunal further relied on the decision in Smt. Delilah Raj Mansukhani, which held that compensation received for displacement or relinquishment of rights in redevelopment scenarios is a capital receipt and not taxable as revenue income. The judgment emphasized that hardship allowance or rehabilitation compensation is not liable to tax and is not to be treated as income from other sources.

The Tribunal concluded that the receipt of Rs. 1.75 crore was rightly treated as long-term capital gains and not income from other sources.

Claim of Deductions under Sections 54 and 54EC

The assessee claimed deductions under Section 54 for reinvestment in residential property and under Section 54EC through investment in NHAI bonds. The AO and CIT(A) denied these deductions on the premise that the receipt was not capital gains.

Since the Tribunal held that the amount received was capital gains, it also held that the deductions claimed under Sections 54 and 54EC were rightly claimed and supported by investment documents. The denial of deductions was therefore arbitrary and unjustified.

Possession and Documentary Evidence

The Revenue argued that the assessee failed to produce conclusive documentary evidence of possession or ownership, relying on the unregistered nature of the agreement. The Tribunal noted that the assessee's continuous occupation since the 1960s, reflected in income tax returns filed from the same address, and assertion of rights through litigation, constituted sufficient evidence of possessory and beneficial interest.

The Tribunal emphasized settled law recognizing possession and beneficial interest as capital assets, thus rejecting the contention that absence of registered title precluded capital gains treatment.

Nature of Payment: Capital Receipt or Gift

The Tribunal considered the transaction from an alternative perspective. The registered owners (legal heirs of the deceased brother) received sale consideration for the property, but part of this consideration was paid directly to the assessee and her sister, who were in possession and litigating their rights.

The Tribunal reasoned that such payments could be viewed as either an application of income by the registered owners in favor of the possessors to perfect title and possession or as payments made by the purchaser to obtain vacant possession and clear title.

In either scenario, the payments did not constitute taxable income in the hands of the assessee. If treated as a gratuitous transfer between close relatives (sisters-in-law), the amount would be exempt under the provisions of the Income Tax Act, as transfers between specified relatives are not chargeable under Section 56(2)(x).

Thus, the Tribunal held that even if the amount was not a capital gain, it was not taxable income but a capital receipt or exempt gift.

Voluntary Declaration of Income

The assessee had declared the entire amount as long-term capital gains in the income tax return. The Tribunal held that this voluntary and consistent declaration could not be dislodged by the Revenue. The assessee could not withdraw the admitted income, reinforcing the correctness of capital gains treatment.

3. SIGNIFICANT HOLDINGS

"The possession and beneficial interest held by the assessee over a prolonged period, her assertion of rights through legal proceedings, and the receipt of consideration under a family settlement fall within the definition of 'capital asset' under Section 2(14), and the act of relinquishment is a 'transfer' under Section 2(47). The compensation received therefrom is liable to be assessed under the head 'Capital Gains' and not 'Income from Other Sources'."

"Compensation received by the assessee towards displacement in terms of Development Agreement is not a revenue receipt and constitute capital receipt as the property has gone into re-development. The said payment is in the nature of hardship allowance / rehabilitation allowance and is not liable to tax."

"Where one close relative transfers an amount to another without consideration, such a transfer assumes the character of a gift. Consequently, the provisions of section 56(2)(x) of the Income Tax Act, 1961, would not be attracted in such circumstances."

"The reassessment and addition made by the AO are not sustainable in law."

"The assessee is entitled to the relief claimed. The AO and CIT(A) erred in treating the receipt as income from other sources in the absence of legal title, disregarding settled law that ownership for tax purposes includes possessory and beneficial rights."

"The appeal of the assessee is allowed, and the capital gains declared in the return are directed to be accepted."

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