Construction payments before asset transfer don't disqualify Section 54F exemption, COVID-19 delays considered valid

ITAT Chennai allowed assessee's appeal regarding deduction under Section 54F. The tribunal held that commencement of construction payments before transfer of original asset does not disqualify the exemption, reversing AO's disallowance. Despite construction completion beyond the statutory three-year period due to COVID-19 disruptions, the tribunal granted relief considering the pandemic's impact on construction activities. The assessee had made substantial payments totaling Rs. 4.52 crores by February 2020, with building completion delayed until January 2024. ITAT directed AO to allow the deduction, acknowledging COVID-19 as valid reason for delay and ordered verification of architect expenses of Rs. 16,10,800 upon production of evidence.

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The core legal questions considered in this judgment are:

1. Whether the Revenue's appeal is maintainable in view of the tax effect threshold prescribed by CBDT Circular No. 9/2024.

2. Whether the assessee is eligible to claim exemption under section 54F of the Income Tax Act, 1961, for the amount spent on construction of a new residential house commenced before the date of transfer of the original asset that gave rise to capital gains.

3. Whether the direction of the Commissioner of Income Tax (Appeals) to the Assessing Officer (AO) to verify completion of the new residential house within three years of the transfer is justified.

4. Whether the disallowance of a portion of architect fees claimed by the assessee is justified.

Issue 1: Maintainability of Revenue Appeal under CBDT Circular No. 9/2024

The CBDT Circular No. 9/2024 dated 17.09.2024 prescribes a threshold tax effect of Rs. 60 lakhs for filing appeals before the Tribunal by the Revenue. The Revenue's appeal in this case involved a tax effect of Rs. 55,98,635, which is below the threshold. The Court examined the Form 36 submitted by the Revenue and found the tax effect to be less than the prescribed limit. Consequently, the appeal was held to be non-maintainable and dismissed. This reflects the Court's strict adherence to procedural mandates and circular instructions issued by the CBDT, reinforcing that appeals below the threshold tax effect are not to be entertained by the Tribunal.

Issue 2: Eligibility for Exemption under Section 54F for Construction Commenced Prior to Transfer

The assessee declared long-term capital gains (LTCG) of Rs. 4,45,32,798 and claimed exemption of Rs. 3,93,40,633 under section 54F of the Income Tax Act for reinvestment in construction of a new residential house. The AO disallowed Rs. 2,63,82,379 of the claimed exemption on the ground that the assessee had commenced construction and made payments towards the new house before the date of transfer of the original asset (shares sold on 02.04.2019). The AO's position was that the exemption under section 54F requires construction to commence only after the transfer, and payments made prior to transfer were not eligible.

The Commissioner of Income Tax (Appeals) reversed this disallowance, relying heavily on judicial precedents, particularly the jurisdictional Madras High Court decision in C. Aryama Sundaram v. CIT. The Court noted that section 54F requires the new residential house to be constructed within three years of the transfer, but does not explicitly prohibit commencement of construction before the transfer date. The Madras High Court, along with other High Courts (Delhi, Karnataka, Kerala), had interpreted the provision to mean that as long as the construction is completed within the stipulated period, the timing of commencement is immaterial.

The Court emphasized the principle that the exemption's core condition is completion within the prescribed period, not the start date. The Court also referenced the Supreme Court's extension of limitation periods during the Covid-19 pandemic, recognizing delays in construction caused by extraordinary circumstances as justifiable. Therefore, the Court upheld the CIT(A)'s decision allowing exemption for payments made before the date of transfer.

Issue 3: Direction to AO to Verify Completion of Construction within Three Years

Although the CIT(A) allowed the exemption for payments made before the transfer date, he directed the AO to verify whether the new residential house was completed within three years of the transfer. The assessee challenged this direction, contending that the AO had not disputed completion within the time frame and that the direction was unnecessary and caused practical difficulties, as the AO refused to verify the matter citing lack of jurisdiction post-assessment.

The Court examined the evidence submitted by the assessee, including payment records totaling over Rs. 4.52 crores made to the builder before 25.02.2020, well within the three-year period from the transfer date (02.04.2019). The Court took judicial notice of the Covid-19 pandemic's impact on construction activities, noting labor shortages and lockdowns that delayed completion beyond the three-year limit.

Supporting documents included a building tax notice dated 18.03.2022 indicating the building's completion and an architect's completion certificate dated 28.11.2023, with the builder handing over possession on 08.01.2024. The Court found that the delay was caused by pandemic-related disruptions, for which the assessee could not be faulted. Relying on the Supreme Court's extension of limitation periods during Covid-19, the Court held that the assessee substantially complied with section 54F requirements and should not be denied exemption due to pandemic-related delays.

Thus, the Court concluded that the AO's verification direction was unnecessary and that the exemption should be allowed accordingly.

Issue 4: Disallowance of Architect Fees

The AO disallowed Rs. 16,10,800 of architect fees claimed by the assessee, as the assessee submitted proof of payment for only Rs. 17,70,000 against a claimed amount of Rs. 33,80,800. The Court observed that if the assessee is able to produce evidence of the remaining payments before the Joint Assessing Officer (JAO), the disallowance may be reconsidered and the amount allowed. This indicates the Court's approach of allowing genuine claims subject to documentary proof.

Significant Holdings and Core Principles

1. The Revenue's appeal is non-maintainable if the tax effect is below the threshold prescribed by CBDT Circular No. 9/2024, as the Court dismissed the appeal on this ground.

2. The Court held: "It is not prerequisite of section 54 construction could not have commenced prior to the date of the transfer of the asset resulting in capital gain." The timing of commencement of construction before the transfer date does not disqualify the exemption under section 54F, provided the construction is completed within the stipulated period.

3. The Court recognized the impact of the Covid-19 pandemic on construction timelines and held that delays caused by such extraordinary events should not prejudice the assessee's claim for exemption, relying on the Supreme Court's extension of limitation periods during the pandemic.

4. The Court emphasized that substantial compliance with the reinvestment conditions of section 54F is sufficient to claim exemption, and technical delays due to unforeseen circumstances should be excused.

5. The Court directed that disallowances based on lack of documentary evidence should be reconsidered if the assessee produces adequate proof.

In conclusion, the Court dismissed the Revenue's appeal as non-maintainable and allowed the assessee's Cross-Objection, holding that the assessee is entitled to exemption under section 54F for the amount spent on construction commenced before the transfer date, subject to completion within the prescribed period, and recognizing pandemic-related delays as excusable. The Court also allowed the assessee an opportunity to substantiate the architect fees claimed.

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