Sale of developer-allotted flat before completion: gains treated as LTCG; Section 54(2) relief and lease costs allowed

Where a flat forming part of the assessee's allocation under a development arrangement was sold before completion, the ITAT held that the assessee never acquired possession or "held" that flat; the buyer obtained possession during construction under an agreement for sale and later conveyance, and the assessee only transferred the undivided share in land attributable to that flat. Consequently, the gain was assessable as LTCG and not STCG, and the AO was directed to recompute accordingly. Expenditure incurred to fulfill an existing lease obligation to deliver a specified completed area to the original lessor was held deductible in computing capital gains, and the addition was deleted. Section 54(2) exemption was allowed since the funds, though not parked in CGDS, were actually utilized for construction within time.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether capital gains arising from the transfer connected with the first-floor unit (agreed to be sold prior to completion and possession) were liable to be assessed as short-term capital gains by treating the unit as a "new asset" held and transferred within three years, or as long-term capital gains on transfer of a capital asset/right arising under the development arrangement.

(ii) Whether the amount paid towards construction of the area required to be provided to the original lessor under the lease obligation was deductible in computing capital gains as an allowable expenditure connected with the transfer.

(iii) Whether exemption under section 54(2) could be allowed where unutilized capital gains were placed in term deposits with a nationalized bank (not expressly under the Capital Gain Deposit Scheme), but were subsequently utilized for construction/finishing/extension of the residential house within the stipulated time, with the utilization and purpose not being disputed.

2. ISSUE-WISE DETAILED ANALYSIS

(i) Characterisation of gains on transfer relating to the first-floor unit: short-term vs long-term; treatment as "new asset"

Legal framework: The Court examined the application of section 54(1)(ii) in the context of treating a unit as a "new asset" and taxing gains as short-term when the "new asset" is transferred within three years of its purchase/construction, as applied by the revenue authorities.

Interpretation and reasoning: The Court focused on the factual finding that the agreement for sale of the first-floor unit was entered into much before completion of the building and before the assessee received possession of the allocated flats. The developer, under the tripartite arrangement, was obligated to complete construction and to hand over possession directly to the buyer. The Court found that possession of the first-floor unit was never received by the assessee, and the buyer acquired and possessed it during construction. The Court held that assessing the transaction as if the assessee held and transferred a completed "new asset" was based on conjecture and contrary to the material facts, particularly because the developer delivered possession directly to the buyer and the conveyance was executed accordingly.

Conclusions: The Court concluded that the revenue authorities erred in computing profit on the transfer of the first-floor unit as short-term capital gain by treating it as a "new asset" held by the assessee. The Court held that the assessee had correctly computed the gain as long-term capital gain, and directed that the amount assessed as short-term capital gain be treated as long-term capital gain, setting aside the contrary view.

(ii) Deductibility of expenditure incurred to provide constructed area to the original lessor while computing capital gains

Legal framework: The Court considered deduction of expenditure in computation of capital gains in light of the assessee's obligation under the lease arrangement, and the disallowance made by applying the view that the obligation was "personal" and not linked to transfer.

Interpretation and reasoning: The Court found that the lease terms imposed an existing obligation on the assessee to provide a specified constructed area to the original lessor upon redevelopment after demolition. The Court accepted that the expenditure was incurred to fulfil a binding obligation embedded in the lease arrangement governing the property under development. On that basis, the Court treated the cost as necessarily incurred under obligation and therefore allowable while computing the gain from the property.

Conclusions: The Court set aside the disallowance and directed deletion of the addition, holding that the construction cost incurred for the area to be provided to the lessor was allowable in computation of capital gains.

(iii) Eligibility of exemption under section 54(2) where deposit was in bank term deposits not expressly under CGDS, but amount was later utilized for eligible construction purposes

Legal framework: The Court examined section 54(2), noting the requirement that unutilized capital gains (not appropriated or utilized before filing the return under section 139) should be deposited in an account maintained in accordance with the Capital Gain Deposit Scheme, to be utilized as per the scheme.

Interpretation and reasoning: The Court acknowledged that the assessee made term deposits in a nationalized bank without specifying the CGDS. However, it emphasized that the intention from inception was to utilize the funds towards construction-related activity for the residential house (including super finishes and extension), and that subsequent utilization for such construction purposes was not disputed. The Court treated the lapse of not depositing under the specific scheme as technical in nature in the circumstances, and held that the purpose and actual utilization within the stipulated time were decisive for allowing the benefit.

Conclusions: The Court set aside the denial of exemption and directed allowance of the claimed amount under section 54(2), holding that exemption could not be denied merely because the deposit was not explicitly under CGDS when the funds were demonstrably and undisputedly used for eligible construction within time.

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