Charging of Tax Rate in FY 2025-26, on Withdrawn of Capital Exemption claimed under section 54 in FY 2022-23

[PRIYAM KHAMBHATA]

Respected Sir

One of my client has claimed Exemption u/s. 54 of Rs.1,00,00,000 by way of Investment in Capital Gain Account Scheme for construction of new residential house, against against the Long Term Capital Gain on sold of residential house in AY 2023-24, Due to some unavoidable circumstances such new construction is not completed within 3 years from the date of transfer of original assets. Therefore, he has to withdraw such claimed exemption u/s. 54 of Rs.1,00,00,000 in FY 2025-26, and paid Advance Tax @ 20% on such Deemed LTCG of Rs.1,00,00,000/-

Now, while filing his Return of Income for AY 2026-27, I am facing big problem that, Tax computed at 12.5% in stead of 20%, on such Deemed LTCG income (Rs.1,00,00,000) offered in return of income of AY 2026-27. Please guide me, what is the correct tax rate would be charged as per the Income tax provision for filing Income tax Return of FY 2025-26.

[Ryan Vaz]

Short Practical Answer

The deemed Long Term Capital Gain of Rs. 1,00,00,000 arising from the non-utilisation of CGAS funds under Section 54(3) will be taxable at a flat rate of 20% under Section 112(1)(a) of the Income-tax Act, 1961, for AY 2026-27. Additionally, applicable surcharge and Health and Education Cess of 4% will be levied on this tax. The 12.5% rate observed in the return filing utility is incorrect.

Detailed Steps / Computation

1. Nature of Income: The unutilised amount from CGAS, as per Section 54(3), is treated as Long Term Capital Gain (LTCG) of the previous year in which the three-year period expires.

2. Applicable Tax Rate: Since this LTCG arises from the sale of a residential house property (and is deemed to be so upon withdrawal of exemption), it is taxable under Section 112(1)(a) at a rate of 20%. The option to pay tax at 10% without indexation (under the proviso to Section 112(1)) is generally less beneficial for residential property where indexation benefit is significant, and it is an option, not the default.

3. Computation for AY 2026-27 (FY 2025-26):

   • Deemed LTCG (u/s 54(3)): Rs. 1,00,00,000
   • Income Tax @ 20% (u/s 112(1)(a)):
     Rs. 1,00,00,000 * 20% = Rs. 20,00,000
   • Surcharge: The surcharge rate depends on the total income of the assessee.
     • If total income > Rs. 50 lakh but up to Rs. 1 crore: 10% of income tax.
     • If total income > Rs. 1 crore but up to Rs. 2 crore: 15% of income tax.
     • If total income > Rs. 2 crore but up to Rs. 5 crore: 25% of income tax.
     • If total income > Rs. 5 crore: 37% of income tax.
       Assuming the client's total income (including this deemed LTCG) is exactly Rs. 1 crore or between Rs. 50 lakh and Rs. 1 crore, the surcharge would be 10%.
       Surcharge @ 10%: Rs. 20,00,000 * 10% = Rs. 2,00,000
       (If total income exceeds Rs. 1 crore, the surcharge would be 15% or higher, as applicable.)
   • Total Tax + Surcharge: Rs. 20,00,000 + Rs. 2,00,000 = Rs. 22,00,000
   • Health and Education Cess @ 4%:
     Rs. 22,00,000 * 4% = Rs. 88,000
   • Total Tax Liability: Rs. 22,00,000 + Rs. 88,000 = Rs. 22,88,000

   The advance tax paid at 20% (which would be Rs. 20,00,000 before surcharge and cess) is consistent with the correct tax rate. The 12.5% computation in the return filing utility is incorrect and should be overridden or corrected by ensuring the proper income head and section are selected.

AI Summary

Deemed long-term capital gain on unutilised housing exemption funds is taxable at the applicable long-term rate. Unutilised amount invested in the Capital Gain Account Scheme for a claim under section 54 is treated as deemed long-term capital gain in the previous year in which the prescribed three-year period expires, where the new residential house is not completed within that period. The deemed gain is taxable under section 112(1)(a) at the applicable long-term capital gains rate of 20%, with surcharge and health and education cess as applicable.