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Courts have liberally interpreted exemption provisions via investment of capital gains in a residential house!

 Under Section 54 of the Income-tax Act, an exemption is available to a taxpayer who is an individual or a Hindu Undivided Family, in respect of the transfer of a residential house (whether self-occupied or let out) held for more than 36 months, where the capital gains arising from the transfer are invested either for the purchase of another residential house (whether old or new) within a period of one year before or two years after the date of transfer or the construction of another residential house within a period of three years after the date of transfer.

If the whole of capital gains are invested in the cost of the house so purchased or constructed, the entire capital gains will be exempt from tax. If, however, the amount of capital gains is greater than the cost of the house so purchased or constructed, the difference between the two will be chargeable to tax. Exemption under Section 54 can be availed even if the taxpayer owns more than one house on the date of transfer.

It is important to note that as per the provisions of Section 54, if the new house property is transferred within a period of three years of its purchase or construction, the amount of capital gains arising therefrom, together with the amount of capital gains exempted earlier will be chargeable to tax in the year of transfer as Short Term Capital Gains.


In the context of the above referred provisions of Section 54, some liberal interpretations as laid down by various High Courts need to be borne in mind and can be usefully relied upon in appropriate cases:

  • As held by the Calcutta High Court in the case of ‘B.B. Sarkar vs. CIT’ 132 ITR 150(Cal.), where a taxpayer spends capital gains partly for purchase of another house and partly for further construction on it, he is still entitled to exemption under Section 54. The High Court held that Section 54 contemplates fulfillment of two alternate conditions, viz. purchase or construction, but, where both the conditions are fulfilled within the time stipulated, the taxpayer would also be entitled to the relief.

  • As held by the Karnataka High Court in the case of ‘CIT vs. J. R. Subramanya Bhat’ 165 ITR 571(Kar.), construction of the new house property may be commenced even before the transfer of the old house property and it is not necessary that it should commence only after such transfer. The High Court held that the material condition is that the construction must be completed within three years from the date of transfer.

  • The Bombay High Court in the case of ‘CIT vs. Dr. Laxmichand Nagpal Nagda’ 211 ITR 804 (Bom.) has held that taking into consideration the letter as well as spirit of Section 54, the word ‘purchase’ is not used in the sense of legal transfer. The High Court held that in this case the taxpayer had paid the full consideration, obtained the possession of the flat and it was actually put to use and hence exemption under Section 54 was clearly available, though no registered purchase deed was executed.

  • The Delhi High Court in the case of ‘CIT vs. R.L. Sood’ 245 ITR 727(Del.) has also held that payment of substantial amount to the builder for purchase of a new flat within the specified period would entitle the taxpayer to exemption under Section 54, even though the builder may have handed over the possession of the flat to the taxpayer beyond the specified period.

  • In the case of ‘Shri Shashi Varma vs. CIT’ 224 ITR 106 (MP), the Madhya Pradesh High Court has held that where the investment of capital gains in the purchase of a flat has been duly made within two years of the sale, the taxpayer would be entitled to exemption under Section 54, even though the construction is not completed within the statutory time limit. In this connection, the High Court relied upon the CBDT Circular clarifying to the effect that investment under the self financing scheme of Delhi Development Authority or other co-operative societies or similar bodies, where a house property is allotted to a taxpayer, shall be treated as a case of construction for the purpose of Section 54.

In the case of ‘ITO vs. K.C. Gopalan’ 107 Taxman 591 (Ker.) the taxpayer had sold his land along with the building. His claim under Section 54 in respect of exemption from capital gains was rejected by the Assessing Officer on the ground that the sale price received by the taxpayer was deposited in private banks and the construction of the building had been undertaken by borrowed funds. The Kerala High Court held that there was no provision in the statute that the taxpayer should utilize the same amount which he obtained by way of sale consideration for the purpose of meeting the cost of the new asset. Entitlement of the exemption under Section 54 relates to the cost of the acquisition of a new asset in the nature of a house property for the purpose of the taxpayer’s residence within the specified period and that condition having been fulfilled the benefit of the exemption could not be denied.

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