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Taxing the tenant

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A set of questions that Mumbai residents are likely to have, about taxation on sale/surrender of tenancy rights in residential buildings, answered by veteran chartered accountant and property expert Vimal Punmiya

Q. Is pagdi official?
A: Yes. As per the Bombay Rent Act, it was illegal to take as well as pay pagdi. However, the Maharashtra Rent Control Act, 1999 has legalised the receiving of any payment of pagdi. Section 56 of the Maharashtra Rent Control Act, 1999 reads as follows:

Sec. 56: Rights of Tenant and Landlord to receive lawful charges — Notwithstanding anything contained in this Act, it shall be lawful for
1) The tenant or any person acting or purporting to act on behalf of the tenant to claim or receive an sum or any consideration, as a condition of the relinquishment, transfer or assignment of his tenancy or any premises;
2) The landlord or any person acting or purporting to act on behalf of the landlord to receive any fine, premium or other like sum deposit or any consideration on respect of the grant, or renewal of a lease of any premises, or for giving his consent to the transfer of a lease to any other person.

Q. What is the cost of purchase for the tenant when it was not official? Since no document can support the pagdi transaction, is it ‘nil’?
A: If money is not paid officially, then cost of acquisition will be taken as nil. However, in case some amount has been paid officially, then of course, he can claim the cost of acquisition along with indexation.

Q. Is the tenant liable for capital gains tax at all?
A: After 1994, the amount received on surrender of tenancy is subject to capital gains tax depending upon the holding period. If the tenancy period is less than three years then the capital gains shall be short term capital gains and shall form a part of the total income of the assessee. However, if the tenancy period is more than three years then the same shall be treated as long term capital gains and shall form a part of the total income thereto subject to deductions under section 54EC, 54F etc.

Section 54EC: The assessee can invest an amount upto R 50 lakh in NHAI / RECL Bonds within six months from date of transfer of tenancy rights. Such investment amount [upto R 50 lakh] can be claimed as an exemption under

Section 54EC of the IT Act, 1961. However, the interest earned on such bonds thereafter, which may range between 6 per cent pa to 7 per cent pa is taxable.

Section 54F : Assessee can invest in purchase of a residential house property within one year before or two years after the date of transfer of tenancy rights or construct a residential house property within three years from the date of such transfer of tenancy rights or he can purchase from a builder, an under-construction property before the receipt of the occupation certificate by the builder and the individual must also receive possession of the same within three years.

However, the assessee must not own more than one residential house other than the new asset [in which investment is made] on the date of transfer. Also, the assessee cannot, within a period of three years after the date of transfer, transfer the new residential house property and cant purchase any other residential house property for a further period of two years from the date of possession of the new house.

If the entire sales proceeds is not invested in the new house property, then the exemption under Section 54F shall be allowed on pro-rata basis thus: Amount of Investment x Capital Gains / Net Consideration.

If the entire amount of sales proceeds is not invested in the purchase or construction of the residential house property before the due date of filing of return of income under section 139(1), then the amount of capital gain or the net consideration as the case may be, is required to be deposited in an account under Capital Gains Account Scheme. The relevant points are:

i. The deposit shall be made before furnishing the return of income under section 139(1) or before furnishing the return of income, whichever is earlier

ii. The deposit shall be made in an account with a bank or institution approved for the purpose i.e. Nationalised bank.

iii. The return of income shall be accompanied by proof of such deposit.

iv. The amount deposited can be withdrawn for utilisation in accordance with the scheme, for the specified purpose.

v. If the amount deposited is not utilised for acquiring the new asset within the period stipulated, the capital gain related to the unutilised amount shall be treated as the capital gain of the previous year in which the period specified in the above provision expires.

However, the CBDT has clarified vide Circular No 743 dated 06.05.1996 that in case of an individual who dies before the expiry of the stipulated period, any unutilised amount of deposit made under capital gains account scheme shall not be chargeable to tax in the hands of the legal heirs of the deceased. This is because the unutilised amount of deposit does not partake the character of income in the hands of the said legal heirs but only a part of the estate devolving upon him.


Liability: If the tenancy period is more than three years then the amount received on surrender of tenancy is treated as long term capital gains (picture for representation)

Q. If yes, then should the indexation of the year 1980-1981 be considered?
A: If there is no cost, there is no question of either indexation or substitution of fair market value as on April 1, 1981.
Even if the cost exists, the fair market value as on 01.04.1981 and the indexation thereon cannot be claimed in accordance with the provisions of Section 55 (2) of the IT Act, 1961 which reads as under:
“For the purpose of Section 48 and 49, ‘cost of acquisition’ – 

(a) in relation to a capital asset being goodwill of a business [or trademark or brand name associated with a business], [or right to manufacture, produce or process any article or thing] [or right to carry on any business], tenancy rights, stage carriage permits or loom hours –
i. In the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price, and ii. In any other case [not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49], shall be taken to be nil

(b) in relation to any other capital asset –
i. Where the capital asset became the property of the assessee before the [1st day of April, 1981] means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the [1st day of April, 1981] at the option of the assessee; ..........”
Hence, as per the provisions stated above, tenancy is already covered under the clause (a) and the substitution of fair market value as on 01.04.1981 does not apply to tenancy rights.

Q. Should it be the year when the agreement was signed? When he gave up his room of 200 sq ft and gained a commitment of 300 sq ft ?
A: Capital gain liability will arise on date of handing over possession of 200 sq ft.

Q. If he intends to stay in the new house, is he still liable to pay capital gains tax?
A: If the new house is purchased as per the provisions of Section 54F, then the assessee is not liable to pay capital gains tax. Liability of capital gains tax would arise on the unutilised amount at the tax rate of 20.60 per cent.


Lawful: The Rent Control Act of 1999 has legalised pagdi payment (picture for representation)

Q. Suppose he decides to sell off the new premises in 2014, then which is the year of capital gain? The year of agreement or the year of sale?
A: If the amount is invested under section 54F then the assessee will be liable to pay the tax at the time of sale of sale of new property as provided under Section 54F(3):
“Where the new asset is transferred within a period of three years from the date of its purchase or, as the case may be, its construction, the amount of capital gain arising from the transfer of the original asset not charged under section 45 on the basis of the cost of such new asset as provided in clause (a) or, as the case may be, clause (b), of sub-section (1) shall be deemed to be income chargeable under the head “Capital gains” relating to long-term capital assets of the previous year in which such new asset is transferred.”

Twice-taxed? 

Q: Would a tenant have to pay capital gains twice by any chance?
A: Capital gains tax is not payable twice. No single income can be taxed twice. At first when the exemption is claimed, no capital gains tax is payable.

Section 54 F (2) reads as under:
“Where the assessee purchases, within the period of [two years] after the date of the transfer of the original asset, or constructs, within the period of three years after such date, any residential house, the income from which is chargeable under the head “Income from house property”, other than the new asset, the amount of capital gain arising from the transfer of the original asset not charged under section 45 on the basis of the cost of such new asset as provided in clause (a), or, as the case may be, clause (b), of sub-section (1), shall be deemed to be income chargeable under the head “Capital gains” relating to long-term capital assets of the previous year in which such residential house is purchased or constructed.”

Hence, the re-taxability of capital gains is framed as under:

Retaxability: Section 54F of the IT Act, 1961

Situation 1: Due to short-utilisation/ non-utilisation/ misutilisation of Capital Gain Account Deposit
Mis-utilised/ short-utilised amount is taxable on expiry of the investment period

Situation 2: Due to transfer of new asset within lock-in period
Re-taxability of originally Taxable as LTCG
exempted capital gains :
Re-taxability on gain arising Full value of consideration less on sale of new asset: adjusted cost [STCG]

Situation 3: Re-taxability due to purchase/ construction of more than one house property
The exemption claimed by the assessee shall become re-taxable as long term capital gain

How to justify to the income tax department

In case of transfer of premises and purchase/ construction of the new residential house property, the following points should be kept in mind which will help justify the exemption under section 54EC/ 54F to the income tax department:

>> Ensure that the purchase is made within a period of one year before or two years after the date of transfer. The purchase deed would serve as evidence.

>> Construction of the new residential house property should be completed within 3 years from the date of transfer. Completion certificate, occupation certificate etc would serve the purpose.

>> If the purchase is made from a builder then it must take place while the house is under construction. Moreover, the occupation certificate by the builder must be received after such purchase is made. Nevertheless, it must be received within three years from the date of transfer of the original asset.

>> The amount of investment not utilised before the due date of filing return of income under section 139(1) must be invested in capital gain account. The bank statements would serve as good evidence.

>> In case of substitution of fair market value as on 01.04.1981, the registered valuer’s report must be obtained.

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