Capital Gains Exemption under Section 54 of the Income-tax Act, 1961: A Jurisprudential Analysis

Capital Gains Exemption under Section 54 of the Income-tax Act, 1961: A Jurisprudential Analysis

1. Introduction

Section 54 of the Income-tax Act, 1961 (“the Act”) grants roll-over relief from long-term capital gains tax when an assessee sells a residential house and reinvests the gains in another residential house within prescribed time-lines. Despite its apparently simple wording, the provision has generated extensive litigation concerning the meaning of “purchase”, “construction”, “a residential house”, temporal limits, source of investment, and allied procedural requirements. The present article critically analyses the evolving Indian jurisprudence, synthesising leading authorities and statutory amendments to clarify the current doctrinal position and identify persisting grey areas.

2. Statutory Framework

Section 54(1) provides exemption where:

  • The original asset is a long-term capital asset being a residential house used by the assessee for own residence in the two years preceding transfer;
  • The assessee purchases a residential house within one year before or two years after the date of transfer, or constructs a residential house within three years after that date;
  • Unutilised consideration by the due-date for filing the return must be deposited under the Capital Gains Accounts Scheme (“CGAS”) in terms of s. 54(2).

Finance Act 2014 substituted the phrase “a residential house” by “one residential house” w.e.f. 1 April 2015; Finance Act 2019 introduced a limited option to invest in two houses where capital gain does not exceed ₹2 crore (once in a lifetime).

3. Determinants of Eligibility: Doctrinal Themes

3.1 Date of “Purchase”: Agreement, Possession or Registration?

In CIT v. R.L. Sood[2] the Delhi High Court held that for s. 54 the crucial date is the agreement to purchase coupled with substantial payment, not the later registration. A similar purchaser-centric approach appears in CIT v. Beena K. Jain[3] (Bombay), recognising possession as determinative. Recent ITAT rulings such as Dr. Sheela Puttabuddi[12] reiterate that utilisation of consideration within time suffices even if conveyance is executed later. These cases emphasise purposive construction to avoid penalising procedural delays beyond the assessee’s control.

3.2 Source of Funds and the “Same Money” Fallacy

Kerala High Court in ITO v. K.C. Gopalan[4] clarified that the statute does not require the exact sale proceeds to be ploughed back; what matters is cost of the new asset incurred within the window. Gauhati High Court endorsed this view in CIT v. Rajesh Kumar Jalan[5]. The Supreme Court’s dictum in Fibreboards (P) Ltd. v. CIT[13], though under s. 54G, affirms the broader principle that utilisation within statutory period, not formal acquisition, is decisive.

3.3 Construction v. Purchase: Commencement and Completion

Delhi High Court in CIT v. Bharti Mishra[6] held that s. 54F does not insist that construction must commence after the sale; analogous reasoning applies to s. 54. Similarly, in Brinda Kumari[20] the Delhi High Court allowed exemption where flats were constructed by the developer within two years, rejecting a narrow interpretation that the assessee must physically build the house herself.

3.4 Singular v. Plural: “A” Residential House

Karnataka High Court’s landmark ruling in CIT v. K.G. Rukminiamma[7] (relying on Ananda Basappa) held that “a residential house” includes multiple flats forming one residential unit. Andhra Pradesh High Court reached a similar conclusion in CIT v. Syed Ali Adil[8]. While ITAT Mumbai in Sushila Jhaveri had earlier taken a restrictive view, subsequent legislative amendments in 2014 and 2019 partially codified and partly rolled back this liberal interpretation, limiting automatic plurality but carving out a ₹2 crore double-investment option. The pre-2015 ratio of Rukminiamma therefore still governs legacy years, whereas post-2015 assessments must heed the amended text but may invoke the 2019 proviso where applicable, as seen in Sapna Mukesh Thapar[9].

3.5 Ownership in the Assessee’s Name

Madras High Court in CIT v. V. Natarajan[10] allowed exemption where the new property was purchased in the spouse’s name but assessed in the transferor’s hands, emphasising substantive investment by the assessee. Conversely, where beneficial ownership is absent, courts have denied relief, reflecting an emerging principle of real and beneficial ownership over mere name.

3.6 Demolition and Reconstruction on Same Land

ITAT (Madras) in Ashok Kumar (HUF)[16] treated demolition of an existing floor and construction of a new unit as “construction” for s. 54, following Delhi and Gujarat precedents. The focus remains on creation of a distinct residential unit within the statutory period.

3.7 Residential Use of the Original Asset

Punjab & Haryana High Court in Dr. A.S. Atwal[17] reiterated that the original property must have been used for own residence in the two preceding years; a mere tin shed did not qualify. Therefore, factual enquiry into residential usage remains critical at the threshold stage.

3.8 Interaction with Section 50 (Depreciable Assets) and Other Exemptions

Supreme Court in CIT v. V.S. Dempo Co.[11] (dealing with s. 54E) held that the deeming fiction under s. 50 is confined to computation and does not preclude exemption. The logic equally applies to s. 54, preserving relief even where the original house was a depreciable asset in business books.

3.9 Procedural Compliance: Capital Gains Accounts Scheme

Non-deposit of unutilised consideration in CGAS can defeat the claim, yet courts adopt a pragmatic approach where the assessee demonstrates actual utilisation within the statutory window, as in Rajesh Kumar Jalan[5]. Nevertheless, prudent compliance with CGAS remains advisable to avoid litigation.

4. Comparative Synthesis of Key Precedents

The following themes emerge:

  1. Purposive Construction: Leading cases favour a liberal, purposive reading to advance the legislative intent of promoting housing (R.L. Sood, K.C. Gopalan).
  2. Substance over Form: Courts focus on substantive investment and residential use rather than technical formalities (Natarajan, Rukminiamma).
  3. Consistency with Amendments: Post-2015 assessments must align with the “one residential house” language, subject to the 2019 ₹2 crore carve-out (Sapna Mukesh Thapar).
  4. Temporal Flexibility: Possession/agreement dates and partial instalments may satisfy the timing condition if within the legislative spirit (Beena K. Jain, Bharati C. Kothari[14]).

5. Policy Considerations and Recent Trends

The jurisprudence reflects a balancing act between preventing tax avoidance and incentivising genuine reinvestment in housing. Legislative amendments narrowing the scope (2014) and partially expanding it again (2019) indicate a calibrated policy response. With rising real-estate prices, practical difficulties in strict time compliance persist, prompting judicial relaxation grounded in equitable interpretation.

6. Unresolved Issues

  • Partial Residential and Commercial Use: The extent to which mixed-use properties qualify for s. 54 needs further clarification.
  • Joint Development Agreements Post-2015: Whether multiple flats obtained under a single agreement constitute “one” house after the amendment remains contentious.
  • CGAS Procedural Rigour: Divergent views on substantial compliance v. strict compliance continue to generate appeals.

7. Conclusion

Section 54 has undergone a doctrinal evolution driven by purposive judicial interpretation. The core principle emerging from the case-law is that bona fide reinvestment in residential accommodation within statutory timelines merits exemption, and procedural or semantic hurdles should not thwart that objective. Practitioners must, however, remain vigilant of post-2015 textual constraints, ensure documentary evidence of utilisation, and anticipate litigation in grey zones such as multiple units and mixed-use properties. Ongoing legislative fine-tuning and appellate guidance are likely to further shape this dynamic area of Indian tax jurisprudence.

Footnotes

  1. Income-tax Act, 1961, s. 54.
  2. Commissioner of Income-tax v. R.L. Sood, 1999 SCC OnLine Del 1121.
  3. Commissioner of Income-tax v. Smt. Beena K. Jain, (1993) 199 ITR 173 (Bom).
  4. Income-tax Officer v. K.C. Gopalan, 1999 KER LT 3421.
  5. Commissioner of Income-tax v. Rajesh Kumar Jalan, (2006) 286 ITR 274 (Gau).
  6. Commissioner of Income-tax v. Bharti Mishra, (2014) 265 CTR 374 (Del).
  7. Commissioner of Income-tax v. Smt. K.G. Rukminiamma, 2010 SCC OnLine Kar 517.
  8. Commissioner of Income-tax v. Syed Ali Adil, 2012 SCC OnLine AP 565.
  9. Sapna Mukesh Thapar v. CIT, 2019 SCC OnLine ITAT 1479 (Mum).
  10. Commissioner of Income-tax v. V. Natarajan, 2006 SCC OnLine Mad 1395.
  11. Commissioner of Income-tax, Panaji v. V.S. Dempo Co. Ltd., 2016 SCC OnLine SC 1115.
  12. Dr. Sheela Puttabuddi v. ITO, 2022 SCC OnLine ITAT _. (Bengaluru).
  13. Fibreboards (P) Ltd. v. Commissioner of Income-tax, (2015) 376 ITR 596 (SC).
  14. Commissioner of Income-tax v. Bharati C. Kothari, 2000 SCC OnLine Cal 676.
  15. Commissioner of Income-tax v. Brinda Kumari, 2000 SCC OnLine Del 829.
  16. Ashok Kumar (HUF) v. ACIT, 1998 SCC OnLine ITAT _. (Mad).
  17. Dr. A.S. Atwal v. CIT, (2005) 279 ITR 22 (P&H).