Commissioner of Income Tax, Ahmedabad vs Tikyomal Jasanmal

P.N. Bhagwati, C.J.—The question which arises for determination in this reference is a narrow one and it relates to the interpretation of

section 54 of the Income tax Act 1961. The facts giving rise to the reference are few and may be briefly stated as follows. The assessee is a

refugee from Pakistan. He purchased a house property at an auction held by the rehabilitation department. The price was Rs. 6,825 and it was

paid by the assessee by way of adjustment of his claim for compensation in respect of properties left in Pakistan. This house property was used by

the assessee mainly for the purpose of his own residence right up to 26th June, 1962 when he sold it for the price of Rs. 40,000. The sale of the

house property resulted in a capital gain of Rs. 33,175. The assessee by utilising the sale proceeds purchased a piece of land on 30th July, 1962,

and started constructing a building on it in August, 1962. The construction of the ground floor of the building was completed by March, 1963, at a

cost of Rs. 34,000. The total area of the ground floor was 1,389 sq. ft. and as soon as it was about to be ready the assessee occupied the whole

of it in February, 1963. Out of the total ares of 1,389 sq. ft. the assessee let out an are of 734 sq. ft. to certain tenants in March, 1963, with the

result that an area of only 655 sq. ft. remained in the occupation of the assessee. The assessee thereafter started construction on the first floor of

the building towards the end of 1964 and completed construction on an area of 132 sq. ft. at a cost of Rs. 6,000 and occupied it for his personal

residence. On these facts the question arose before the Income tax Officer in the course of the assessment for the assessment year 1963-64, the

relevant accounting year being Samvat Year 2018 whether the profit of Rs. 33,175 arising to the assessee from the sale of the old building was

chargeable to tax under the head ""capital gains"". Now ordinarily since this profit arose to the assessee from the transfer of the old house property

which was a capital asset in the relevant year of account, it would be chargeable to tax as capital gain u/s 45 but the assessee claimed that it was

exempt from tax on the ground that it fell within the exempting provision contained in section 54. The Income Tax Officer did not accept this claim

of the assessee : he held that the condition for the applicability of the exemption was not satisfied in the case of the assessee since the assessee did

not construct the new building within a period of two years from the date of sale of the old house property and, moreover, the new building was

not constructed by the assessee for the purpose of his own residence as required by section 54. The assessee carried the matter in appeal to the

Appellate Assistant Commissioner but the Appellate Assistant Commissioner took the same view and rejected the appeal The assessee thereupon

preferred a further appeal to the Tribunal and before the Tribunal the assessee was successful in his claim for exemption. The Tribunal held that, on

a proper construction of section 54, it was not necessary that the new building in its entirety must be constructed within a period of two years from

the date of sale of the old building and it was sufficient if a part of it was constructed for the purpose of the residence of the assessee. What was

essential according to the Tribunal was that the new building should have been constructed for the purpose of the residence of the assessee and so

far as this requirement was concerned, the Tribunal found that it was satisfied since the new building was constructed by the assessee mainly for the

purpose of his own residence. The Tribunal stated that when the old building was sold and the new building constructed by the assessee, the main

purpose of the assessee could not have been anything except to use it as his own residence and the new building was, therefore, constructed by the

assessee mainly ""for the purpose of his own residence"" The Tribunal accordingly allowed the claim of the assessee for exemption in respect of the

capital gain resulting from the sale of the old building. Hence, the present reference at the instance of the Commissioner of Income Tax.

The short question which arises for consideration on these facts is :

Whether the claim of the assessee for exemption in respect of capital gain resulting from the sale of the old house property is sustainable u/s 54 for

that is the only section on which the claim to exemption is founded ?

Section 54 enacts an exempting provision by way of exception to the general rule as to chargeability laid down in section 45 and is in these

terms :

Profit on sale of property used for residence. - Where a capital gain arises from the transfer of a capital asset to which the provisions of

section 54 are not applicable, being buildings or lands appurtenant thereto the income of which is chargeable under the head ''Income from house

property'', which in the two years immediately preceding the date on which the transfer took place, was being used by the assessee or a parent of

his mainly for the purposes of his own or the parent''s own residence, and the assessee has within a period of one year before or after that date

purchased, or has within a period of two years after that date constructed, a house property for the purposes of his own residence then instead of

the capital gain being charged to Income Tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance

with the following provisions of this section, that is to say, -

(i) if the amount of the capital gain is greater than the cost of the new asset, the difference between the amount of the capital gain and the cost of

the new asset shall be charged u/s 45 as the income of previous year, and for the purpose of computing in respect of the new asset any capital gain

arising from its transfer within a period of there years of its purchase or construction, as the case may be, the cost shall be nil, or

(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged u/s 45; and for the

purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or

construction, as the case may be, the cost shall be reduced by the amount of the capital gain.

The section grants exemption in respect of capital gain arising to the assessee from the transfer of a house property provided two conditions are

satisfied, namely : (1) the house property must have been used by the assessee or a parent of his, mainly for the purposes of his own or the

parent''s own residence, during the period of two years immediately preceding the date on which the transfer took place; and (2) the assessee must

have within a period of one year before or after such date, purchased or within a period of two years after such date constructed, a house property

for the purposes of his own residence. It is only if these two conditions are satisfied that the assessee can lay a claim to exemption in respect of

capital gain arising from the transfer of the house property. Now it was not in dispute between the parties that the old house property sold by the

assessee in respect of which capital gain was sought to be assessed by the revenue was used by the assessee mainly for the purpose of his own

residence during the period of two years immediately preceding the date on which it was sold and the first condition was, therefore, satisfied. The

only controversy between the parties was as to the fulfillment of the second condition.

The second condition consists of two limbs : one is that the new building must have been constructed by the assessee within a period of two

years from the date of sale of the old house property, and the other is that such construction must have been made by the assessee for the

purposes of his own residence. The revenue contended that neither of these two requirements was satisfied and the second condition was,

therefore, not fulfilled. Now, so far as the first limb of the condition is concerned, it is possible to say that the requirement embodied in it was

satisfied by the assessee since the ground floor of the new building was constructed by the assessee within a period of two years from the date of

sale of the old house property. There was an interregnum of a period of more than a year and a half between the completion of construction of the

ground floor and the commencement of construction of the first floor of the new building and we may, therefore, take the ground floor of the new

building as a unit of house property for the purpose of determining the applicability of the exempting provision and this unit of house property was

admittedly constructed before the expiration of the period of two years from the date of the sale of the old house property. But the real difficulty in

the way of the assessee lies in so far as the requirement embodied in the second limb of the condition is concerned. Can it be said, on the facts of

the present case, that the assessee constructed the ground floor of the new building for the purpose of his own residence ? The answer can only be

in the negative. The construction of the ground floor of the new building was completed by March, 1963, and immediately on completion of the

construction, the assessee let out an area of 734 sq. ft. to tenants and retained with him an area of only 655 square feet for his own occupation.

When more than 50 per cent. of the area of the ground floor of the new building was let out by the assessee to tenants as soon as the construction

was completed, it is difficult to see how it can be said that the ground floor of the new building the purpose for which the ground follow was

constructed by the assessee was his own residence, it is inexplicable why the assessee should have let out a major portion of the area of the ground

floor was originally constructed by him for the purpose of his own residence but by reason of subsequent events or supervening circumstances it

became impossible or impracticable for him to occupy a part of the ground floor for the purpose of his own residence and it was, therefore let out

to tenants. Such indeed could not be the case of the assessee since no period of time elapsed between the completion of the construction of the

ground floor and the letting out of a portion of it to tenants. More than 50 per cent. of the portion of the ground floor was let out to tenants

immediately on completion of the construction and there was, therefore no question of any change of circumstances arising by reason of

subsequent events which might induce the assessee not to utilise such portion of the ground floor for the purpose for which it was constructed

namely, his own residence and to let it out. It is in the circumstances impossible to say that the assessee constructed the ground floor of the new

building for the purpose of his own residence. He constructed a part of it for the purpose of his own residence and the other part for the purpose

of letting it out in order to earn rent. That is not sufficient compliance with the requirements of the section.

It was suggested on behalf of the assessee that he let out a portion of the ground floor to tenants since he did not require it immediately for the

purpose of his own residence but he had minor children and, when they grew up, more space would be required and it was in order to provide for

this anticipated requirement in future that he had constructed the whole of the ground floor, and therefore, the entire ground floor must be held to

have been constructed for the purpose of his own residence. This suggestion cannot stand scrutiny for a moment. When the section says that the

house property must be constructed by the assessee for the purpose of his own residence it refers to the immediate purpose of construction. It is

not sufficient to comply with the requirement of the section say that the assessee has constructed the house property for the purpose of occupying it

for his residence after a period of ten years and in the meantime letting it out with a view to earning rent. It is the immediate purpose of construction

which is relevant and not the remote, future or ultimate purpose. Here, on the facts found by the Tribunal, if we look at the immediate purpose for

which the ground floor of the new building was constructed, it is evident that the ground floor unit of the house property was constructed not for his

own residence and the second condition for the applicability of the exempting provision was not satisfied. The Tribunal was, therefore, in error in

allowing the assessee''s claim for exemption u/s 54.

We, accordingly, answer question No. 1 in the negative. In view of our answer to question No. 1, question Nos. 2 and 3 do not arise and need

not be answered. The assessee will pay the costs of the reference to the Commissioner.