Must Knows

Are profits on the cancellation of a property deal taxable?

[] Does a mere allotment letter issued by a builder create a capital asset in favour of the allottee and if so, can the allottee claim capital gains tax exemption on the profits from the cancellation of such a unit? We examine a judgement by the Mumbai Income Tax Appellate Tribunal, to get some answers

When you book a property, the builder generally issues an allotment letter. The actual agreement may not be executed immediately. The agreement to sell, may, in fact, be executed after years, in some cases. It may also happen that the deal gets cancelled and the builder pays you something more than what you had paid. Does the excess so received, have to be treated as income and taxed? If so, is it taxed under the head ‘income from other sources’ as compensation, or under the head ‘capital gains’? These questions were answered by the Mumbai bench of the Income Tax Appellate Tribunal (ITAT), in August 2020.

You are reading: Are profits on the cancellation of a property deal taxable?

Does an allotment letter create a capital asset and rights in a property?

One Mukesh Sohanraj Vardhan had booked a flat for a total consideration of Rs 30 lakhs, paid via two separate cheques, dated January 7, 2005. The builder then issued an allotment letter, dated January 10, 2005. No formal agreement was ever executed. The rights under the allotment letter were surrendered on September 12, 2011 and the builder paid an enhanced amount of Rs 48.75 lakhs, to the tax payer. The tax payer treated the difference as capital gains and claimed an exemption under Section 54 of the Income Tax Act, as he had bought a residential flat for Rs 101.95 lakhs using the money.

[] Does the RERA allow buyers to cancel an allotment at any time?

During the assessment proceeding, the income tax officer refused to treat the surplus as capital gains and instead, taxed it under the head ‘income from other sources’. The reason given by the income tax officer, for not treating the differential received as capital gains, was that no formal purchase and sale agreement was executed for the transaction.

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The tax payer appealed before the Commissioner of Income Tax-Appeal (CIT-A), which rejected the appeal of the tax payer, stating that the agreement that was supposed to be executed after the issue of the allotment letter, was not produced. The CIT-A also pointed out various defects in the allotment letter and concluded that the allotment letter issued by the builder was not a valid allotment letter. The CIT-A too arrived at a conclusion that the allotment letter does not create any capital asset.

The matter ultimately went before the ITAT Mumbai. As no agreement was ever executed, the Tribunal was required to find out whether any rights were created, only by virtue of an allotment letter issued by the builder.

What is a capital asset: Findings of the Mumbai Income Tax Appellate Tribunal

Does an allotment letter create any capital asset?

In the course of hearing, the Tribunal observed that the term ‘capital asset’ as defined in Section 2(14) can be construed to include any type of rights in an immovable property. Therefore, a right to obtain a conveyance of an immovable property, is also a capital asset. The Tribunal also observed that any capital asset for which no specific holding period requirement is provided, for treating the same as long-term, becomes so, if the right with respect to the asset remains with the tax payer for 36 months or more. Once the capital asset becomes a long-term capital asset, the tax payer, in the opinion of the ITAT, becomes entitled to claim exemption under Section 54/54F, if the sale proceeds are invested for acquiring a residential house. Since the tax payer had invested more than the difference received on cancellation of the earlier flat, the Tribunal did not go into whether the exemption under Section 54 was available or under Section 54F.

While deciding the case, the Tribunal also considered the case of CIT v. Vijay Flexible Containers – [(1990) 186ITR 693 (Bom)], which was decided by the Bombay High Court. The Tribunal also observed that they did not find any infirmity in the allotment letter, when it was examined along with the bank statement, which reflected the fact of the payment having been made by the tax payer, for booking the flat.

Can you claim long-term capital gains (LTCG) tax exemption based on an allotment letter?

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The Tribunal held that even if the builder has not started construction of the flats, the buyers still get a right in the asset which has to come into existence and the fact that the builder has not constructed the flat, cannot go against the person‘s ‘right to get the flat’. The Tribunal further held that by paying advance for the flats and obtaining an allotment letter, the tax payer had acquired rights in the property and the right in the property was a capital asset. The Tribunal held that any surrender or cancellation of such right, was actually extinguishment of any right in relation to capital assets, in view of the provisions of Section 47 of the Act and fell under the definition of ‘transfer’ and hence, resulted in capital gains chargeable under Section 45 of the Act.

Any profits which accrues or arises has to be assessed under the head ‘capital gains’, as and when it is cancelled, transferred or surrendered. The Tribunal also held that even as per the CBDT circular No. 471, dated October 15, 1986, property acquired by an allotment letter was also considered as a capital asset, for the purpose of taxation. So, the Tribunal held that the right of acquiring property amounts to capital assets.

[] Agreement for sale or final payment: What constitutes a transfer of property?

From the ITAT’s order, we can infer that an allotment letter, even if it has some infirmities, will still create legal rights, with respect to the property, as long as you are able to establish that payment was also made at the time of issuance of the allotment letter. So, the rights acquired under an allotment letter in relation to a property, create a right in the nature of a capital asset.

(The author is chief editor – Apnapaisa and a tax and investment expert, with 35 years’ experience)


What is an allotment letter?

An allotment letter is provided by the builder to the buyer of an under-construction property when the buyer pays the token amount. It precedes the agreement for sale and indicates the unit in the project that has been allotted to the buyer.

What is a capital asset?

According to the Income Tax Appellate Tribunal, Mumbai, a ‘capital asset’ as defined in Section 2(14), includes any type of right in an immovable property.

Does an allotment letter create a right in a property?

An allotment letter will create legal rights in a property, if the allottee is able to establish that payment was made for the said allotment.

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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