Sale of property mortgaged to bank held liable to capital gain tax. Encumbrance not deductible u/s 48

Sale of property mortgaged to bank liable to capital gain tax. Encumbrance created as a guarantee by assessee not deductible u/s 48 of Income Tax Act, 1961

ABCAUS Case Law Citation:
ABCAUS 2875 (2019) (04) HC

Important Case Laws Cited/relied upon by the parties
M. Arunachalam V. CIT, 227 ITR 2
CIT Vs. Thressiamma Abraham, [1997] 227 ITR 802 (Ker)
Commissioner of Income Tax Vs. Attili N.Rao., 2001 Vol. 252 ITR 880 (SC)
CIT Vs. Shakuntala Kantilal [1991] 190 ITR 56 (Bombay
CIT Vs. Sunil J. Kinariwala, [2003] 1 SCC 660
CIT Vs. N. Vajrapani Naidu, [2000] 241 ITR 560 (Madras)
Commissioner of Income Tax Vs. Abrar Alvi, [2001] 247 ITR 312 (Bom)

The assessee had filed the appeal in the High Court challenging the order of the Income Tax Appellate Tribunal (ITAT/Tribunal) dismissing the appeal of the assessee on the issue of capital gains tax.

The appellant assessee along with two other co-owners purchased a land which was offered as collateral security in a bank loan obtained by a company. The assessee and the other two co-owners stood as guarantors, for the said loan. Mortgage was by way of deposit of title deeds. However, no registered mortgage deed was executed.

Since the loan was not repaid, the assessee and the other two co-owners consented for sale of the property by Bank to realize its dues. However, the land was sold by the bank and the sale consideration was paid by the purchaser directly to the Bank.

The assessee did not file her Returns under section 139(1) of the Income Tax Act, 1961 (the Act)but filed it belatedly. The assessment was re-opened under Section 147 of the Act and notice was issued under Section 148.

The assessee maintained that since the entire sale consideration had been paid towards the loan account to the Bank, no capital gains was earned on the sale of the land.

However, the Assessing Officer (AO) rejected the said contention. The AO noted that the mortgage deed had not been registered and the bank had never been vested with the power to alienate the property and appreciate the sale proceeds towards the loan given by it.

The AO also noted that the bank had not taken any initiative to sell the property. It was only the guarantors i.e. the assessee along with the two co-owners who had taken the initiative to sell the property towards the loan taken by the company. Also that all the three co-owners were the creditors of the said company.

Thus, AO was of the view that it was only an application of income and not a case of diversion of income as contended by the assessee.

Accordingly the AO assessed the capital gain by computing 1/3rd share of the assessee. This assessment was challenged in appeal before the Commissioner of Income Tax (Appeals) by the Assessee. However, the CIT(A) dismissed the appeal.

The Assessee then filed a further appeal before the Tribunal which held that the assessee purchased the property without any encumbrance and the subsequent encumbrance created as a guarantee had nothing to do and it could not be deducted as it never comes within the allowable deduction under section 48 of the Act.

That order of the Tribunal was challenged before the Hon’ble High Court. The main thrust of the assessee was that payment by the purchaser of the property directly to the bank amounted to expenditure incurred wholly and exclusively in connection with sale, covered under section 48(i) of the Act.

The assessee claimed that the amount had been paid, since by creation of mortgage, the bank had acquired overriding title to the property and therefore, when the property was brought for sale, the amount paid towards clearing the cloud over the title should be deducted as provided under Section 48 of the Act.

The Hon’ble High Court observed that mortgage by the bank was done by deposit of title deeds. The High Court pointed out that in a mortgage by deposit of title deeds, the mortgagee, (bank in this case), does not acquire title, much less overriding title to the property.

The Hon’ble High Court opined that the charge created over the property was to the extent of the mortgage amount or not to the extent of value of the property. Since the mortgage had been created voluntarily, the balance sale consideration paid to discharge the mortgage would also be the total value of the property and capital gains is to be computed on the full value of consideration received or agreed as a result of transfer of the capital assets.

The Hon’ble High Court stated that the amount of sale consideration which was paid directly to the bank was not to clear a cloud over the title. This was paid to clear the interest or charge over the property which had been offered as collateral security. As the loan amount was far higher than the full value of the capital assets, full sale consideration of the capital assets was paid directly to the bank. The purpose of the sale was only to clear the loan. The value of the property which had accrued on such sale has to be treated as capital gains in the hands of the assessee and the two co-owners.

The Hon’ble High Court opined that the ratio of the judgment of the Hon’ble Supreme Court squarely applied to the case. As held by the Hon’ble Supreme Court, such payment would go to reduce the cost of acquisition only where the mortgage had not been created by the assessee, but was created by the person from whom the assessee had acquired the title and the mortgage was subsisting at the time title was acquired by the assessee. The position is, however, different where the mortgage is created by the owner after he has acquired the property. The clearing off of the mortgage debt by him prior to transfer of the property would not entitle him to claim deduction under section 48 of the Act because in such a case he did not acquire any interest in the property subsequent to his acquiring the same.

The Hon’ble High Court held that there was no diversion of sale proceeds by virtue of overriding title, but on the contrary, there was only a mere application by the owners themselves of the profits realized on the sale of land towards the discharge of loan obligations of same firm.

The Hon’ble High Court also held that the assessee could not claim any part of such application as cost of acquisition for the purpose of computing capital gains as per the provisions of Section 48 of the Act.

Accordingly, the Hon’ble High Court answered the substantial questions of law framed against the Assessee and in favour of the Revenue and the appeal filed by the assesse was dismissed.

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