The Supreme Court of India in an important judgment dated 01-07-2014 has held that an agreement to sell extinguishes some right of the transferor in the property and creates some right in favour of the transferee which is in line with the definition of the term “transfer” as per section 2(47) of the Income Tax Act for grant of exemption u/s54 related to long term capital gain on residential house. The apex court also stressed that a purposive interpretation must be given in considering a claim for exemption.

Case Details:
Civil Appeal Nos.5899-5900 of 2014
Sh. Sanjeev Lal Etc. Etc. Appellants Versus Commissioner of Income Tax, Chandigarh & Anr. Respondents
Coram: Anil R. Dave, J. ; Shiva Kirti Singh, J.

Date of Judgment: 01-07-2014

Facts of the Case:
In 1993, the appellants had received the ownership of a residential house at Chandigarh by operation of the conditions of will of their grandfather. The appellants had decided to sell the house and in December 2002, entered into an agreement to sell and received the earnest money. The appellants, by utilising the sale proceeds including the capital gains purchased another house in April, 2003 (within one year). However due to a court order in a legal suit, the appellant could not execute the sale till September, 2004. Believing that resulting capital gain are exempt due to operation of section 54 of the Income Tax Act, 1961, the appellant did not disclose the said long term capital gain in their return of income filed for the Assessment Year 2005-2006.

However, the Assessing Officer denied the benefit under Section 54 on the reason that the sale of the house was made on 24th September, 2004 whereas purchase of another residential house was made on 30th April, 2003 (more than one year prior to the purchase of the new house).

Later, both the Commissioner of Income Tax CIT (Appeals) and Appellate Tribunal upheld the decision of the assessing officer and the high Court of Punjab and Haryana also, in 2013 dismissed the appeal

The main submission of the appellants was that since the assessee appellant, by an order of the civil court was restrained to deal with the house, the date of the agreement to sell (27-12-2002) should be taken as the date of transfer which was well within the period of one year as prescribed under Section 54.

Considering the facts of the case, the Supreme Court allowed the appellants the benefit of section 54 of the income tax act in respect of long term capital gain on the basis of the date of agreement to sell.

Excerpts from the Judgment:

“In normal circumstances by executing an agreement to sell in respect of an immoveable property, a right in personam is created in favour of the transferee/vendee. When such a right is created in favour of the vendee, the vendor is restrained from selling the said property to someone else because the vendee, in whose favour the right in personam is created, has a legitimate right to enforce specific performance of the agreement, if the vendor, for some reason is not executing the sale deed. Thus, by virtue of the agreement to sell some right is given by the vendor to the vendee. The question is whether the entire property can be said to have been sold at the time when an agreement to sell is entered into. In normal circumstances, the aforestated question has to be answered in the negative. However, looking at the provisions of Section 2(47) of the Act, which defines the word “transfer” in relation to a capital asset, one can say that if a right in the property is extinguished by execution of an agreement to sell, the capital asset can be deemed to have been transferred.”

“…… a law-abiding citizen cannot be expected to violate the direction of a court by executing a sale deed in favour of a third party while being restrained from doing so. In the circumstances, for a justifiable reason, which was not within the control of the appellants, they could not execute the sale deed……”

“In addition to the fact that the term “transfer” has been defined under Section 2(47) of the Act, even if looked at the provisions of Section 54 of the Act which gives relief to a person who has transferred his one residential house and is purchasing another residential house either before one year of the transfer or even two years after the transfer, the intention of the Legislature is to give him relief in the matter of payment of tax on the long term capital gain…… The intention of the Legislature or the purpose with which the said provision has been incorporated in the Act, is also very clear that the assessee should be given some relief.”

“Though it has been very often said that common sense is a stranger and an incompatible partner to the Income Tax Act and it is also said that equity and tax are strangers to each other, still this Court has often observed that purposive interpretation should be given to the provisions of the Act. In the case of Oxford University Press v. Commissioner of Income Tax [(2001) 3 SCC 359] this Court has observed that a purposive interpretation of the provisions of the Act should be given while considering a claim for exemption from tax. It has also been said that harmonious construction of the provisions which subserve the object and purpose should also be made while construing any of the provisions of the Act and more particularly when one is concerned with exemption from payment of tax. Considering the aforestated observations and the principles with regard to the interpretation of Statute pertaining to the tax laws, one can very well interpret the provisions of Section 54 read with Section 2(47) of the Act, i.e. definition of “transfer”, which would enable the appellants to get the benefit under Section 54 of the Act”.

“Consequences of execution of the agreement to sell are also very clear and they are to the effect that the appellants could not have sold the property to someone else. In practical life, there are events when a person, even after executing an agreement to sell an immoveable property in favour of one person, tries to sell the property to another. In our opinion, such an act would not be in accordance with law because once an agreement to sell is executed in favour of one person, the said person gets a right to get the property transferred in his favour by filing a suit for specific performance and therefore, without hesitation we can say that some right, in respect of the said property, belonging to the appellants had been extinguished and some right had been created in favour of the vendee/transferee, when the agreement to sell had been executed.”

“The sale deed could not be executed for the reason that the appellants had been prevented from dealing with the residential house by an order of a competent court, which they could not have violated.”