Removal of 'encumbrance' is cost of improvement and eligible for indexation

CA V.K. Subramani

Tax on income by way of capital gain is at flat rate in contrast to other heads of income. Perhaps, this makes the taxpayers to think and explore avenues to minimize the tax outgo. Income-tax Act, 1961 has certain provisions meant for reinvestment of capital gain or net sale consideration in order to minimize the tax liability. One of the issues which is not alien to our society is tenant claiming tenancy right by virtue of occupying the property for long period of time and thus seeking some compensation for vacating the premises which could disturb/dislocate his present status/affairs. Also, illegal occupancy of vacant land/premises by persons with no justification is also possible in our society. The owner of asset is left with no choice but has to negotiate for amicable settlement for eviction of such person(s) from the land/premises by sharing some money. The issue is whether such sharing of cake (read as part of sale consideration) is to be treated as cost of improvement for insulating the taxpayer in respect of capital gains tax.

In Sanmati Realtors (P) Ltd v. Asst. CIT (2023) 107 ITR (Trib) 376 (Delhi) the assessee purchased land in the financial year 2005-06. At the time of completion of purchase of land, the assessee found that a few persons were claiming their rights of possession on the land and thus encumbrances were associated with the land. The persons who claimed right in the land were either members of the large family of the vendor or the members of the families who were recorded as cultivators of the land. The assessee made payment of Rs.192.28 lakh. All the payment were made through banking channel. The assessee claimed indexation benefit for the payment made to those persons in order to remove encumbrance. The stakes involved was material and only one party to whom Rs.15 lakh was paid confirmed the receipt.

The tribunal held that the perusal of bank statement showed that the assessee has made payments to some persons and such payments are prevalent in our eco-system. Since all the payments were made through bank and got accounted for in the financial year in which the payments were made, the claim was allowed.

Readers may note that the character of the capital asset i.e. land etc., being short-term or long-term would apply for payments made for removing encumbrance as well. Thus, the payment for removal of encumbrance would be eligible for indexation benefit even if the time lag between such payment and transfer thereof is less than 24 months. However, to apply indexation benefit, the payment and transfer of asset must fall in two different financial years. In this case, the payments were made during the period October, 2010 to March, 2011. Transfer was made in financial year 2011-12 and the claim of indexation benefit was thus allowed.