Interest on Borrowed Capital as Cost of Acquisition Under Section 48 Prior to Finance Act 2023: ITAT Mumbai Ruling in DCIT Vs Neville Tuli

Background of the Dispute

The Mumbai Bench of the Income Tax Appellate Tribunal in DCIT Vs Neville Tuli examined whether interest paid on a housing loan, used to purchase a capital asset, can be treated as part of the cost of acquisition for computing Long-Term Capital Gains (LTCG) under Section 48, in years prior to the amendment made by the Finance Act 2023.

The Revenue challenged the order of the CIT(A)/NFAC, who had allowed the assessee to treat the indexed interest on borrowed funds as part of the cost of acquisition/cost of improvement while computing LTCG on sale of a property.

Key factual elements were:

  • The assessee, an individual, had acquired a property funded through borrowed capital from a bank.
  • The property was later sold for Rs. 27,00,00,000.
  • While computing LTCG, the assessee claimed:
    • Rs. 9,90,67,611 as indexed cost of acquisition, and
    • Rs. 3,95,42,739 as indexed cost of interest paid to the bank, disclosed as “indexed cost of improvement”.
  • The resultant LTCG offered to tax amounted to Rs. 13,13,89,649.

In earlier assessment years, the assessee had already claimed interest deduction on the same housing loan to a limited extent under Section 24(b) (interest on borrowed capital under income from house property). The balance, unclaimed portion of interest was capitalised and treated as part of the cost of acquisition/improvement in the year of sale.

The Assessing Officer (AO) disallowed the assessee’s claim of indexed cost of interest, leading to the present litigation.

AO’s Stand: Interest Not Part of Cost of Acquisition/Improvement

Questions framed by the AO

The AO focused on two legal questions:

  1. Whether interest paid on borrowed capital could be regarded as cost of acquisition or cost of improvement of the property for the purposes of Section 48.
  2. Whether indexation benefit could be granted on such interest component.

Reliance on Section 55 and nature of “cost of improvement”

The AO examined Section 55 and emphasised the definition of “cost of any improvement”. As per the AO’s reading, cost of improvement meant:

“All the expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property.”

On this basis, the AO concluded:

  • Interest paid on a housing loan after acquisition of the property does not amount to capital expenditure incurred for additions or alterations to the asset.
  • Therefore, such post-acquisition interest cannot be brought within the scope of either cost of acquisition or cost of improvement, unless it can be shown to be expenditure on actual improvement to the asset—which was not the case here.

Case law relied upon by the AO

The AO placed reliance on the following Tribunal decisions:

  1. Income Tax Officer Vs Vikram Sadanand Hoskote (2007) 18 SOT 130 (Mumbai)

    • Held that expenditure incurred after the asset has come into existence cannot be treated as part of “actual cost” for capital gains purposes.
    • Specifically, interest on a loan obtained against mortgage of a property was held not to form part of cost of acquisition.

  2. Harish Krishnakant Bhatt Vs ITO (2004) 91 ITD 311 (Ahmedabad)

    • Held that interest paid for acquiring shares could not be allowed as a deduction from capital gains where the expenditure is incurred after the date of acquisition.

Disallowance by the AO

On these premises, the AO concluded:

  • Interest of Rs. 3,95,42,739 (after indexation), paid after acquisition and claimed as part of indexed cost of improvement, did not qualify as cost of acquisition or cost of improvement.
  • Since there was no actual improvement carried out using borrowed funds, and the nature of interest did not fit into Section 55, the claim under Section 48 was disallowed.

The AO added the disallowed sum back to the assessee’s income as LTCG, and completed assessment under Section 143(3) determining total income at Rs. 17,44,37,570.

CIT(A)’s Decision: Interest Forms Part of Cost of Acquisition

The assessee appealed before the CIT(A)/NFAC. The appellate authority carried out a detailed examination of:

  • Statutory provisions: Section 48, Section 49, Section 55, Section 24(b).
  • Conflicting judicial precedents of various High Courts and Tribunals.

Findings on prior deduction under Section 24(b)

During appeal proceedings, the CIT(A) noted: