Capital Gains Tax Applies Even When Bank Sells Mortgaged Property and Retains Full Proceeds: Kerala High Court

Overview of the Dispute

In a significant ruling, the Kerala High Court upheld the capital gains assessment levied on an assessee whose mortgaged property was auctioned by South Indian Bank to recover outstanding loan dues. The central question before the Court was whether an assessee who receives no portion of the sale proceeds from such a forced sale can be held liable for capital gains tax under the Income Tax Act, 1961. The Court answered this question decisively in the affirmative and dismissed the appeal filed by the assessee.

Background and Facts of the Case

Case Name: Giju Purapadathil Mathai Vs CIT (Kerala High Court)

The assessee, Giju Purapadathil Mathai, owned a property that he had mortgaged equitably to South Indian Bank under Section 58(f) of the Transfer of Property Act. This mortgage was created not to secure the assessee's own borrowings, but to serve as collateral security for loan facilities availed by a third party. Over time, the borrower defaulted on repayment obligations, and the outstanding liability grew substantially.

Consequent to the default, South Indian Bank exercised its rights as a mortgagee and brought the property to sale. The entire sale consideration was appropriated by the Bank toward the outstanding loan account. As a result, the assessee — the property owner — did not receive even a single rupee from the transaction.

Despite this, the Income Tax Department raised a capital gains assessment against the assessee. The Assessing Officer, followed by the First Appellate Authority, and subsequently the Income Tax Appellate Tribunal, Kochi Bench (ITAT), all confirmed the tax liability. The assessee, aggrieved by these concurrent findings, approached the Kerala High Court by way of this appeal.

Arguments Raised by the Assessee

The assessee's counsel placed primary reliance on the following factual position:

  • The property was mortgaged purely as a third-party security to facilitate a loan taken by someone else.
  • When the Bank sold the property and applied the proceeds entirely to the loan account, the assessee received no financial benefit whatsoever from the transaction.
  • Since no consideration passed into the hands of the assessee, there was no "gain" — capital or otherwise — that could be attributed to him.
  • Taxing a transaction in which the assessee neither participated voluntarily nor received any monetary benefit would be wholly unjust and contrary to the spirit of the Income Tax Act, 1961.

On this basis, the counsel submitted that the assessments at all prior levels were illegal and deserved to be set aside.

Submissions of the Income Tax Department

The Junior Standing Counsel appearing for the Income Tax Department countered these arguments robustly by placing reliance on the Supreme Court's binding precedent in CIT v. Attili N.Rao [2022] 252 ITR 880.

The Department's key submissions were: