ITAT Bangalore Clarifies Indexation Year and Construction Cost Deduction in Co-owner Capital Gains Case

Background of the Dispute

The case Shreshta Sheel Patil Vs ITO came before the Income Tax Appellate Tribunal (ITAT), Bangalore, in the context of reassessment proceedings under Section 147 of the Income Tax Act 1961. The core controversy revolved around:

  • The correct year of acquisition to be considered for indexation while computing long-term capital gains, and
  • The allowability of cost of construction and improvement in respect of a co-owned immovable property.

The assessee had not filed a return of income under Section 139(1) for the relevant assessment year. Information regarding the sale of an immovable property and professional receipts triggered selection of the case under the Non-filers Monitoring System (NMS). Based on this, reassessment proceedings were initiated under Section 147, and notice under Section 148 was issued.

In response, the assessee filed a return offering total income of ₹14,44,910/-, which included long-term capital gains on her one-third undivided share in a property sold for ₹2.5 crore. The computational dispute and subsequent appeal focused on indexation and deduction of construction and improvement costs.

Facts Relating to Property and Capital Gains

Co-ownership and Sale Consideration

  • The property in question was jointly owned by three co-owners.
  • The total sale consideration received on transfer of the property was ₹2,50,00,000.
  • The assessee held a one-third share, and capital gains were computed on that basis.

Assessee’s Stand on Year of Acquisition and Indexation

While computing long-term capital gains, the assessee:

  • Treated the date of acquisition as falling in Financial Year (FY) 1996–97.
  • Adopted Cost Inflation Index (CII) of 305 corresponding to FY 1996–97.
  • Claimed this on the footing that consideration was fully paid and possession was handed over during April 1996, even though registration was completed later.

The assessee also claimed:

  • Cost of construction of ₹26,00,000 incurred during FY 1996–97, and
  • Indexed cost of improvement aggregating to ₹58,32,166 over multiple financial years.

Assessment Proceedings and AO’s Findings

AO’s View on Indexation Year

The Assessing Officer (AO):

  • Accepted that the assessee held a one-third undivided interest in the property.
  • However, for indexation, the AO took the view that:
    • The purchase deed recorded the date of purchase as 12.06.1997.
    • The registered document was executed on 24.04.1998.
    • Therefore, the relevant year of acquisition was FY 1998–99.
  • Accordingly, the AO adopted CII of 351 applicable to FY 1998–99, in place of CII 305 claimed by the assessee.

Disallowance of Construction and Improvement Cost

The assessee had claimed:

  • ₹26,00,000 as construction cost (stated to have been incurred in FY 1996–97), and
  • ₹58,32,166 as indexed cost of improvement over several years.

The AO:

  • Observed that the assessee had not produced supporting documents such as bills, vouchers, contractor payments, or other contemporaneous evidence.
  • Disallowed the entire claim towards construction and improvement for lack of verification.
  • Restricted deduction while computing capital gains to:
    • One-third share of the original purchase price, and
    • Registration charges of ₹3,06,300.

On this basis, the AO recomputed long-term capital gains as under:

  • Full sale consideration: ₹2,50,00,000
  • Indexed cost of purchase (CII = 351): ₹80,47,171 (computed as ₹27,56,300 × 1024 / 351)
  • Total long-term capital gains: ₹1,69,58,829
  • Assessee’s one-third share: ₹56,52,943

The AO thus made an addition of ₹52,58,038 under the head “Capital Gains” over and above the capital gains originally offered by the assessee (₹3,94,905).

First Appeal Before CIT(A)

Aggrieved, the assessee approached the Commissioner of Income Tax (Appeals) [CIT(A)] under Section 250, challenging:

  • Adoption of FY 1998–99 as the year of acquisition for indexation, and
  • Complete disallowance of cost of construction and improvement.

Submissions of the Assessee Before CIT(A)

The assessee substantially reiterated the contentions raised before the AO. The key points were:

  1. On Year of Acquisition and CII

    • The acquisition was effectively completed in FY 1996–97, as:
      • Entire sale consideration had been paid by April 1996, and
      • Possession was handed over in April 1996.
    • Therefore, CII 305 applicable to FY 1996–97 ought to be applied.

  2. On Construction and Improvement Cost

    • The property was only a semi-finished building at the time of purchase.
    • By the time of sale, it had become a fully completed residential building.
    • This fact was evident from the descriptions given in the registered purchase and sale deeds.
    • The expenditure on construction and improvement was spread over several years, from FY 1996–97 to FY 2011–12.