ITAT Mumbai clarifies taxability of flat received on surrender of tenancy rights and Section 54F eligibility

The Mumbai Bench of the Income Tax Appellate Tribunal, in the case of ITO Vs Varun Jaisingh Asher, has delivered an important ruling on whether a flat obtained in a redevelopment project against surrender of tenancy rights is taxable under Section 56(2)(x) as “income from other sources” or as “capital gains” with possible exemption under Section 54F. The Tribunal ultimately upheld the order of the CIT(A) granting Section 54F relief and rejecting the application of Section 56(2)(x).

The decision is particularly relevant for assessees who occupy premises as tenants and later receive ownership flats in redevelopment schemes, and for cases where the Revenue alleges that tenancy arrangements within family groups are colourable devices.

Background of the dispute

Assessment proceedings and claim of exemption

• The assessee is an individual commission agent dealing in chemical distribution.
• For Assessment Year 2020–21, he filed a return showing total income of Rs. 4,87,280/-.
• He also claimed long-term capital gain exemption under Section 54F of Rs. 11,68,89,000/-.
• The exemption related to a flat received in a redevelopment project in exchange for surrender of tenancy rights.

The assessment was completed under Section 143(3) read with Section 144B on 28.09.2022. The case was taken up to verify the large Section 54F claim.

Origin of tenancy and redevelopment arrangement

Key factual elements considered in the case:

1. Earlier tenant and vacation of premises

   • The property in question had an earlier long-standing tenant on the first floor.
   • Pursuant to an RAE suit and decree based on consent terms, the old tenant vacated on 31.03.2013.
   • A sum of Rs. 2.75 crore was paid to the outgoing tenant, as recorded in the tenancy agreement later.

2. Assessee and brother commencing tenancy

   • After the earlier tenant vacated, the assessee and his brother, Shri Vivek Jaisingh Asher, started using the vacated floor as tenants from 01.04.2013.
   • Each paid rent of Rs. 5,000/- per month.
   • At that point, no registered tenancy agreement was executed because the property remained within the family; however, rent receipts and electricity bills were available to show the tenancy and occupation.

3. Formalization of tenancy for redevelopment

   • When redevelopment was proposed, the developer insisted on a formal tenancy document.
   • A registered tenancy agreement dated 05.08.2014 was executed, granting tenancy effective from 01.04.2013.
   • MHADA verification records during the redevelopment process recognized the assessee as tenant.

4. Development agreements and alternate accommodation

   • The landlords entered into a joint development agreement on 11.08.2014.
   • Subsequently, a Permanent Alternate Accommodation Agreement (PAA) was signed in March 2017 between the tenants (including the assessee) and the builder.
   • Pursuant to redevelopment, the tenants vacated and handed over possession.
   • An occupation certificate (OC) for the redeveloped building was issued in February 2020, after which the assessee received possession of a residential flat measuring 1550 sq. ft. in the new building in exchange for surrendering his tenancy rights.

Assessment Officer’s view: Alleged colourable device and invocation of Section 56(2)(x)

AO’s core findings

The Assessing Officer (AO) treated the entire arrangement as a tax avoidance mechanism and:

• Alleged that the tenancy agreement dated 05.08.2014 was sham and a colourable device, mainly because it was between close family members and was executed close to redevelopment.
• Considered the tenancy as not having independent commercial substance.
• Ignored rent receipts, electricity bills, MHADA verification, and the PAA, considering them self-serving or not establishing genuine tenancy rights.
• Held that the flat received on redevelopment was not in consideration of any genuine tenancy rights and, therefore, represented a gratuitous benefit.

Application of Section 56(2)(x) and denial of Section 54F

On this basis, the AO:

1. Applied Section 56(2)(x)(b)

   • Treated the stamp duty value of the flat of Rs. 11,68,99,000/- as income from other sources, invoking Section 56(2)(x) on the premise that the assessee had received an asset (flat) without consideration or for inadequate consideration.

2. Rejected capital asset characterization

   • Disregarded the tenancy as a capital asset and refused to view its surrender as a transfer under Section 2(47).