Sold commercial units & bought 2 flats, taxman denies Rs 2.5 crore relief on one - what ITAT said

The Assessing Officer accepted the claim for one flat but rejected the deduction relating to the second. (Image for representative purpose)A taxpayer sells commercial properties and invests the proceeds in two residential flats. But the flats are on different floors. Does that automatically mean he can claim capital gains tax relief on only one of them?In one such case, a taxpayer faced disallowance on capital gains exemption for the second flat. Read on to know why the Income Tax Appelate Tribunal (ITAT) Mumbai ruled in his favour:What the case is aboutA man sold six commercial units in Mumbai and the sales generated long-term capital gains of around Rs 5 crore. He claimed a deduction of the same amount under Section 54F after investing in residential property.For this purpose, he purchased two flats in Wing A of a building but on separate floors. Agreements for both flats were executed and registered on the same date.The Assessing Officer accepted the claim for one flat but rejected the deduction relating to the second, taking the view that Section 54F allowed relief for only one residential house. This resulted in a disallowance of Rs 2,51,31,621. The Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, upheld the decision.The appellate authority pointed to the fact that the flats were on different floors, had separate entrances and attracted stamp duty separately. In its view, the common building and lift did not change the fact that they were two distinct properties.The man subsequently challenged this interpretation before ITAT. His counsel argued that both flats had been acquired together to accommodate the family as one residential unit.His counsel submitted that adjacent flats that could be interconnected were not available, given the constraints of finding suitable residential accommodation in Mumbai. The two flats were in the same wing and accessible through a common lift, which the taxpayer relied on to support his argument that they were intended to function as one family residence.Why ITAT ruled in favour of taxpayerThe Income Tax Appellate Tribunal (ITAT), Mumbai, ruled in favour of the taxpayer. The tribunal held that separate entrances, floors and registration documents did not, by themselves, prevent the two flats from qualifying as one residential house under Section 54F of the Income Tax Act.The tribunal considered earlier judicial decisions, including the Delhi High Court's ruling in CIT v. Gita Duggal and the decision in Principal Commissioner of Income Tax v. Lata Goel. These decisions supported the principle that residential accommodation need not always be confined to a single physical unit to qualify for the relevant capital gains relief.The tribunal explained the test it applied: “What is relevant is the substance and functional character of the residential accommodation and whether the units, in the facts of the case, constitute one residential house.”This meant that the question could not be settled merely by counting the number of registered units. The tribunal considered the circumstances in which the man had purchased the flats: both were acquired on the same date, from the same developer, in the same building and wing, and had identical areas and purchase prices. Their location on different floors was the principal distinguishing feature.The fact that adjacent flats were said to be unavailable also helped explain the man’s decision to purchase units on different floors.The tribunal held that the separate entrances and separate stamp duty payments did not, on their own, establish that the units had to be treated as two independent residential houses for Section 54F.It observed: “The statutory provision does not prescribe that a residential house must necessarily be evidenced by a single registered instrument or must comprise one undivided physical unit.”The judges drew a distinction between the physical layout of a property and its character as residential accommodation. A building may contain separate units that can be used independently, but that fact alone does not necessarily prevent the accommodation from being treated as one residential house for the purpose of the deduction.Applying the principle to this case, the tribunal concluded: “We, therefore, find that the facts of the present case, considered in the light of the ratio laid down by the Hon'ble Delhi High Court in Gita Duggal (supra) and Lata Goel (supra), justify treating the two residential flats as constituting one residential house for the purposes of section 54F.”The tribunal therefore found the disallowance relating to the second flat unsustainable. It directed: “We, therefore, set aside the order of the learned CIT(A) and direct the Assessing Officer to allow the deduction under section 54F in accordance with law.”