Decision cited :

In the case of CIT v. V. Indira (1979) 119 ITR 837 (Mad.), payment was made by the assessee to the plaintiff in a suit where the plaintiff sought to assert some rights in respect of the property in question and the compromise amount was sought to be cited as cost of improvement to the asset. It was in such context that the Division Bench of the Madras High Court held that the relevant expression was “cost of any improvement thereto” and the use of the word “thereto” implied that it had to be a cost on the asset itself and not a cost for improving the owner’s title to the asset. A distinction was made between improving the asset itself, which would be covered by the relevant expression, and improving the owner’s title thereto, which would fall beyond such expression.

In the case of R.M. Arunachalam v. CIT (1997) 227 ITR 222 (SC), the Supreme Court held that if the mortgage had been created by the previous owner and the assessee after inheriting the same had discharged the mortgage debt, the amount paid by the assessee for the purpose of clearing off the mortgage could be claimed as a part of cost of acquisition under Section 48 and Section 49 read with Section 55(2) of the Act.

Acelegal Analysis :

The High Court has laid down two propositions :

(i) The conversion of leasehold property into freehold by the assessee would not partake character of acquisition of new capital asset but would be cost of improvement. This decision is in contrast to certain Mumbai ITAT decisions on similar point. 

(ii) Secondly, the court has distinguished the Madras High Court decision and rather applied the Supreme Court decision holding the clearance of encumbrance of earlier owner is cost of acquisition.

Facts of the case :

The assessee obtained a property under a Will. The Will apparently gave some interest to a trust and, thus, the assessee’s acquisition of the perpetual lease was subject to rights of the trust as flowing from the Will. In addition, the testator had entered into an agreement for sale of the property with a third party and had even obtained clearance under Chapter XX of the Act for such purpose. When the assessee evinced a desire to transfer the property or the interest therein, such third party lodged a claim which had to be settled by the assessee.

Further, at the time of the acquisition of the leasehold rights by the assessee’s predecessor-in-interest in or about 1968, a perpetual lease was granted by the relevant authority. After the assessee inherited such rights under the Will, the assessee perfected the rights to full ownership (freehold) upon payment of a sum of about ₹ 55 lakh to the Delhi Development Authority (DDA).

Questions before High Court :

(i)    Whether the date of acquisition of a property is as per earlier owner who willed the property or whether the date when it was converted from “leasehold” to “freehold” property?

(ii)     Whether amount paid for removal of encumbrance in any immovable property is allowed as cost of improvement?

Proceedings before High Court :

Revenue’s contention : Since the acquisition of the full ownership pertaining to the property preceded the transfer, thereof, by the assessee by a few months, the assessee was liable to pay tax as short-term capital gain. Further, the payments made to the trust, to DDA for bettering the title of the asset qua the property and to the third party to give up his rights under the agreement for sale executed by the assessee’s predecessor would not qualify for deduction since none of such payments were for the improvement of the property within the meaning of the relevant expression in Section 55(1)(b)(2)(ii) of the Act.

Assessee’s submission : Section 47(iii) excludes the transfer by way of Will from the purview of “transfer”. Thus, upon a bequest under a Will in respect of an immovable property taking effect, it cannot be regarded as a transfer for the purpose of the capital gains provisions. Further, the Act also permits the cost of acquisition incurred by the predecessor in such a situation to be taken as the cost of acquisition if the successor were to transfer the relevant property.

There is no doubt that substantial interest in the property was acquired by the assessee in terms of the Will. However, the interest of the assessee was clouded by the rights conferred to the trust by the Will, the claim of the third party who entered into an agreement for sale with the predecessor of the assessee and the fact that it was a perpetual lease and not outright ownership. The assessee asserts that without taking care of the claims of the trust and of the agreement-holder for sale, there could be no meaningful transfer of the property or the leasehold interest therein as, at any rate, it would be a transfer with encumbrances. Thus, when encumbrances to an immovable property are removed by payment and the removal of such encumbrances enhances the value of the property and the sale price thereof, the costs incurred for such purpose have to be regarded as part of the cost of acquisition of the capital asset.

High Court’s verdict :

(i)       Date of acquisition : The assessee in this case inherited the relevant immovable property under a Will and the perfection of the title from perpetual leasehold rights to complete ownership did not amount to the acquisition of the property by the assessee; the acquisition took place upon the bequest under the Will being effective. The perfection of the title from perpetual leasehold rights to complete ownership had, in such circumstances, to be regarded as a cost of acquisition within the meaning of such expression in Sections 48 and 55 of the Act. Indeed, the assessee in this case was no longer transferring the leasehold rights to the assessee’s transferee; the assessee was transferring complete ownership rights therein.

(ii)       Cost of improvement : The encumbrances to the property in this case were created by the Will and the conduct of the assessee’s predecessor-in- interest. These encumbrances were got rid of by the assessee by payment. A better title to the property was acquired by the assessee and transferred to the assessee’s transferee. For the same principle as recognised in the Supreme Court judgment, the cost of getting rid of such encumbrances in any immovable property has to be accepted as a part of the cost of acquisition of the property, subject, however, to the assessment as to the genuineness and validity of such encumbrances.