FMV of flats received in exchange of surrender of tenancy rights as on date of exchange is Cost Of Acquisition for sale of flats subsequently

 In a recent ruling, the Mumbai Bench of the Income Tax Appellate Tribunal (“ITAT”) held that where a taxpayer acquires ownership flats in exchange for surrendering tenancy rights, the fair market value (FMV) of such flats on the date of acquisition should be treated as the cost of acquisition for computing capital gains.

In this case, the assessee had inherited tenancy rights in a property. Pursuant to a redevelopment arrangement, the tenancy rights were surrendered to a developer in exchange for ownership flats. The assessee later sold one such flat and computed capital gains by adopting the FMV of the flat on the date of acquisition (i.e., the date of surrender of tenancy rights) as the cost of acquisition and claiming indexation.

The Assessing Officer (AO) rejected this approach and treated the cost of acquisition as “nil,” on the premise that the tenancy rights were self-generated and no monetary consideration had been paid to acquire the property. The AO accordingly taxed the entire sale consideration as capital gains and denied exemption under section 54/54F holding that the assessee did not substantiate the claim with supporting documents. The first appellate authority upheld the AO’s view.

On further appeal, the ITAT noted that tenancy rights are a valuable capital asset and that in a case where ownership flats were not received by the assessee, certain cash compensation
equivalent to the market value of such right on the date of such surrender of tenancy right would have been received by the assessee. Relying on earlier decisions, the ITAT held that where tenancy rights are exchanged for ownership property, the FMV of the property received on the date of exchange represents the cost of acquisition. The ITAT therefore directed the AO to recompute capital gains by allowing the FMV as the cost of acquisition. However, the claim under section 54/54F was rejected for want of supporting documentation.

This ruling reaffirms that surrender of tenancy rights in a redevelopment context is not a cost-free transaction. The FMV of the property received in exchange shall form the cost base for capital gains computation. The decision provides important guidance for taxpayers involved in redevelopment projects.