Mumbai ITAT allows 'exemption' in reassessment proceedings which was not claimed in the original return of income

 In a significant and taxpayer-friendly ruling, the Hon’ble ITAT, Mumbai Bench in Sanjay Gopaldas Bajaj vs. ITO has held that a taxpayer is entitled to claim deduction under section 54 in a return filed pursuant to reassessment proceedings, even where no original return was filed. The ruling assumes importance for individual taxpayers facing reassessment proceedings involving capital gains, particularly in cases where exemption claims are made for the first time during reassessment proceedings.

In the present case, the assessee had not filed his original return of income within the timeline prescribed under the Act. Based on information available in TDS statements reflecting salary, rental income and property transactions, the Assessing Officer (AO) initiated reassessment proceedings. In response to the notice, the assessee filed his return of income declaring long-term capital gains arising from sale of a residential property and claimed deduction under section 54 on the ground that the entire capital gains had been reinvested in a new residential house within the prescribed time.

While the AO accepted the computation of capital gains, he denied deduction under section 54 solely on the ground that the assessee had not filed the original return. The Ld. CIT(A) upheld the disallowance by placing reliance on the Supreme Court’s decision in CIT v. Sun Engineering Works (P.) Ltd. Aggrieved, the assessee preferred an appeal before the Hon’ble ITAT.

The Hon’ble ITAT ruled decisively in favour of the taxpayer and allowed the claim, making the following important observations:

• The decision in Sun Engineering Works does not prohibit an assessee from raising claims directly relatable to the income sought to be taxed in reassessment proceedings.
• Reassessment proceedings are confined to escaped income; however, the assessee is entitled to make claims that are intrinsically connected with such income.
• The exemption under section 54 is directly linked to the computation of long-term capital gains and therefore cannot be regarded as an unrelated or fresh claim.
• Section 54 does not prescribe filing of a return under section 139(1) as a condition precedent for claiming exemption.
• A legitimate statutory benefit cannot be denied merely because the return was filed pursuant to the reassessment proceedings.

Accordingly, the Hon’ble ITAT restored the matter to the AO for limited verification of compliance with the substantive conditions of section 54.

This ruling is a strong reaffirmation that reassessment proceedings, though initiated to bring escaped income to tax, cannot be used as a mechanism to deny legitimate deductions directly connected to such income. The decision underscores that exemption provisions like section 54 are substantive in nature, and procedural lapses such as non-filing of an original return cannot override statutory entitlements where the conditions of the section are otherwise satisfied. It is pertinent to note, that in the present case the exemption claim was directly linked to the very income alleged to have escaped assessment. However, the position in relation to claims that are not intrinsically connected with the escaped income may require separate judicial consideration. The contours of such claims in reassessment proceedings continue to evolve and will undoubtedly remain an area of close scrutiny in future litigation.