Mumbai ITAT clarifies: Capital gains exemption under Section 54F cannot be restricted by intra-head capital loss adjustment

 Recently, in a significant taxpayer-friendly ruling, the Hon’ble Mumbai ITAT, in the case of Nikesh Bhagwandas Mehta vs. ITO, has clarified an important issue concerning the interplay between capital gains exemption under section 54F and set-off/carry forward of long-term capital loss under the provisions of the Income-tax Act, 1961 (‘the Act’). The ruling reaffirms that where the conditions of section 54F are duly satisfied, the exemption is to be granted on the entire eligible long-term capital gain, and the assessee cannot be compelled to first adjust long-term capital losses before claiming such exemption.

In the present case, the assessee, an individual taxpayer, had earned long-term capital gains (LTCG) of approximately Rs. 69.84 lakhs from sale of certain equity shares during AY 2022-23. Since the net sale consideration was duly invested in a qualifying residential house property, the assessee claimed full exemption under section 54F on the aforesaid capital gains. During the same year, the assessee had also incurred long-term capital loss (LTCL) of approximately Rs. 37.72 lakhs on sale of another set of equity shares, which was claimed to be carried forward to subsequent years in accordance with the provisions of the Act.

However, while processing the return under section 143(1), the CPC denied the carry forward of such LTCL. In first appeal, the Ld. CIT(A) upheld the CPC’s action and held that the provisions relating to set-off/carry forward of losses under the Act, require the long-term capital loss to be first adjusted against the long-term capital gains earned during the year, and only the net capital gains remaining thereafter would qualify for exemption under section 54F. Accordingly, the Ld. CIT(A) restricted the exemption under section 54F to the net gain and denied the carry forward of LTCL.

Aggrieved by the aforesaid action, the assessee preferred an appeal before the Hon’ble Mumbai ITAT. After examining the statutory scheme and the interplay between the exemption available under section 54F and the provisions governing set-off and carry forward of capital losses, the Hon’ble Tribunal ruled in favour of the assessee and made the following important observations:

• Charging section of Capital gains (i.e. section 45) itself provides that chargeability of capital gains is subject to the exemptions contained in sections 54 to 54H, including section 54F.

• Once the conditions prescribed under section 54F are fulfilled, the eligible capital gain effectively exits the charging provision itself.
• The computation provisions relating to capital gains must first be given effect, including the exemption under section 54F.
• The provisions relating to intra-head set-off of capital losses come into operation only after the capital gains are computed in accordance with the aforesaid provisions.
• Therefore, the assessee cannot be compelled to first set-off long-term capital loss, before claiming exemption under section 54F.

Accordingly, the Hon’ble Tribunal held that the assessee was entitled to claim full exemption under section 54F on the entire LTCG of Rs. 69.84 lakhs, while simultaneously being entitled to carry forward the LTCL of Rs. 37.72 lakhs to subsequent years.

This ruling assumes considerable significance for taxpayers claiming exemptions under sections 54 / 54F while simultaneously incurring capital losses on other assets during the same year. The decision strengthens the position that exemption provisions embedded within the charging mechanism should take precedence over subsequent computational provisions relating to loss adjustment. Taxpayers may consider evaluating ongoing assessments, CPC adjustments, and appellate matters involving similar issues in light of this ruling.