Capital Gains Exemption on Reinvestment in Residential House to Be Allowed Before Set-off of Capital Losses

 In a recent ruling, the Mumbai Tribunal in the case of Nikesh Bhagwandas Mehta held that capital gains exemption must be granted before applying the provisions relating to set-off of capital losses. Accordingly, where the conditions are satisfied, long-term capital gains eligible for exemption cannot be reduced by long-term capital losses before allowing the exemption.

In this case, the assessee earned long-term capital gains of INR 69.84 lakhs on sale of certain equity shares and claimed exemption under Section 54F of the Income Tax Act on the entire amount by investing the net consideration in a residential house. During the same year, the assessee also incurred a long-term capital loss of INR 37.73 lakhs on sale of another set of equity shares and claimed to carry forward the said loss. While processing the income tax return, the CPC adjusted the long-term capital loss against the exempt capital gains, thereby restricting the exemption under Section 54F to the net capital gains and denying carry forward of the long-term capital loss. The CIT(A) upheld the action of the CPC.

The Tribunal observed that the charging provision itself makes the taxation of capital gains subject to the exemptions available under Sections 54 to 54H of the Act. It further noted that once the conditions prescribed are fulfilled, the eligible capital gains cease to be chargeable to tax. Accordingly, the provisions relating to intra-head set-off of capital losses would apply only after the capital gains have been computed in accordance with Sections 45 to 55A, including giving effect to the exemption available under Section 54F. Accordingly, the Tribunal held that the assessee was entitled to claim exemption under Section 54F on the entire eligible long-term capital gains as well as carry forward the long-term capital loss incurred on sale of other shares.

This ruling provides useful guidance on the interplay between the exemption provisions and the capital loss set-off mechanism under the Act and reinforces that exemptions are to be given effect before applying the provisions governing intra-head adjustment of capital losses.