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Sale of mortgaged property by mortgagee — Capital gain — Is the amount of ‘Consideration’ gross or net ?

Subject : Income Tax Law
Month-Year : Jan 2002
Author/s : Kishor Karia
Rajendra Chitale

Chartered Accountants
Topic : Sale of mortgaged property by mortgagee — Capital gain — Is the amount of ‘Consideration’ gross or net ?
Article Details :

1.1   Introduction :
For the purpose of computing capital gain, cost of acquisition (and cost of improvement, if any) and expenses connected with the transfer are required to be deducted from the full value of consideration received or accruing as a result of transfer of capital asset (hereinafter such consideration is referred as ‘Consideration’) as provided in S. 48 of the Income-tax Act, 1961 (the Act). This is subject to provisions relating to indexation in case of transfer of long-term capital asset as provided in that Section with which we are not concerned.
1.2  

Many a time, the property belonging to the assessee is mortgaged with the lender, creditor etc. to provide security for the loan etc. (herein- after such lender or creditor is referred to as mortgagee). In such cases, if the owner of the property who has borrowed money (or incurred any debt) on security of such property does not discharge his debt, then in that event, many a time, the mortgagee sells such property as per the terms agreed between the parties and realises the amount due to him and balance, if any, is given to the owner of the property. In such cases, the issue has come up in the past as to whether for the purpose of computing capital gain in the hands of the owner, the actual amount realised by the mortgagee on sale of such property (‘gross amount’) should be treated as ‘Consideration’ or the amount paid by the mortgagee to the owner of the property after deducting amount due to him (‘net amount’) should be treated as ‘Consideration’. The preponderant view in the profession has been that in such cases the ‘gross amount’ should be treated as ‘Consideration’. However, in some Tribunal decisions view was taken that, in such cases, it is the ‘net amount’ of ‘Consideration’ which should be taken into account for computing capital gain. Such a view also got support from the judgement of the Andhra Pradesh High Court in the case of Attili Narayana Rao.

1.3  

Recently, the Supreme Court had an occasion to consider the above referred judgement of the A.P. High Court and hence it is thought fit to consider the same in this column.

CIT v. Attili Narayana Rao — 233 ITR 10 (A.P.) :

2.1  

In the above case, the assessee was an individual and the issue of the type referred to in para 1.2 above came up for consideration before the High Court for the A.Y. 1982-83. In that case, the assessee carried on abkari business during the financial years 1970-71 and 1971-72. He had mortgaged his immovable property to the Excise Department as security for the amount of Kist due to the Government. Ultimately, the Government sold the property in public auction without intervention of the Court and realised a sum of Rs.5,62,980. Out of the said amount, the Government deducted a sum of Rs.1,29,020 due to it towards the arrears including interest and paid the balance amount to the assessee. It appears that Rs.5,000 was deducted from the total sale price and accordingly, the amount of sale price was treated as Rs.5,57,980. For the purpose of computing capital gain in the hands of the assessee, the Revenue took the view that the amount of ‘Consideration’ should be Rs.5,57,980 (i.e. ‘gross amount’) and on the other hand, the assessee contended that for this purpose, the ‘Consideration’ should be the ‘net amount’ (i.e. Rs.5,57,980 less Rs.1,29,020). We are not concerned with the ultimate amount of capital gain computed and therefore, the other facts relating to the same are not given. The order of the Assessing Officer was confirmed by the First Appellate Authority.

2.2  

When the matter came up before the appellate Tribunal to decide the issue, the Tribunal decided the issue in favour of the assessee relying on the judgement of the A.P. High Court in the case of Bilquis Jahan Begum, (150 ITR 508). It may be noted that the A.P. High Court in the said case has actually held that while computing capital gain on sale of inherited property by the legal heir, the estate duty paid cannot be deducted. Such a view has subsequently been confirmed by the Apex Court also in the case of RM. Arunachalam, (227 ITR 222). It appears to us that, the Tribunal in this case has actually relied on some of the observations of the A.P. High Court in that case. Otherwise, the said judgement does not, in any way, support the case of the assessee.

2.3  

When the matter came up before the A.P. High Court at the instance of the Revenue, the Court after referring to the facts of the case, refer-red to hereinbefore, noted as under (page 12) :

“The Tribunal held that the assessee held the property subject to the mortgage deed or a charge due to the Government. There is a clear charge or mortgage over the same property which was subsequently sold by public auction. The amount realised under the charge or mortgage is the amount which never reached the hands of the assessee but which reached the Government by overriding title. The Income-tax Officer in his assessment order clearly stated that the Excise Department deducted Rs.1,29,020 from the sale proceeds and paid the balance only to the assessee.”

2.4  

After noting the above referred view of the Tribunal, the Court held as under (pages 12-13) :

“We agree with the view expressed by the Tribunal. The undisputed fact is that the property was mortgaged to the Government and thereby an interest in property is created in favour of the Government. When the property was sold by public auction, the value of the property can be reduced to the extent of interest that was created in favour of the Government by mortgage. Therefore, what the assessee got is the price minus the value of the interest of the Government in whose favour the mortgage was created. Therefore, what the assessee got is the value after deducting the amount payable to the Government on the mortgage. Therefore, the Tribunal is right in its view that the capital gains is to be calculated after deducting the amount paid to the Government on the mortgage.”

  2.4.1

The Court also mentioned that it is not necessary to refer to the judgement in the case of Bilquis Jahan Begum (supra), as the Tribunal has relied on the said judgement.

2.5  

The Court finally took the view that it is the ‘net amount’ of ‘Consideration’ which should be taken into account while computing capital gain in such cases.

CIT v. Attili N. Rao — 252 ITR 880 (SC) :

3.1  

The judgement of the A.P. High Court referred to in para 2 above came up before the Apex Court for consideration at the instance of the Revenue. The Court noted the facts of the case referred to hereinbefore. The Court also noted the view of the Tribunal referred to by the High Court. The Court also noted that the High Court observed that the undisputed fact was that the immovable property was mortgaged to the State and thereby an interest in the property was created in favour of the State. When the immovable property was sold by public auction, its value had to be reduced to the extent of the interest that was created in favour of the State by reason of the mortgage.

3.2  

After referring to the view of the Tribunal as well as the High Court referred to hereinbefore, the Court reversed the judgement of the High Court and held as under (page 883) :

“We are of the view that the Tribunal and the High Court were in error. What was sold by the State at the auction was the immovable property that belonged to the assessee. The price that was realised therefore belonged to the assessee. From out of that price, the State deducted its dues towards ‘kist’ and interest due from the assessee and paid over the balance to him. The capital gain that the assessee made was on the immovable property that belonged to him. Therefore, it is on the full price realised (less admitted deductions) that the capital gain and the tax thereon has to be computed.”

Conclusion :

4.1   In view of the above judgement of the Apex Court, it is now clear beyond doubt that in a case where the property is mortgaged for securing the debt and subsequently, if the mortgagee sells the property and recovers the amount due to him and pays the balance of the sale price, if any, to the owner of the property, then, the ‘gross amount’ should be taken as the ‘Consideration’ for computing capital gain in the hands of the owner of the property.
4.2  

We may also state that the Apex Court in the case of RM. Arunachalam, (227 ITR 222) has also held that the amount paid for discharging mortgaged debt created by the previous owner is to be treated as cost of acquisition for computing capital gain. This is also followed by the Apex Court in the case of V.S.M.R. Jagdishchandran, (227 ITR 240). We have analysed this judgement in this column in December, 1998 issue of the Journal.

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