Most Indian cities have a large number of old buildings, substantially occupied by tenants. Many of these old buildings are in a dilapidated condition. Of late, such buildings are, therefore, either purchased by tenants, redeveloped by developers or purchased for development and sale by builders. The tenant either becomes the owner of his existing premises, or gets a new premises on tenancy basis or ownership basis, or receives a lump sum payment for vacating the premises and surrendering his tenancy. So what are the tax consequences of such transactions for the tenants?
When the tenant purchases his premises from the landlord by paying a certain amount to the landlord, it is not an exchange of tenancy for ownership, but acquisition of additional rights of ownership in addition to the rights of tenancy. As per the Transfer of Property Act, the lesser right of tenancy merges with the larger right of ownership in such a case. There are, therefore, no tax consequences of such acquisition of ownership for the tenant. If and when he sells this newly acquired ownership premises, for computation of capital gains, the date of acquisition would be the date from which the ownership was acquired from the landlord and the cost would be the amount actually paid to the landlord.
Tenancy is a protection granted by the law to the tenant, whereby he cannot be evicted from the premises. Tenancy right is an asset which is different from the property itself, but is a right connected to the property. The tax treatment is, therefore, different than for the immovable property itself. Undoubtedly, a tenancy right is a capital asset of the tenant in most situations. Earlier, surrender of a tenancy right for a lump sum price was not subjected to capital gains tax at all, if the tenancy had not been acquired for a price by the tenant, as the tenancy was then a no-cost asset. As held by the Supreme Court earlier, in case of no-cost assets, it was not possible to compute capital gains and, therefore, no capital gains could be charged to tax in such cases.
The law was amended from 1995 to subject such surrender of tenancy right to capital gains tax with the cost being deemed nil. Therefore, if the tenant receives a lump sum consideration for surrender of his tenancy right, such amount would be chargeable to tax as long-term capital gains (assuming that the tenancy was for at least three years) at 20%. Of course, the tenant would have the option to claim exemption by reinvesting the proceeds into a residential house or in bonds of National Highway Authority of India or Rural Electrification Corp. Ltd.
In rare situations where the existing building is demolished by a developer or the landlord and a new building is erected and the tenant is provided accommodation in the new building on a tenanted basis, it is a mere continuation of the existing tenancy of the tenant with no transfer of tenancy and such a transaction, therefore, does not attract any capital gains tax.
However, the most common situation is where the tenant temporarily vacates his premises, the building is demolished and reconstructed, and the tenant is provided premises in the new building on an ownership basis. In such a case, the tenant is exchanging his tenancy for the new premises on ownership basis. The market value of the new premises would be taken as the sale price of the tenancy right and the capital gains tax would be charged on such amount.
There is normally no difficulty in a situation where the tenancy has been in existence for at least three years and the new premises received in exchange is residential. In such a case, the tenant would be entitled to exemption of long-term capital gains for reinvestment in a residential house. The difficulty arises in a situation where the new premises received is not a residential house but a commercial premises. In such a case, there is no exemption for reinvestment in a commercial premises and, therefore, there is a liability to capital gains tax. In such situations, it may be more advantageous for the tenant to continue as a tenant in the new premises, with an option to purchase it at a future date on payment of a certain amount.
Tenancy is increasingly at risk due to amendment of laws. It may, therefore, be advantageous for a tenant to accept an offer for conversion to ownership, irrespective of the tax treatment. After all, taxes become payable only if there is a benefit.
Gautam Nayak is a chartered accountant.
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