Decoding capital gains taxation on leasehold and tenancy rights sale

According to Section 2(14) of the Income Tax Act, "capital asset" means rights in or in relation to an Indian property.

When you sell a property or transfer some rights that go with it, like leasehold or tenancy rights, the proceeds you make from the sale may be taxable as "Capital Gains." But capital gains tax on these rights is tricky because they're not absolute ownership rights like freehold property. Here's what the Indian tax law says.

What are leasehold and tenancy rights?

Leasehold rights are the right to occupy or use a property for a fixed term under a lease, generally issued by a development authority or the government. You don't own the land but have rights for a limited period, often 30, 60, or 99 years.

Tenancy rights are rights obtained by tenants, frequently under rent control legislation, that provide them with protection from eviction and occasionally the capacity to transfer or assign such rights for consideration, particularly in metro cities such as Mumbai and Kolkata.

Are leasehold and tenancy rights capital assets?

Yes. According to Section 2(14) of the Income Tax Act, "capital asset" means rights in or in relation to an Indian property. This implies that tenancy rights and leasehold rights are considered capital assets. Therefore, if you sell or transfer such rights for consideration, any profit is considered as capital gains.

How is capital gains tax computed?

1. Leasehold rights

• If you transfer leasehold rights prior to converting them into freehold, the gain is subject to tax as a capital gain.
• The cost of acquisition is what you paid to obtain the leasehold rights (if any), plus registration fees or stamp duty.
• If the leasehold interest was obtained gratuitously or without expense (such as under inheritance or gift), and no acquisition cost is ascertainable, the whole proceeds can be taxed as capital gains—but this has created legal uncertainty in the past.
• Holding period decides whether it is long-term (over 24 months) or short-term (up to 24 months), and the rate of tax is applicable accordingly (20% indexed for long-term, marginal rate for short-term).

•  If you received compensation for giving up tenancy rights, it is a transfer and subject to capital gains tax.
•  In CIT v. D.P. Sandu Bros. Chembur (P) Ltd. (2005), the Supreme Court made it clear that tenancy rights are capital assets and that their transfer is taxable.
• Acquisition cost of tenancy rights is problematic. Where the tenancy was purchased without consideration (as in most earlier cases), courts have held that no capital gains can be taxed, as in Section 55(2)(a), which provides cost is to be taken as nil only when rights were bought for a consideration. Here, some courts have held that the full amount is taxable as capital gains, but others have decided in favour of the assessee.
• Like leasehold, holding period determines whether it would be taxed as short- or long-term capital gain.

• When you convert leasehold property to freehold before selling, the holding period is determined from the date of acquisition of the leasehold rights, not the date of conversion.
• This has been held in a number of court decisions and CBDT circulars.

Yes, if the gain is long-term, indexation of the cost of acquisition is permitted under Section 48, which reduces your taxable gain by taking into account inflation.

Reporting and compliance

• Say the capital gain in your ITR under the "Capital Gains" schedule.
• You might be eligible to claim exemption under Section 54EC (by investing in specified bonds) or Section 54F (if you reinvest proceeds into residential property) subject to terms.