Surplus on sale of agricultural land is capital gain

Under the last will and testament of F.E. Dinshaw, a life interest was created of his share in the land in favour of his daughter, Bachoobai, a reversionary interest being created in favour of two U.S. based charities.  By a judgment of the Bombay High Court dated 21.12.1972, W was appointed as sole administrator of the estate.  The other half share was bequeathed to E.F. Dinshaw. 

On 27.12.1973, Bachoobai leased out 72 acres of the lands jointly owned by her and her brother to a company by the name of Haven Kores Real Estate Pvt. Ltd. for a period of ninety nine years.  On 29.3.1973, Bachoobai created three charitable trusts :

(i) F.M. Dinshaw Foundation – with a corpus consisting of the reversionary interest of herself and the administrator in the land leased to Haven Kores Real Estate  Pvt. Ltd. ;

(ii) F.E. Dinshaw Charities – consisting of the corpus of mostly tenanted properties jointly owned ; 

(iii) F.E. Dinshaw Trust – with a corpus consisting of mainly leased and unencumbered free land of F.E. Domshaw Estate jointly owned by her and her late brother. 

From early times, different portions of the property were leased out to various persons against the payment of ground rent for the purposes of constructing house properties. Over time, a large part of the land was encroached upon.  From November, 1968, agreements to sell were executed in respect of different portions of the land. 

Before any sale deed could be entered into, permission was required to be taken of the Charity Commissioner under section 36 of the Bombay Public Trusts Act, 1950.  Since E.F. Dinshaw and Bachoobai were not citizens of India, permission was also required under the Foreign Exchange Regulation Act, 1973. 

The provisions of the Urban Land (Ceiling and Regulation) Act, 1971, rendered some parts of the land as surplus.  Permissions were also required to be taken under Chapter XX-C of the IT Act.  After permissions were taken and the conveyances were finalized upon registration, there was a surplus which the assessee claimed as a long-term capital gain. 

When the matter came up before the Assessing Officer during the course of assessment proceedings, the Assessing Officer held that there that there was a steady, systematic and continuous process of selling portions of the property for making profits in the real estate. 

According to the Assessing Officer, the nature of expenses debited to the income and expenditure account, the quantum, the activities and the manner in which the value of the trust properties was reduced, was suggestive of the fact that the lands were purchased only for the purpose of earning profit. 

The profit arising from the sale of the land was treated as business income.  In appeal, the CIT (Appeals) held that the mere ownership of the land did not constitute trade.  The Commissioner of Income-tax (Appeals) held in favour of the assessee on the basis of the following findings : (i) neither of the assessees had purchased the land themselves. 

The land had been purchased by the late F.E. Dinshaw nearly seventy years earlier when the growth of Mumbai to its present state could not have been foreseen ; (ii) the land was purchased as a source of earning income from ground rent ; (iii) encroachment took place after 1947 whereupon it became difficult to protect open land. 

In selling the land, the assessees had been motivated more by the desire of protecting their corpus than of earning profits ; (iv) the assessees were trusts or the administrator of the estate and could not enter into the business of selling land.  

The Income-tax Department filed appeal to the Income-tax Appellate Tribunal.  When the matter came up before the Income-tax Appellate Tribunal, The Tribunal had relied upon the following circumstances in support of its conclusion that the income that was realized upon the sale of the lands constituted capital gains and not business income : 

(i) The late F.E. Dinshaw had no intention to trade in the lands at the time of purchase.  After the purchase of the lands in 1923, there was no sale thereafter for nearly thirty-five years ;    

(ii) The late F.E. Dinshaw was far from any business in real estate   and, therefore, this was not a case where a transaction can be regarded as being relatable to the business which was normally carried on by the assessee ;   

(iii) In the present case, there was no activity such as in the nature of improvements on the lands, for instance, by laying drainage lines, electricity, levelling or construction of roads.  The fencing of the land and the construction of the compound well were only intended to protect the property and not to carry out improvements ;      

(iv) Though the extent of the sales had increased over time, compared to the vast extent of holding, the sales could not be regarded as expensive. Morever, while there were sales of some parts of the land, there was no corresponding activity involved of purchases ; 

(v) The repurchase of about a hundred acres of land which had been declared surplus under the Urban Land Ceiling Act was not a purchase in the commercial sense since it constituted nothing but a retention of the property which was earlier vested in the assessees

(vi) The  property  was  purchased nearly seventy years earlier and it could not be  expected  that  it  should remain vested indefinitely.  The sale of the property was explained by the fact that there were encroachments on the lands leading to heavy litigation and expenditure on account of which it became necessary to sell parts  of  the  land. 

On  the  evaluation  of  the  record  and  having regard to the aforesaid circumstances, the Tribunal affirmed the view  of  the Commissioner of Income-tax (Appeals) that the income generated from the sale of land during the Assessment years in question, should be treated as capital gains.

Finally, while deciding this important issue the Honourable judges of the High Court were of the view that a large tract of land of nearly 2500 acres was acquired in or about the year 1923 by the late F,E. Dinshaw.  F.E. Dinshaw  was a solicitor.  The acquisition of the land was evidently not motivated by an adventure in the nature of trade.

The statement of case makes it clear that there was no transaction involving the sale of the land during his life time. Secondly,    neither E.F. Dinshaw nor for that matter Bachoobai purchased the land. 

The land had devolved on E.F. Dinshaw and upon Bachoobai by testamentary succession.  Thirdly, upon the death of F.E. Dinshaw in 1936, there was no transaction involving the sale of the land for a period of nearly sixty five years since the purchase of the land. 

Fourthly, the assessee in the present case, is the administrator of the estate of the late E.F. Dinshaw.  Half  the interest of the land devolved upon E.F.Dinshaw under the will that was executed by his father F.E. Dinshaw.  Fifthly, both the Commissioner of Income-tax (Appeals) and the Tribunal have rendered concurrent findings of fact. 

The finding of fact recorded by the Tribunal is that since independent encroachments gradually took place over certain areas of the land.  The sale of the land was not motivated by a desire to make a profit, but to protect the corpus and the resulting expenditure due to litigation. 

The finding of the Tribunal is also to the effect that there were no improvements on the land by way of laying out drainage, levelling or construction of roads. 

Though an area admeasuring about a hundred acres was repurchased, the Tribunal recorded that this was hardly a purchase in the commercial sense since it was a repurchase of lands which were declared as surplus under the Urban Land Ceiling Act. 

Finally after discussing many important decided case laws on the subject the Honourable judges of the High Court came to the conclusion that the surplus that was realized on sale of the land was in the nature of capital gain.

The author is tax & investment consultant at New Delhi for last over 40 years. He is also Director of M/s R.N. Lakhotia & Associates & The Strategy Group.