The Finance Act 2014 which was presented by Arun Jaitley has brought in several amendments one of which is Section 56(2)(ix) which deals with tax treatment of advance forfeited on the sale of property.

Section 56(2)(ix) – Advance Forfeited on Sale of Property taxable under head Other Sources

Any amount received as Advance or otherwise in the course of negotiations for transfer of a capital asset which has been forfeited by the Seller for non-compliance by the buyer with the clauses in the Agreement would now be taxable as Income under head Income from Other Sources.

After being included under head Other Sources in the Income Tax Return, this amount would be taxable as per the Income Tax Slab Rates of the Individual.

Old Law with respect to Amount Forfeited on Sale of Property

Earlier the amount forfeited on the sale of asset was reduced from the Cost of Acquisition of Asset. As the Cost of Acquisition was reduced, the net gains on the Sale of Property would automatically increase.

The old and the New Provisions can be explained with the help of the following Illustrations:-

Mr. A purchased a property for Rs. 15 Lakhs in 2003 and sold it to Mr. B in 2014 for 85 Lakhs and received an advance of Rs. 5 Lakhs for the same.

The deal didn’t materialise as Mr. B was unable to make the Balance Payment as a result of which Mr. A forfeited the entire amount. Mr. B now intends to resell this property to Mr. C for Rs. 95 Lakhs in 2016.

Tax Treatment under New Law

Tax on amount forfeited in 2014:- Advance forfeited of Rs. 5 Lakhs in 2014 would be taxable under head Income from Other Sources in the year of Receipt.

Tax on Sale in 2016:- Long Term Capital Gains = Sale Price (-) Indexed Cost of Acquisition

Tax Treatment under Old Law

Under Section 51, the amount forfeited of Rs. 5 Lakhs was required to be subtracted from the Cost of Acquisition i.e. 15 Lakhs. Therefore, the net cost of acquisition would be Rs. 10 Lakhs (15 Lakhs – 5 Lakhs). This Cost of Acquisition would be indexed and then subtracted from the Sale Price to arrive at the Long Term Capital Gains.

It is to be noted here that under the Old Law – no tax was required to be paid in the year in which the advance was forfeited and is only liable to be paid in the year of actual sale.

However, under the New Law – tax would be required to be paid both in the year of forfeiture as well as in the year of Sale.

Reasons for Introduction of Section 56(2)(ix):- Change in Tax Treatment of Amount Forfeited

There were several problems and complexities in the old law and many a times it was also used to regulate the unaccounted money and therefore the new law has been introduced with Section 56(2)(ix) coming into force from Assessment Year 2015-16 onwards. A proviso for the same has also been inserted in Section 51 for the same so as to ensure that double taxation does not happen.

Other Reasons for Introduction of Section 56(2)(ix) are as follows:-

  1. Under the Old Law if advance has been forfeited it was not taxable in the year of receipt but taxable in the year of Actual Sale of the Property.
  2. If the amount was received in the year in which the Period of Holding was Short Term and the actual sale happened in the year in which the Period of Holding was Long Term – the total transaction was regarded as Long Term. Therefore, the seller was required to pay only 20% of the amount as Long Term Capital Gains Tax and could also claim Exemption under Section 54 & Section 54F.
  3. There was difficulty in ascertaining the Indexed Cost of Acquisition as the Indexation was allowed only after reducing the amount forfeited.

Tax Treatment in the hands of the Buyer

  1. The amount paid by the Buyer which has been forfeited does not amount to relinquishment of a right and therefore would not be allowed to be claimed as a Capital Loss.
  2. If the Seller fails to honour the deal and pays back the Buyer the advance as well as some amount because of failure to dishonor the deal, this amount would be treated as Capital Gain because it amounts to relinquishment of a right by a buyer.
  3. The amount forfeited which was paid for purchase of a Commercial Building will not be regarded as Revenue Loss.