On 31 October 2012, the Income Tax Appellate Tribunal (ITAT) delivered an order that is set to bring an unexpected relief to millions of home buyers in the country. It clarified that the interest paid on home loans is an expense to the home buyers and hence is to be counted as a cost to them. Thus, when they sell the house, the capital gains on its sale will be the sale price less the purchase cost and all the interest that they paid on its home loan, if availed of.

So far, capital gains on the sale of a house were its sale price less the purchase price. The only relief available was for LTCG (long-term capital gains) (ie, if the house was held for at least 3 years after its possession) where the cost of purchase and its improvement could be indexed to the CII (Cost Inflation Index). For short term capital gains, no indexation relief could be availed of. As far as the interest on housing loan was concerned, its advantage was available under Income Tax Section 24(b) where yearly relief of Rs 30,000 or 1.5 Lakhs for self-occupied property, and interest paid less the rent for rented out property was available. There was no relief available on capital gains for the interest paid.

The case under consideration of the tribunal was of a tax payer C Ramabrahmam, who borrowed money for buying a house property. He claimed deduction for the home loan interest paid while computing income from house property. When he sold the house, he also treated the interest paid as his ‘cost of acquisition’ of the house and claimed deduction there too. The income Tax assessing officer disallowed it. Matter went to the first appellate authority, Commissioner (Appeal), who allowed the claim of the taxpayer. Income Tax department appealed but even the ITAT has now sided with the tax payer holding that deduction under IT Section 24(b) deals with house property while the capital gains IT Section 48 deals with only the gains and the two can co-exist separately since they are covered under different heads of the income.

To illustrate the effect of this ruling, consider the case of a person X who buys a house for Rs 30 Lakhs in 1997, takes a home loan of Rs 24 Lakhs (80% of value) paying an EMI of Rs 23,672 for 15 years at average 9% per annum interest rate. The total interest outgo is about Rs 18.6 Lakhs over 15 years. Let’s say he sells it for Rs 1.87 crores in 2012 (taking a good 13% per annum appreciation). Using normal method of indexation, his cost of acquisition comes to Rs 73.77 Lakhs, capital gains is Rs 1.13 Crores and he pays a tax of Rs 35 Lakhs on it if he is in 30% tax bracket. However, if the ITAT judgement delivered now stands, his cost of acquisition (counting indexed payment of interest also) would be Rs 1.12 Crores, capital gains would be Rs 74.6 Lakhs and he would have to pay a tax of only Rs 23 Lakhs. Thus, he saves tax to the extent of Rs 12 Lakhs, ie a saving of about 35% of tax.

Now the question uppermost in everybody’s mind should be – will this ruling by the ITAT go unchallenged by the Income Tax department, given the large revenue loss that the Govt is likely to face. It is very unlikely that the Govt will let the matters lie at this point. The course open to Income Tax Department now is to go to the higher courts – first High Court, then Supreme Court and if even then there is no favourable ruling, a change in Income Tax Act itself should not be ruled out. What if anybody files his Income Tax Return as per new ruling in the intervening period? It will have to be allowed by the Income Tax assessing officer but chances of it being rolled back are also equally high if the Income Tax department gets a favourable ruling at any stage.

Another pertinent point is – will the interest paid at different points of time be allowed to be indexed? In case the interest is allowed as a cost as per the recent ruling, to my mind, there should be no dispute that indexation will have be allowed in the interest cost, as it is allowed currently in the cost of improvement or renovation of the house property.