Capital Gains Taxation | Cost of Improvement Must Be Allowed Despite Lack of Documents : Income Tax Appellate Tribunal

The Income Tax Appellate Tribunal, Bangalore has established a critical precedent in capital gains taxation by holding that cost of improvement cannot be disallowed solely due to lack of documentary evidence. The judgment mandates that Assessing Officers must verify such claims through alternative means, including valuation reports, when primary documents are unavailable. This ruling significantly impacts tax assessments involving property transactions where construction or improvement costs are disputed.

Background & Facts

The Dispute

The appellant, M/s. Crystal Ice and Cold Storage, a partnership firm engaged in cold storage operations, faced a reassessment under Section 147 of the Income Tax Act, 1961. The Revenue initiated proceedings after receiving information about a TDS statement under Section 194IA reflecting a property sale of Rs. 70,00,000. The Assessee had disclosed a capital gain of Rs. 10,43,896 in its return filed under Section 148, claiming deductions for the cost of acquisition and subsequent improvements to the property.

Procedural History

The case progressed through the following stages:

• 2023: Notice under Section 148 issued for reopening assessment
• 2024: Reassessment order passed under Section 147 read with Section 144B, disallowing Rs. 38,19,957 towards cost of improvement and brokerage
• 2025: Appeal before the National Faceless Appeal Centre dismissed for non-compliance with notices
• 2025: Appeal filed before ITAT Bangalore

The Parties' Positions

The Assessee contended that:

• It had purchased land with an old building in 2004, demolished it, and constructed a shed in 2005-06
• The indexed cost of acquisition and improvement was Rs. 58,87,104, resulting in a capital gain of Rs. 10,43,865
• Brokerage payments of Rs. 60,000 were made through bank transactions

The Revenue argued that:

• The Assessee failed to furnish complete details during assessment proceedings
• No documentary evidence was provided for the claimed improvements and brokerage
• The return was filed only in response to Section 148, not under Section 139(1)

The Legal Issue

The central question before the Tribunal was whether the Assessing Officer could disallow the cost of improvement and brokerage expenses in capital gains computation solely on the ground of lack of documentary evidence, without making any effort to verify the claims through alternative means.

Arguments Presented

For the Appellant

The Assessee's counsel argued that:

• The property sold was materially different from the one purchased, as evidenced by the sale deed
• While detailed construction documents were unavailable, the Assessee had provided bank statements for brokerage payments
• The Assessing Officer failed to exercise powers under the Act to verify the claims, including seeking valuation reports
• The CIT(A)'s ex-parte order was unjustified as it did not consider the merits of the case

For the Respondent

The Revenue contended that:

• The Assessee's failure to respond adequately to notices justified the disallowance
• No primary documents were furnished to substantiate the cost of improvement
• The return was not filed under Section 139(1), raising questions about its validity
• The Assessing Officer had no option but to disallow the claims in the absence of evidence

The Court's Analysis

The Tribunal conducted a meticulous examination of the burden of proof in capital gains assessments and the powers of the Assessing Officer under the Income Tax Act. The analysis centered on three key principles:

1. Substance Over Form in Property Transactions The Tribunal observed that the property sold was not identical to the one purchased:

"The above facts clearly show that Assessee purchased a plot of land on which old building was constructed. According to the sale deed, the Assessee submits that Assessee has sold constructed property wherein the construction of shed was done in 2005-06 at the total cost of Rs. 13,52,600. Therefore, in fact there is a difference between the property which was purchased by the Assessee, and which is sold by the Assessee."

This finding established that some form of improvement had occurred, warranting deduction.

1. Assessing Officer's Duty to Verify Claims The Tribunal held that the Assessing Officer cannot adopt a mechanical approach to disallow claims:

"To determine the cost, the Assessing Officer has been given wide powers. He could have taken the help of valuation officer also. Further, with respect to the details of brokerage paid by the Assessee of Rs. 60,000, the Assessee has given complete details of the name of the persons along with the date of payment to these parties. The Ld. Assessing Officer has disallowed the same despite producing the above information before him."

The judgment emphasized that Section 142A empowers the Assessing Officer to refer matters to a valuation officer when primary evidence is lacking.

1. CIT(A)'s Failure to Adjudicate Merits The Tribunal criticized the CIT(A) for dismissing the appeal without examining the core issue:

"The order of the Ld. CIT(A) cannot be sustained that despite the fact available that whatever is sold by the Assessee chargeable to tax under the head capital gain, the capital cost of the same deserves to be granted while working out capital gain. This simple fact was not adjudicated by the Ld. CIT(A)."

This observation underscored the importance of natural justice in appellate proceedings.

The Verdict

The Tribunal allowed the Assessee's appeal for statistical purposes and restored the matter to the Assessing Officer with the following directions:

1. The Assessee must substantiate the construction of the shed through municipal permissions or registered valuer's report
2. The Assessing Officer must verify the claims, including seeking a valuation officer's report if necessary
3. The cost of improvement must be allowed if the Assessing Officer is satisfied with the evidence
4. The brokerage claim of Rs. 60,000 must be examined based on the bank transaction details provided

What This Means For Similar Cases

Assessing Officers Must Verify Claims, Not Merely Disallow

Tax practitioners should note that:

• Lack of documents is not fatal to claims of cost of improvement or brokerage
• Assessing Officers are obliged to verify such claims through alternative means, including:
  • Referral to valuation officers under Section 142A
  • Examination of municipal records for construction permissions
  • Cross-verification of bank transactions for expenses
• Ex-parte orders without merit adjudication are vulnerable to challenge

Burden of Proof in Capital Gains Cases

The judgment clarifies that:

• The initial burden lies on the assessee to provide prima facie evidence of improvements
• Once a plausible claim is made, the onus shifts to the Revenue to disprove it
• Indexed cost of improvement must be allowed if the property sold is materially different from the one purchased

Procedural Safeguards in Reassessment

Key takeaways for reassessment proceedings under Section 147:

• Section 148 returns cannot be treated as invalid merely because they were not filed under Section 139(1)
• Non-compliance with notices does not automatically justify disallowance of claims
• CIT(A) must adjudicate the merits of the case, even if the assessee is non-cooperative