Court directs payment of 20% of correctly computed tax demand, stays balance pending appeal; clarifies no opinion on merits of exemption claim under Section 54F for contiguous flats
In a significant ruling dated November 2, 2026, the Bombay High Court (Division Bench of Justices B.P. Colabawalla and Farhan P. Dubash) addressed the contentious issue of tax liability computation under Section 54F of the Income Tax Act, 1961, arising from the purchase of two contiguous flats by the petitioner, Mr. Nilesh Ramesh Modi. The petitioner had claimed exemption on capital gains arising from the sale of certain assets by investing in two adjacent flats in the Piramal Mahalaxmi project, intending to use them as a single residential house.
The Income Tax Officer (ITO) disallowed the exemption for one of the flats (Flat No. 4107), treating it as a separate residential house, and added the entire investment amount for that flat to the petitioner's income, resulting in an inflated tax demand. Moreover, the tax computation attached to the assessment order showed a capital gain figure exceeding the total sale consideration, indicating a computational error.
The petitioner challenged the assessment order and sought rectification and stay of demand, contending that even if exemption was not available for the second flat, only proportionate capital gains should be added to income as per Section 54F(1)(b). The Revenue maintained that the issue of whether two flats could be treated as one residential house was pending appellate adjudication and that the rectification application was not maintainable under Section 154.
The Court, however, refrained from expressing any opinion on the substantive question of whether two contiguous flats could constitute "one residential house" under the amended Section 54F. Instead, it focused on correcting the evident computational error in determining the tax demand. The Court held that the Assessing Officer's addition of the entire investment in the second flat to income was manifestly incorrect and that capital gains should be computed proportionately when the cost of the new house is less than the net consideration.
Accordingly, the Court directed that the petitioner pay only 20% of the correctly computed tax demand amounting to Rs.6,50,108 within one week. The recovery of the remaining demand of Rs.32,24,910 was stayed pending disposal of the appeal before the Commissioner of Income Tax (Appeals) and for four weeks thereafter. The Court also urged the CIT(A) to dispose of the appeal expeditiously, preferably by March 31, 2027, noting that the petitioner had already filed written submissions.
This ruling clarifies that while the appellate process will settle the substantive exemption claim, tax liability during the pendency of appeal must be computed in accordance with the statutory provisions to avoid manifest injustice. The judgment underscores the principle that under Section 54F(1)(b), if the cost of the new residential house is less than the net consideration, only proportionate capital gains are chargeable and not the entire investment.
The petitioner was represented by Senior Advocate Mr. Percy Pardiwala and others, while the Revenue was represented by Mr. P. A. Narayanan.
Bottom Line:
Income Tax - Section 54F - While considering stay of demand, tax liability must be computed in accordance with Section 54F(1)(b) - Even assuming exemption is not available for second flat as a separate residential unit, full investment in second flat cannot be added to income - In peculiar facts, Court reduced 20% deposit condition by correcting computational error and stayed balance demand pending appeal.
Statutory provision(s):
Income Tax Act, 1961 Sections 54F(1)(b), 133(6), 143(3), 154, 220(6)
