Is interest on home loan treated as a cost of acquisition for calculating capital gains tax on sale of a house?

A common question often which arises in the mind of the tax payers is that if someone takes a housing loan and pays interest towards it for acquiring a property, is the payment of interest considered as a cost of acquisition when such property is sold.
Section 24 of the Income Tax Act permits to treat the interest on home loan as a deduction at the time of calculating income from house property.
However another issue arises about calculating capital gains tax when such property is sold. The Income Tax laws allow reduction of capital gains by adding some expenses to the cost of acquisition of the said property.

Interest Payment as Cost of Acquisition:

Sections 48, 49 and 55 of the Income Tax Act deal with the cost of acquisition of a capital asset at the time of calculating capital gains. But the provisions do not state whether interest paid towards housing loan can be considered as cost of acquisition at the time of calculating capital gains when a house is sold.

Judicial decisions:

In some judgments it has been held that interest paid towards housing loan can be considered as cost of acquisition of house property.
The Income Tax Appellate Tribunal at Chennai in the case of Assistant Commissioner of Income Tax, Business Circle IV, Chennai – 34, vs. C. Ramabrahmam, PAN:AACPR0103K, has held that interest on home loans shall remain out of the periphery of income tax even if the house is sold at a later stage.

Brief facts of the case:

This was an appeal preferred by the Revenue against the order of the Commissioner of Income Tax (Appeals) – VIII, Chennai dated 24.01.2012 passed in ITA No. 53/09-10(A)-VIII relating to the assessment year 2007-08 in proceedings initiated under the provisions of section 143(3) of the Income Tax Act, 1961.
In the instant case, the assesee C. Ramabrahmam borrowed money for the purpose of purchasing property and claimed deduction for interest paid towards the loan at the time of computing income from house property.
The assessee filed his return of income declaring income of Rs.6, 40,440/-. At the time of scrutiny, the Assessing Officer observed that the assessee had purchased a house at T. Nagar, Chennai on 20.01.2003 fro Rs. 32.64 lakhs and he paid Rs.4.00 lakhs for its registration and added Rs. 39,926/- as cost of improvement. In total, the assessee paid Rs.37, 03,926/-. In the return, the assessee mentioned an amount of 4, 82,042/- as interest towards home loan taken for purchasing the property. The assessee sold the house on 20.04.2006 for Rs. 26.00 lakhs.
However, when the said house was sold, the assessee considered the interest paid towards his loan as “cost of acquisition” for calculating capital gains and claimed deduction for the same.
After considering the above facts, the Assessing Officer refused to allow the deduction due to the reason that interest has been allowed as per section 24 (b) of the Income Tax Act which deals with income from house property and the deduction cannot be allowed again at the time of calculating capital gains arising from the sale of the property.
The Assessing Officer rejected the contention of the assessee by holding that since there was no regularity in granting loans by the assessee; the same could not be called as a business activity though the assessee incurred some expenses towards payment of interest.
The Revenue contended that allowing such deduction under both the provisions of section 24(b) and 48 would result in “double deduction”.
The Commissioner (Appeals) allowed the claim of the assessee but the department moved before the Income Tax Appellate Tribunal being the second appellate authority against the said order. The Appellant was represented by the learned counsel Shri Guru Bashyam, IRS and the Respondent was represented by Shri Ananda Kumar, C.A.

Issue that arose before the Tribunal:

In the instant case, the main issue that arose before the Tribunal was whether “interest paid towards housing loan” should be treated as “cost of acquisition” at the time of computing capital gains according to section 48.
Section 48 lays deals with the method of calculating capital gains. According to the provisions of section 48, capital gains is computed by deducting two items from the consideration amount, which are cost of acquisition or improvement and cost of transfer.
The term “cost of acquisition” has nowhere been defined in section 48. However section 55(2) defines the expression in some particular cases. “Cost of acquisition” is the value for which a property is acquired. It may increase in a subsequent year for any liability or expenses incurred after the acquisition. One such expense is interest paid towards loan borrowed for payment of consideration of the property. In the case of CIT v. K. Raja Gopala Rao (2001) 252 ITR 459 (Mad), it has been held by the Hon’ble Madras High Court that expenses paid on account of interest is a part of “cost of acquisition”.
The Hon’ble Karnataka High Court in the case of CIT and ITO v Hariram Hotels (P) Ltd. (2010) 229 CTR 455, has held that interest on housing loan is a part of cost of acquisition of the buyer.

The judgment:

The ITAT dismissed the appeal for the reason that deduction under section 24 (b) of the Act and computation of capital gains as per section 48 of the Act falls under separate heads of income. Section 24 (b) of the Income Tax Act deals with house property and section 48 of the Act deals with capital gains. The first deduction was claimed when the assessee computed income from house property and the second claim was made when he sold the house and capital gains arose.
The ITAT held that both the aforesaid provisions are different, the assessee can rightly claim deduction of interest paid towards loan at the time of computing capital gains. It was further held that interest on housing loan can get the benefit of deduction under both the heads “Income from house property” and “Capital gains”.
The ITAT clarified that the interest paid towards loan amounts to an expenditure which should be considered while computing the income from house property and also at the time of computing capital gains arising from sale of the house. The Tribunal allowed the claim for deduction for housing loan interest under both the said provisions. The order was passed on 31.10.12 by a double bench comprising of OK. Narayanan and S.S. Godara.
The judgment attempts to give an overall view of the consequences of payment of interest towards loan taken for acquiring a property while computing capital gains arising from its sale.