A Complete Legal and Judicial Analysis on Tax Treatment When Property Is Not Acquired or Project Remains Incomplete
When the Dream House Becomes a Tax Question
Thousands of taxpayers invest in under-construction flats, expecting possession within a promised timeframe. Yet, delays, cancellations, or non-completion often result in the builder refunding the booking amount or instalments — sometimes with interest or compensation.
While emotionally distressing, such refunds pose a complex tax question:
“Is the refunded amount taxable — and if so, under which head and to what extent?”
The correct tax treatment depends on whether a capital asset or right to acquire property ever came into existence, and whether the loan interest claimed under Section 24(b) remains deductible when the property was never owned or completed.
Legal Framework — Statutory Provisions Involved
| Section | Provision | Relevance |
|---|---|---|
| Sec. 2(14) | Definition of “Capital Asset” | Determines if right in a flat qualifies as a capital asset |
| Sec. 2(47) | Definition of “Transfer” | Cancellation = extinguishment of right → taxable event |
| Sec. 45 | Charge of Capital Gains | Gains arising from transfer or extinguishment of capital asset |
| Sec. 54 / 54F | Exemption on reinvestment | Applicable if gain reinvested in another residential house |
| Sec. 56(2)(viii) | Income from Other Sources | Refund interest or compensation where no capital asset existed |
| Sec. 57(iii) | Deductions from Other Sources | Interest on borrowed funds for earning refund interest may be claimed |
| Sec. 24(b) | Interest deduction on house property loan | Permissible only for ownership-linked property |
| Proviso to Sec. 24(b) | Pre-construction interest handling | Allows amortization over 5 years post-possession |
| CBDT Circulars 471 & 672 | Clarify allotment as ownership event | Allotment confers capital asset status for exemption and holding period |
| Sec. 37(1) | General deduction (for business cases) | Not applicable to individual buyers unless for business property |
Key Determinant — Existence of “Right to Acquire Property”
The pivot of tax classification lies in determining whether a “right to acquire a specific property” ever existed. This depends on documentation:
| Scenario | Tax Implication | Reasoning & Legal Basis |
|---|---|---|
| Only booking form submitted, no allotment | No capital asset created → Refund taxable u/s 56 | Mere booking or token advance is not “property” or “right to property” |
| Allotment letter or buyer’s agreement issued | Right to acquire property = capital asset → taxable under capital gains on cancellation | Supported by CBDT Circular 471 (1986) and Ahmed G.M. Ariff (SC) — right to property = capital asset |
| Builder cancels allotment / project shelved | Extinguishment of right → transfer u/s 2(47) → capital gains taxable u/s 45 | Mukesh Sohanraj Vardhan v. ITO (2020) ITAT Mumbai — cancellation = transfer |
| Refund + interest paid by builder | Principal refund = capital recovery; interest portion taxable u/s 56(2)(viii) | Rajesh Jain v. DCIT (ITAT Delhi, 2018) — interest on delayed refund taxable as Other Sources |
Judicial & Interpretative Support
(a) Allotment Confers Ownership Rights
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CBDT Circular No. 471 (1986) and No. 672 (1993) — Allotment under a housing scheme gives rise to “ownership rights” even before conveyance or registration.
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Held in: CIT v. Podar Cement (P) Ltd. (1997) 226 ITR 625 (SC) — ownership can exist without registered title if possession and rights are transferred.
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Hence, once an allotment letter is issued, the buyer holds a capital asset.
(b) Cancellation = Transfer
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Mukesh Sohanraj Vardhan v. ITO (2020) 119 taxmann.com 316 (ITAT Mumbai):
“Cancellation of flat booking resulting in refund is an extinguishment of the right in immovable property and amounts to transfer u/s 2(47).”
The refund amount minus cost of acquisition is taxable as capital gain (short-term or long-term based on holding from date of allotment).
(c) No Allotment = No Capital Asset
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Jitendra Kumar Soneja v. ITO (2016) 76 taxmann.com 105 (Delhi ITAT):
“Mere booking without allotment or identification of specific flat does not create a capital asset; refund of such booking is not capital gain.”
(d) Interest on Refund — Taxable as Other Sources
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Rajesh Jain v. DCIT (Delhi ITAT, 2018):
“Interest on refund from builder is taxable under Section 56(2)(viii).”
(e) Interest Deduction u/s 24(b) — Only on Owned Property
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Abeezar Faizullabhoy v. ITO (2020) ITAT Mumbai:
“Section 24(b) benefit arises only when the property is acquired or constructed; if cancelled or unacquired, such interest cannot be claimed under ‘Income from House Property’.”
Computation & Practical Handling
| Component | Treatment | Explanation / Example |
|---|---|---|
| Refund of booking amount (no allotment) | Not taxable | Mere return of capital; no income element |
| Refund with interest (no allotment) | Interest taxable u/s 56 | Principal non-taxable; interest is income |
| Refund of instalments (with allotment) | Capital Gains | Right extinguished; sale consideration = refund amount |
| Refund with compensation (with allotment) | Capital Gains | Entire consideration taxable less cost |
| Interest already claimed u/s 24(b) | To be reversed/disallowed | Property never acquired; deduction invalid |
| Reinvestment in new property | Section 54 / 54F exemption possible | Within 2 years (purchase) or 3 years (construction) |
| GST refund received | Not taxable | Adjustment entry; coordinate with GST portal filing |
Practical Illustration
Example:
Mr. A booked a flat in FY 2020–21, paid ₹25 lakh as instalments, and received an allotment letter.
In FY 2024–25, the project was cancelled; builder refunded ₹28 lakh (₹25 lakh principal + ₹3 lakh interest).
Tax Analysis:
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Right to acquire flat existed → capital asset u/s 2(14).
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Cancellation = extinguishment → transfer u/s 2(47).
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Refund ₹28 lakh – cost ₹25 lakh = ₹3 lakh → taxable as Capital Gain.
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If ₹3 lakh represented interest on refund instead → taxable u/s 56.
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Section 24(b) interest earlier claimed → to be disallowed/reversed.
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Section 54 exemption can be claimed if Mr. A reinvests in a new residential property.
Section 24(b) Deduction — When It Fails
Section 24(b) allows deduction of interest on borrowed capital for acquisition or construction of property.
But if the property is never acquired or constructed, there is no "house property" under Section 22 — hence no deduction.
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Abeezar Faizullabhoy (ITAT Mumbai, 2020) – disallowed interest on cancelled booking.
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Pre-construction interest (five-year amortization) allowed only after possession.
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If refund interest is taxed u/s 56, interest on loan for earning that refund interest may be claimed u/s 57(iii) (if nexus proved).
Refunds in Delayed / Unfinished Projects
When builder fails to complete the project or offer possession:
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If allotment was issued → right subsists till cancellation → capital asset extinguished on refund → taxable as capital gain.
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If no allotment, only refund of advances → taxable interest component only.
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If refund compensation exceeds instalments → entire difference taxable as capital gain.
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If project is delayed but not cancelled → continue to treat as capital asset; no gain arises until cancellation or possession.
Compliance & Documentation Essentials
| Requirement | Purpose |
|---|---|
| Allotment letter / cancellation letter | To establish capital asset creation and transfer |
| Payment proof & refund receipts | To compute cost and sale consideration |
| Loan sanction letter & interest certificate | For Section 24(b) and 57 claim substantiation |
| GST payment & refund proof | To reconcile indirect tax treatment |
| Communication with builder | For establishing delay/refund grounds |
| Reinvestment proof | For Section 54 / 54F exemption claim |
Key Takeaways – Tax Compass Summary
| Stage | Tax Head | Governing Section | Relief Option |
|---|---|---|---|
| Booking without allotment | Income from Other Sources | 56(2)(viii), 57(iii) | Deduct loan interest if directly related |
| Allotment issued & later cancelled | Capital Gains | 45, 2(47), 2(14) | Section 54/54F exemption |
| Refund interest | Income from Other Sources | 56(2)(viii) | Deduct loan interest u/s 57(iii) |
| Interest earlier claimed u/s 24(b) | To be reversed | 24(b), proviso | Not allowable |
| Project incomplete, refund received | Depends on allotment | — | Consistent reporting required |
Concluding Insight
The tax treatment of refunds from cancelled or incomplete property projects rests squarely on whether a right to acquire property existed.
A mere booking advance is not a capital asset, but an allotment confers a legally recognized right — making refund taxable as capital gains upon extinguishment.
However, Section 24(b) deductions must be reversed if no ownership event occurred, though interest under Section 57(iii) may still provide limited relief.
The rule of thumb:
“No right — No capital gain;
Right extinguished — Capital gain;
Only refund with interest — Income from other sources.”
Meticulous documentation and consistent treatment across years ensure not just tax efficiency, but defensibility under scrutiny.
