Income-tax---

----Capital gains---Short-term or long-term capital gain's---Tenant who took a flat on lease acquiring ownership of such flat---Doctrine of merger applies and interest of lessor comes to an end with acquisition of ownership by lessee---Sale of property within five months of acquiring ownership---Gains arising on sale were short term capital gains---Indian Income Tax Act, 1961, Ss.2 & 45---Indian Transfer of Property Act, 1882, S.111.

The assessee jointly with his mother held a flat in Shanti Kutir. Bombay. The said flat was originally taken on lease in the year 1962-63 by for residential purposes on a monthly rent of Rs.175. Since then it was in occupation of the assessee's father as a tenant and after his death on March 26, 1974, in the occupation of the assessee and his mother. In May, 1974, the existing tenants of the building Shanti Kutir formed a society and entered into an agreement with' the landlords for the purchase of the building. The ownership of the building was transferred to the society in January, 1976. The assessee and his mother, like all other tenants, jointly paid Rs.46,287 towards the purchase price of the flat in their occupation and thereby beanie the owners thereof. After about four months of the purchase of the flat, in May, 1976, the assessee and his mother sold the flat for Rs.1,80,000. The Income-tax Officer computed the capital gains as short-term capital gain. However, the Special Bench of the Tribunal held that what was sold or transferred in this case was a composite asset which had admittedly come into existence as a result of fusion and merger of the smaller estate and bigger estate, assuming that the right of occupation as a tenant was-the smaller estate and the remaining interest of the landlord in the flat including the title constituted the bigger estate. It was observed that the two components of the composite estate were acquired by the assessee separately in two different years. The Tribunal held that the cost of the composite estate should be computed by taking into account the market value of the smaller estate as on the date of acquisition of the bigger estate. As the Income-tax Officer had not considered this issue from this point of view, the Tribunal set aside the order of the Income-tax Officer and directed him to re-compute the surplus liable to short-term capital gain afresh after allowing the assessee an opportunity of being heard. On a reference:

Held, that once the lessee purchases the leased property from the owner, the lease is extinguished as the same person cannot at the same time be both landlord and tenant. The doctrine of merger applies resulting in the "drowning" and "sinking" of the inferior right into the superior right. There is a complete union of the interest of the lessor in that pf the lessee in such a case and the tenancy comes to an end. This principle has been statutorily recognised in section 111 (d) of the- Transfer of Property Act, 1882, which specifically provides for determination of lease in case the interests of the lessee and the lessor m the whole of the property become vested at the same time in one person in the same right. The asset transferred- in the instant case was the flat acquired by the assessee by purchase from the owners with all the rights and interests therein including the occupancy right. The assessee was the owner of the flat and not a tenant. The fact that the assessee was in occupation of the flat as a tenant before its purchase was wholly irrelevant because, on purchase there-was a union of the interests of the lessor and the lessee and the tenancy was extinguished. The said flat having been sold within 4 to 5 months of its purchase, the capital gain arising there from was rightly held by the Income-tax Officer to be a short-term capital gain.

R.V. Desai with J.P. Deodhar-for the Commissioner.

Nemo for the Assessee.

JUDGMENT

Dr. B.P. SARAF, J.---By this reference under section 256(1) of the, Income Tax Act, 1961, the Income-tax Appellate Tribunal has referred the following question of law to this Court for opinion at the instance of the Revenue: '

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the value of the assessee's right of occupation as a tenant should be treated as a part of the cost of the flat even though this right has merged in the bigger estate at the time of the purchase of the remaining rights over the flat for the purpose of computing the surplus liable to capital gains tax?"

This reference pertains to the assessment year 1977-78. The assessee jointly with his mother held a flat in Shanti Kutir, Bombay, admeasuring about 1,800 sq. ft. The said flat was originally taken on lease in the year 1962-63 by the father of the assessee for residential purposes on a monthly rent of Rs.175. Since then it was in occupation of the assessee's father as a tenant and after his death on March 26, 1974, in the occupation of the assessee and his mother. In May, 1974, the existing tenants of the building Shanti Kutir formed a society and entered into an agreement with the landlords for the purchase of the building. The ownership of the building was transferred to the society in January, 1976. The assessee and his mother, like all other tenants, jointly paid Rs.46,287 towards the purchase price to the flat in their occupation and thereby became the owners thereof. After about four months of the purchase of the said flat, in May, 1976, the assessee and his mother sold the said flat to Mr. and Mrs. V.V. Dalal for Rs.1,80,000 and handed over vacant possession thereof to the said purchasers. In the assessment of the assessee under the Income Tax Act, 1961 (the "Act"), for the assessment year 1977-78, the Income-tax Officer computed capital gains from the sale of the said flat at Rs.1,31,213 by deducting Rs.46,287 being, the purchase price and Rs.2,500 being legal expenses incurred in connection therewith from the sale consideration of Rs. 1,80,000 and assessed the same as short-term capital gain from the sale of the flat because the flat had been sold within 4 to 5 months of the purchase. The assessee was aggrieved by the above order of the Income-tax Officer. According to the assessee, the sale of the flat by the assessee comprised two capital assets, viz., occupancy right and the remaining rights of owner including title. It was contended by, the assessed that the tenancy right was acquired by the father of the assessee in year 1962-63 and the ownership right was acquired by the assessee and his mother in January, 1976. The assessee, therefore, claimed that the consideration for the sale of the flat should be apportioned as consideration for transfer of occupancy right and for transfer of ownership right and the capital gains from the transfer of ownership right so arrived at should only be treated as short-term capital gains. The assessee appealed to the Commissioner of Income-tax (Appeals). The Commissioner (Appeals) did not agree with the contentions of the assessee and dismissed the appeal. While doing so, the Commissioner (Appeals) held that the fact that the assessee was in occupation of the flat in question as a tenant before it was purchased, was irrelevant for the purpose of determining his liability to capital gains on the sale of the flat because what was sold was the flat which the assessee had acquired in January, 1976, and not the tenancy rights. Being aggrieved by the order of the Commissioner (Appeals), the assessee appealed to the income-tax Appellate Tribunal (the "Tribunal"). As there were conflicting views of the different Benches of the Tribunal on this issue, a Special Bench of the Tribunal was constituted for hearing this issue. The Special Bench accepted the contention of the assessee and allowed his appeal. The Special Bench of the Tribunal held that what was sold or transferred in this case was a composite asset which had admittedly come into existence as a result of fusion and merger of the smaller estate and bigger estate, assuming that the right of occupation as a tenant was the smaller estate and the remaining interest of the landlord in the flat including the title constituted a bigger estate. It was observed that the two components of the composite estate were acquired by the assessee separately in two different years. The Tribunal felt that the sale consideration of the composite estate was not capable of apportionment in law. The Tribunal was of the opinion that the solution in such a situation was to take either the smaller or bigger estate as the main estate. The Tribunal observed that if the smaller estate, i.e., the right of occupation as a tenant was taken as the main estate, the cost of the bigger estate will have to be treated as an improvement over the smaller estate but in that case, the period will have to be reckoned from the date of the acquisition of the smaller estate for the purpose of considering whether the surplus would be liable to long-term or short-term capital gain. On the other hand, if the bigger estate, i.e., the remaining interest of the landlord over the flat including the title, was taken as the main estate, the market value of the smaller estate as on the date of the acquisition of the bigger estate would have to be taken into account and the material date for the purpose of considering the surplus as long-term or short-term capital gain, in such a case, would be the date of acquisition of the bigger estate. The Tribunal, therefore, held that the cost of the composite estate should be computed by taking into account the market value of the smaller estate as on the date of acquisition of the bigger estate. As Income? tax Officer had not considered this issue from this point of view, the Tribunal set aside the order of the Income-tax Officer and directed him to re-compute the surplus liable to short-term capital gain afresh after allowing the assessee an opportunity of being heard. Aggrieved by the above order of the Tribunal, the Revenue is before us by Way of this reference.

Mr. R.V. Desai, learned counsel for the Revenue, submits that the approach of the Tribunal in this case itself is erroneous. According to learned counsel, what has been transferred in this case in May, 1976, is the flat which was acquired by the assessee in January, 1976. The flat cannot be regarded as a composite asset comprising tenancy right and ownership right. Learned counsel submits that the tenancy came to an end the moment the assessee purchased the flat and became the owner. What has been transferred by the assessee is the ownership of the flat. That being so, according to learned counsel, ,the Income-tax Officer was right in assessing the capital gains as short-term capital gain because the flat was sold within 4 to 5 months of its purchase. Learned counsel submits that the Tribunal was wrong in holding that the flat was a composite asset comprising "tenancy right" and "ownership right". ?????????

We have carefully considered the submissions of Mr. Desai, learned counsel for the Revenue. We find force in the same. The Tribunal, in our view, was wrong in holding that even after the purchase of the flat by the lessee, the leasehold right subsisted in the lessee. Because, once the lessee purchases the leased property from the owner, the lease is extinguished as the same person cannot at the same time be both landlord and tenant. The doctrine of merger applies resulting in the "drowning" and "sinking" of the inferior right into the superior right. There is a complete union of the interest of the lessor in the lessee in such a case and the tenancy comes to an end. This principle has been statutorily recognised in section 111(d) of the Transfer of 'Property Act, 1882, which. specifically provides for determination of lease in case the interests of the lessee and the lessor in the whole of the property become vested at the same time in one person in the same right.

From the above discussion, it is clear that the asset transferred in the instant case was that the flat acquired by the assessee by purchase from the owners with all the rights and interests therein including the occupancy right. The assessee was the owner of the flat and not a tenant. The fact that the assessee was in occupation of flat as a tenant before its purchase is wholly irrelevant because on purchase, there was a union of the interests of the lessor and the lessee and the tenancy was extinguished. The said flat having been sold within 4 to 5 months of its purchase, the capital gain arising there from was rightly held by the Income-tax Officer to be a short-term capital gain. The Tribunal was not justified in reversing the said finding of the Income tax Officer.

In view of the above, we answer the question referred to us in the negative; i.e. in favour of the Revenue and against the assessee.

?This reference is disposed `of accordingly with no order as to costs.

M.B.A,/4044/FC???????????????????????????????????????????????????????????????????? Reference disposed of.