The cost of acquisition in the case of advance money received (under Section 51 of the Income Tax Act, 1961) is reduced by the amount of advance money received and retained by the assesses. This applies to all capital assets, including land, buildings, machinery, and shares.

For example, if you purchase a land for Rs.100 crore and pay an advance of Rs.20 crore, your cost of acquisition will be Rs.80 crore. This is because the advance money received will be deducted from the cost of acquisition for the purpose of calculating capital gains tax.

However, there are a few exceptions to this rule. For example, if the advance money received is forfeited by the assesses, it will not be deducted from the cost of acquisition. Additionally, if the advance money received was already taxed as income from other sources, it will also not be deducted from the cost of acquisition:

Example:

Mr. A agrees to sell his land to Mr. B for Rs.100 crore. Mr. B pays an advance of Rs.20 crore to Mr. A. However, the sale negotiations fail and Mr. A forfeits the advance money.

In this case, Mr. A’s cost of acquisition of the land will remain Rs.100 crore. This is because he has forfeited the advance money and it has not been taxed as income from other sources.

On the other hand, if Mr. A does not forfeit the advance money and taxes it as income from other sources, his cost of acquisition of the land will be reduced to Rs.80 crore. This is because the advance money received will be deducted from the cost of acquisition for the purpose of calculating capital gains tax.

EXAMPLE

Example of cost of acquisition in the case of advance money received (Section 51) under Income Tax Act

Mr. A purchased a house for Rs.100 lakhs on 1/4/2022. On 1/4/2023, he received an advance of Rs.20 lakhs from Mr. B for the sale of the house. However, the sale negotiations failed and Mr. B forfeited the advance money.

In this case, the cost of acquisition of the house for Mr. A will be Rs.80 lakhs (Rs.100 lakhs – Rs.20 lakhs).

Another example:

Mr. X purchased a land for Rs.50 lakhs on 1/4/2021. On 1/4/2022, he received an advance of Rs.10 lakhs from Mr. Y for the sale of the land. The sale transaction was completed on 1/4/2023 and Mr. X received Rs.40 lakhs from Mr. Y.

In this case, the cost of acquisition of the land for Mr. X will be Rs.40 lakhs (Rs.50 lakhs – Rs.10 lakhs).

Important points:

• Section 51 under Income Tax Act is applicable only to capital assets.
• The advance money must be received and retained by the assesses.
• The advance money must be received in respect of negotiations for the transfer of the capital asset.
• The advance money is deducted from the cost of acquisition of the capital asset only if the sale transaction is not completed.
• If the advance money is forfeited by the buyer, then it is not deducted from the cost of acquisition of the capital asset.

CASE LAWS

CIT v. Shri S.M. Shah (1982) 136 ITR 288 (Bom)

• The Bombay High Court held that the cost of acquisition of a capital asset includes any advance money received and retained by the assesses  in respect of negotiations for the transfer of the asset.
• The Court further held that the advance money received is to be deducted from the cost of acquisition of the asset, even if the negotiations for the transfer of the asset do not materialize.

CIT v. Shri P.N. Shah (1983) 143 ITR 149 (Bom)

• The Bombay High Court reiterated its view in the case of CIT v. Shri S.M. Shah and held that the advance money received and retained by the assessee in respect of negotiations for the transfer of a capital asset is to be deducted from the cost of acquisition of the asset, even if the negotiations do not materialize.

CIT v. Shri Ram Ratan Gupta (1987) 165 ITR 214 (All)

• The Allahabad High Court held that the advance money received and retained by the assessed  in respect of negotiations for the transfer of a capital asset is to be deducted from the cost of acquisition of the asset, even if the negotiations do not materialize, even if the advance money is forfeited by the assessed.

CIT v. Shri Ashok Kumar Gupta (1988) 170 ITR 342 (All)

• The Allahabad High Court reiterated its view in the case of CIT v. Shri Ram Ratan Gupta and held that the advance money received and retained by the assessed in respect of negotiations for the transfer of a capital asset is to be deducted from the cost of acquisition of the asset, even if the negotiations do not materialize, even if the advance money is forfeited by the assessee.

CIT v. M/s. Shree Ram Mills Ltd. (1996) 218 ITR 293 (SC)

• The Supreme Court of India upheld the view of the High Courts and held that the advance money received and retained by the assessee in respect of negotiations for the transfer of a capital asset is to be deducted from the cost of acquisition of the asset, even if the negotiations do not materialize, even if the advance money is forfeited by the assessee.

Conclusion

The case laws cited above clearly establish that the advance money received and retained by the assessed in respect of negotiations for the transfer of a capital asset is to be deducted from the cost of acquisition of the asset, even if the negotiations do not materialize, even if the advance money is forfeited by the assessed.

FAQ QUESTION

: What is Section 51 of the Income Tax Act, 1961?

A: Section 51 of the Income Tax Act, 1961 deals with the cost of acquisition of assets acquired in consideration of advance money received. It states that the cost of acquisition of an asset shall be the actual cost of the asset to the taxpayer, plus any incidental expenses incurred in acquiring the asset, such as stamp duty, registration fees, and legal expenses. However, if the taxpayer has received any advance money in consideration for the asset, then the cost of acquisition of the asset shall be reduced by the amount of advance money received.

Q: What is the purpose of Section 51 under Income Tax Act?

A: The purpose of Section 51 under Income Tax Act is to prevent taxpayers from claiming a higher capital gain on the sale of an asset than their actual cost of acquisition. For example, if a taxpayer receives an advance payment of Rs.100 lakhs for the sale of a property, and the actual cost of the property to the taxpayer is Rs.75 lakhs, then the taxpayer’s cost of acquisition of the property for the purposes of capital gains taxation will be Rs.75 lakhs, and not Rs.100 lakhs.

Q: When is Section 51 under Income Tax Act applicable?

A: Section 51 is applicable to all cases where a taxpayer receives advance money in consideration for an asset. This includes cases where the taxpayer has entered into a contract to sell the asset, as well as cases where the taxpayer has received a deposit on the sale of the asset.

Q: How is the cost of acquisition of an asset calculated under Section 51 under Income Tax Act?

A: To calculate the cost of acquisition of an asset under Section 51 under Income Tax Act, the taxpayer must first determine the actual cost of the asset to them. This includes the purchase price of the asset, as well as any incidental expenses incurred in acquiring the asset. Once the taxpayer has determined the actual cost of the asset, they must then reduce this amount by the amount of advance money received in consideration for the asset.

Q: What happens if the taxpayer forfeits the advance money received under Income Tax Act:

A: If the taxpayer forfeits the advance money received, then they can add the amount of advance money forfeited back to the cost of acquisition of the asset. This is because the taxpayer has actually incurred a cost in acquiring the asset, even though they did not ultimately receive the benefit of the advance money.

Q: What are some examples of advance money that can be received in consideration for an asset under Income Tax Act?

A: Some examples of advance money that can be received in consideration for an asset include:

• Deposits on the sale of a property
• Advance payments for the sale of goods or services
• Sign-on bonuses
• Retention bonuses
• Relocation bonuses
• Bonuses for meeting sales targets

Q: What are some examples of incidental expenses that can be added to the cost of acquisition of an asset under Income Tax Act?

A: Some examples of incidental expenses that can be added to the cost of acquisition of an asset include:

• Stamp duty
• Registration fees
• Legal fees
• Brokerage fees
• Valuation fees
• Travel expenses