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Bank on auction to skip capital gains tax
January, 21st 2008
Banks and housing finance institutions offering loans to senior citizens who pledge their homes, may be spared of paying capital gains tax if they auction the property.

The property can be sold if the legal heir is unable to repay the loan given to a senior citizen under the reverse mortgage scheme. The government is set to clarify the tax treatment of capital gains arising from the sale of property under this scheme soon. Amendments, if any, in the income tax legislation will feature in the next Finance Bill, said a senior official.

The policy announcement on a reverse mortgage scheme for senior citizens was made in the 2007-08 budget. But there has been a years delay in providing clarity on the tax treatment.

Under the scheme, a senior citizen mortgages his house to a lender (bank). The bank, in turn, makes payments to the borrower. The borrower does not have to service the loan during his lifetime. The loan has to be repaid with interest only by his legal heir.

He can repay the loan without selling the property and have the mortgage released. Does the borrower have to pay tax on the payments he receives from the lender? Is the lender liable to pay capital gains tax if the property is sold or auctioned?

The government is set to make it clear that senior citizens will not have to pay tax on the payments they receive from the bank. The rationale is that the payout has to be treated as a loan and not income in the hands of the borrower. A loan is an amount that has to be repaid and hence cannot be charged to tax. So a borrower is spared of paying tax.

The legal heir can sell the property to repay the loan. A capital gain can arise when the property is sold. The legal heir has to pay capital gains tax. Tax officials say that there is no confusion in this case.

Banks can auction the property if the legal heir is unable to service or repay the loan. If profits are made from the public sale, the bank can retain the amount that is due to it and pay the balance to the legal heir. Here again, the legal heir will have to pay capital gains tax.

But the grey area on the tax treatment is when the borrower does not have a legal heir. One option would be to recover the capital gains tax from the bank. This can be done only if the institution has the ownership rights.
Else, the government can forego the tax on the grounds that the scheme helps a senior citizen who is not covered by any social security net. But this would mean taking a hit on tax revenues.

Currently, if a property is sold three years after the date of acquisition, the profits are treated as long-term capital gains and taxed at 20%. Short-term capital gains are taxed like any other income. The maximum rate is 30% for an individual.

State-owned banks, including Punjab National Bank, State Bank of India, Bank of Baroda, Allahabad Bank, among others, have launched the product. So has Deewan Housing finance. It is open only to those who are 60 years and above. The loan amount will depend on the market value of the residential property, the age of the borrower or borrowers and the prevalent interest rate.

The maximum tenure of the loan is 15 years. A few other banks say that they will go ahead only if there is clarity on the tax treatment. Also, regulations need to be in place to create mortgage guarantee companies. Legal and tax issues have to be sorted out immediately. Otherwise, there may not be many takers for the product.
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