Sainaba Hamza Koya v. ITO (2025): Section 54F and borrowed funds

The recurring difficulty with the capital-gains exemptions in Sections 54 and 54F is one of plumbing rather than principle. The provisions are meant to encourage an assessee who sells a capital asset to reinvest in a home. The dispute, again and again, is whether the very same rupees from the sale must flow into the new property, or whether the assessee may build first — often with money raised elsewhere — and reconcile the accounts afterwards. In Sainaba Hamza Koya v. Income Tax Officer, a single judge of the High Court of Kerala, Ziyad Rahman A.A., J., answered that question in favour of the assessee, while adding a guardrail that practitioners should not overlook.

The facts in brief

The petitioner, Mrs. Sainaba Hamza Koya — a widow and senior citizen — sold a property, and the transfer generated capital gains. Within three years of the transfer she set about constructing a residential building for herself. The construction was completed; but it was funded not by tracing the sale consideration directly into the project. Instead, she used money borrowed from her daughter and son-in-law to build the house.

To park the gains pending their proper application, she maintained a Capital Gain SB Account with her bank — the dedicated deposit account contemplated by the capital-gains scheme. Having built the house with the borrowed money, she then sought permission to close that account, or to release the amounts deposited in it, so that she could repay the family members from whom she had borrowed. That permission had been denied — which is what brought her to the High Court.

The questions

Because the matter came up as a writ petition, WP(C) No. 40744 of 2024, the issues were framed around the release of the deposit rather than as an appeal against an assessment. Two questions had to be answered.

The first was the substantive one on which the case turns: does a deduction under Section 54F require that the sale consideration itself be invested in the new residential property, or does it suffice that borrowed funds were used for the construction within the statutory window? On a strict, source-tracing reading, only money flowing from the sale would count. On a broader reading, what matters is that a qualifying residential house was in fact constructed in time, however the construction was financed.

The second was the practical, relief-oriented question: should the petitioner be permitted to withdraw the amounts lying in her Capital Gain SB Account — after retaining whatever was payable to the Revenue — so that she could repay the borrowings she had taken to build the house?

What the Court held

On the substantive question, the Court came down in favour of the assessee. Section 54F, it held, does not insist on a literal, one-to-one tracing of the sale consideration into the new asset. The deduction can be allowed even where the new residential property has been funded through borrowed money — provided the assessee substantiates a genuine intention to repay the borrowings out of the capital gains. The borrowed funds, in other words, must have been deployed on the footing that they would be made good from the gains, and not for some unconnected purpose.

The Court was careful, however, not to make the relief automatic. A bare assertion by the assessee does not by itself entitle her to the deduction; what is relevant is the satisfaction of the appropriate authority that the assessee did in fact utilise the funds for the purposes contemplated by Section 54F. As reported, the Court observed that the borrowed funds were used —

— framing the intention to repay, rather than the precise source of the construction money, as the operative consideration. On the relief sought, the Court accordingly held (as reported) that "the petitioner should have been permitted to withdraw the excess amount, if any, in the deposit, after retaining the amounts payable by the petitioner towards the Revenue." The Capital Gain SB Account was thus to be opened to her to the extent of the surplus, the tax liability being first secured.

Analysis

The decision sits within a well-settled line of authority treating Sections 54 and 54F as beneficial provisions — to be construed so as to advance, rather than defeat, the object of encouraging reinvestment in residential property. The recurring temptation for the Revenue is to read a source-tracing requirement into the language: to insist that the exemption is available only to the extent the actual sale proceeds are sunk into the new asset. Courts have generally resisted that reading, recognising that money is fungible and that an assessee who builds a house in time — using a bridging loan or family funds while the formalities of releasing the deposit are sorted out — has done exactly what the provision wants.

What Sainaba Hamza Koya usefully adds is a structured way of thinking about the limits of that liberality. The Court does not say that any borrowing, for any purpose, suffices. It ties the concession to a bona fide intention to repay the borrowings from the capital gains — and leaves the verification of that intention to the appropriate authority rather than treating the assessee's say-so as conclusive. That is the guardrail: the assessee gets the benefit of a purposive reading, but only on demonstrating that the borrowed funds and the capital gains were genuinely linked in the manner the scheme contemplates.

The phrase that the funds were used "at their own risk with the intention to be repaid with capital gains" captures the balance the Court strikes. The risk-bearing language acknowledges the commercial reality — an assessee who borrows to build before the deposit is released is taking a calculated risk on the strength of the gains — while the intention-to-repay language supplies the discipline that keeps the concession honest. Together they describe an arrangement the Court was willing to recognise as falling within Section 54F, not a blanket licence to substitute borrowed money for reinvested gains.

There is also a human dimension that the writ frame brings into focus. This was not a contested assessment fought over fine points of valuation; it was a widow and senior citizen seeking the release of her own money from a Capital Gain SB Account so that she could repay her daughter and son-in-law. The Court's willingness to grant that relief — subject to the Revenue retaining what was due to it — reflects the equitable temper with which these exemptions are usually applied.

Why it matters

For assessees, the practical takeaway is reassuring but conditional. Section 54F relief is not lost merely because the new house was built with borrowed money rather than with the sale proceeds traced rupee-for-rupee. That is especially significant for cash-flow-constrained taxpayers — senior citizens, pensioners, those waiting on the formalities of releasing a Capital Gain SB Account — who often have little choice but to bridge the construction with a loan or family funds. The source-tracing objection is not allowed to defeat a genuine reinvestment.

But the conditionality matters just as much. The relief is not automatic: the assessee must demonstrate a genuine intention to repay the borrowings out of the capital gains, to the satisfaction of the assessing authority. In practice that means keeping the evidentiary trail — the borrowing arrangement, its timing relative to the transfer and the construction, and the eventual application of the released deposit towards repayment — clean and contemporaneous. An assessee who can show that the borrowed funds and the gains were genuinely connected stands on firm ground; one who treats the principle as a slogan, without the supporting material, may find the authority unpersuaded.

A note of caution on the weight of the decision is warranted. Sainaba Hamza Koya is a single-judge decision of the Kerala High Court, delivered on a writ petition concerned with the release of a Capital Gain SB Account deposit, rather than an appellate ruling on a completed assessment. Its reasoning reinforces a principle that is already well established; its distinctive contribution is the explicit "intention to repay" guardrail. As with any High Court authority, its persuasive value outside Kerala will depend on how other Benches receive it — but the underlying proposition, that Sections 54 and 54F are beneficial provisions not to be read down by a source-tracing requirement, is firmly in the mainstream.

Related on Valkya

• Bacha F. Guzdar v. CIT, Bombay
• CIT v. Vatika Township
• McDowell & Co. v. CTO

Sources

• LiveLaw, "Income Tax Act | Assessee Must Prove Borrowed Funds Used With Intention To Repay From Capital Gains To Claim S.54F Deduction: Kerala High Court" — https://www.livelaw.in/high-court/kerala-high-court/income-tax-act-assessee-must-prove-borrowed-funds-used-with-intention-to-repay-from-capital-gains-to-claim-s-54f-deduction-kerala-high-court-304811
• Taxscan, "Deduction u/s 54F of Income Tax Act can be Allowed on Substantiating Assessee's Intention to Repay Borrowed Funds with Capital Gains: Kerala HC" — https://www.taxscan.in/top-stories/deduction-us-54f-of-income-tax-act-can-be-allowed-on-substantiating-assessees-intention-to-repay-borrowed-funds-with-capital-gains-kerala-hc-1433475