Forfeited Advance on Failed Capital Asset Negotiations

Relevant Provision: Section 92(2)(h)

1. The Provision

Section 92(2)(h) taxes any sum received as an advance or otherwise during negotiations for transfer of a capital asset, where such sum is forfeited by the intending transferor (seller), and the negotiations do not result in an actual transfer of the capital asset.

2. Taxability

This closed a long-standing loophole. Previously, such forfeited advances merely reduced the cost of acquisition of the capital asset for future capital-gains computation — meaning no immediate tax was paid, and the benefit could be deferred or lost entirely if the asset was never sold. Now, the forfeited amount is taxed immediately, in the year of forfeiture, under Income from Other Sources, at slab rate.

3. Exemptions

There is no specific exemption for this item — the only relief is that if the same asset is eventually sold to a different buyer later, the cost of acquisition is no longer reduced by the previously forfeited advance (since it has already been taxed once), avoiding double taxation.

4. Illustrative Example

Mr. Arjun agrees to sell a plot of land for ₹50 lakh and receives ₹5 lakh as earnest money/advance. The buyer later backs out, and Mr. Arjun (as permitted under the sale agreement) forfeits the ₹5 lakh. This ₹5 lakh is taxable in Mr. Arjun's hands in that very year under Income from Other Sources, at slab rates — regardless of whether he ever sells the land to anyone else. If he later sells the same plot to another buyer for ₹55 lakh, his cost of acquisition for capital-gains computation remains unreduced by the ₹5 lakh already taxed.

5. Case Laws

Travancore Rubber & Tea Co. Ltd. v. CIT (2000) SC — under the pre-amendment law, held that a forfeited advance reduces the cost of acquisition rather than being taxed as income in the year of forfeiture; the amendment (carried into Section 92(2)(h)) legislatively overturned this position going forward.

CIT v. Meera Goyal and subsequent High Court rulings interpreting the post-amendment regime confirm that forfeited advances are now taxed as income in the year of forfeiture, not adjusted against cost of acquisition.

6. Precautions

Sellers receiving earnest money on property deals should factor in that a failed deal with forfeiture now creates an immediate tax event, not merely an adjustment to future cost.

Document the reason for forfeiture and the underlying agreement clearly — disputes on genuineness of "negotiations" can trigger deeper scrutiny.

7. FAQs

Q1. Does this apply only to real estate deals?

No — it applies to negotiations for transfer of any capital asset (shares, business undertakings, immovable property, etc.), as long as an advance was forfeited and the deal fell through.

Q2. What if the advance is refunded instead of forfeited?

No tax arises — the provision applies only where the sum is actually forfeited, not where it is refunded to the prospective buyer 

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools