Capital Gains Tax When the Bank Sells Your Mortgaged Property: Kerala High Court Ruling of July 9, 2026

Quick Summary: What Changed and Who Should Read This

• The ruling. In Giju Purapadathil Mathai v. Commissioner of Income Tax, ITA No. 106 of 2026, decided on 9 July 2026, a Division Bench of the Kerala High Court held that a property owner remains liable to capital gains tax on the full sale consideration even though the mortgagee bank appropriated every rupee of it and the owner received nothing.
• The facts are common. The owner had created an equitable mortgage over his property to secure a loan taken by a third party. The borrower defaulted, the bank sold the property, and the entire consideration went to the bank.
• The controlling authority is 25 years old. The Court applied CIT v. Attili N. Rao, (2001) 252 ITR 880 (SC), decided on 11 October 2001, which holds that capital gains are computed on the full price realised, not on what reaches the owner’s hands.
• There is one narrow exception, and it does not help most people. A mortgage created by the previous owner and cleared by the current owner forms part of cost of acquisition and is deductible. A mortgage created by the assessee himself is not.
• Action point. If a lender is enforcing security over property you own, whether under SARFAESI, a decree, or a negotiated sale, budget for the tax before the sale closes and negotiate a tax carve-out from the sale proceeds. After the bank has swept the account, the liability is still yours and there is no cash left to pay it.

The question of capital gains tax when the bank sells your mortgaged property is one of the most painful in Indian tax practice, because the taxpayer’s instinct and the statute point in opposite directions. The owner sees a forced sale, no money received, and a debt that was never even his own. The Assessing Officer sees a transfer of a capital asset for a consideration, and computes gains on that consideration. The Kerala High Court’s judgment of 9 July 2026 confirms, once again, that the Assessing Officer is right.

This matters far beyond one taxpayer in Kerala. Every founder who has pledged a flat to secure a company’s working capital limit, every promoter who has given collateral for a group entity, and every parent who has mortgaged a house for a child’s business is sitting on the same exposure. The RBI’s tightening of lender conduct, which we covered in our note on the new loan recovery Directions taking effect from 1 January 2027, changes how a lender may behave during recovery. It does not change who pays the tax when the security is finally sold.

What the Kerala High Court Decided on 9 July 2026

The facts

The appellant, Giju Purapadathil Mathai, created an equitable mortgage over his immovable property in favour of South Indian Bank. The mortgage was made by deposit of title deeds, the form of mortgage described in Section 58(f) of the Transfer of Property Act, 1882. Critically, the loan facility secured by that mortgage was not his own borrowing. It was availed by a third party.

The borrower defaulted. The bank enforced its security, sold the mortgaged property, and applied the entire sale consideration towards the outstanding dues. The appellant received nothing at all from the transaction.

The Assessing Officer nevertheless computed capital gains on the transfer, taking the full sale consideration as the starting point. The Commissioner (Appeals) confirmed the assessment. The Income Tax Appellate Tribunal confirmed it again. The appellant then took the matter to the High Court.

The finding

The Division Bench, comprising Justice Devan Ramachandran and Justice Basant Balaji, dismissed the appeal and upheld the assessment.

The Court’s reasoning ran along two lines. First, the taxable event is the transfer of the capital asset, and the capital appreciation embedded in that asset does not disappear because of the mechanism by which the sale is executed. As the Bench put it, the basic taxability of the capital appreciation is not altered by the legal mechanism of a sale, whether that sale is executed by the owner or forced by a lending institution.

Second, the Court declined to treat the appellant as a victim of the bank or of the Department. He had willingly created the mortgage, with full knowledge that default by the principal borrower would cost him the property. The fact that he received no sale proceeds was, in the Court’s view, a direct consequence of his own contractual undertaking, and not a defect in the assessment.

The Bench relied on the Supreme Court’s decision in CIT v. Attili N. Rao for the proposition that capital gains taxation applies to the full price realised, regardless of whether the owner personally receives the proceeds.

Why the Owner Pays Tax on Money the Bank Kept: the Attili N. Rao Principle

The governing authority is Commissioner of Income-Tax v. Attili N. Rao, (2001) 252 ITR 880 (SC), decided on 11 October 2001 by a Bench of Justice S. P. Bharucha and Justice Brijesh Kumar.

The facts there were structurally identical, with a government creditor instead of a bank. The assessee, who was in the abkari business, had mortgaged immovable property to the Excise Department of Andhra Pradesh in 1970-71 as security for outstanding duties. In assessment year 1982-83 the State sold the property at public auction for Rs 5,62,980. The State deducted Rs 1,29,020 towards duties and interest and remitted the balance to the assessee.

The Revenue computed capital gains of Rs 3,70,970, that is, on the full auction price less admitted deductions. The assessee contended that only Rs 85,130 was taxable, because the mortgage debt should be deducted first.

The Supreme Court sided with the Revenue in language that has since been applied hundreds of times:

“What was sold by the State at the auction was the immovable property that belonged to the assessee. The price that was realised therefore belonged to the assessee. From out of that price, the State deducted its dues towards ‘kist’ and interest due from the assessee and paid over the balance to him.”

The logic is that of application of income versus diversion by overriding title. The sale consideration first accrues to the owner because the asset sold was the owner’s. What happens next, the sweeping of that consideration by a creditor, is the owner discharging his own obligation. It is an application of an amount that has already become his, and applications of income are not deductible in computing that income.

The One Exception That Does Work: a Mortgage Created by the Previous Owner

There is a real and well-settled exception, but practitioners must be precise about it because the difference between the two situations is a single fact: who created the encumbrance.

The Supreme Court drew the line in two judgments delivered in the same year and reported in the same volume:

• R. M. Arunachalam v. CIT, (1997) 227 ITR 222 (SC)
• V. S. M. R. Jagdishchandran v. CIT, (1997) 227 ITR 240 (SC)

The distinction was restated by the Bombay High Court in CIT v. Roshanbabu Mohammed Hussein Merchant in these terms: where the property acquired by the assessee is subject to a mortgage created by the previous owner, the assessee acquires an absolute interest in that property only after discharging the mortgage debt, and that discharge is therefore treated as cost of acquisition and is deductible. Conversely, where the assessee acquires an unencumbered property and himself creates the encumbrance, the expenditure incurred to remove that encumbrance is not an allowable deduction in computing capital gains.

The 9 July 2026 ruling closes what some advisers had treated as an open flank. It had been argued that where the mortgage secures somebody else’s debt, the owner derives no benefit at all and the Attili N. Rao logic should not apply. The Kerala High Court has rejected that. Voluntariness of the undertaking, not benefit from the borrowing, is what decides the point.

How This Works Under the Income-tax Act, 2025

The Kerala High Court was applying the Income-tax Act, 1961, as it had to for the years before it. For transfers effected in tax year 2026-27 and later, the same principles operate through the renumbered provisions of the Income-tax Act, 2025, which came into force on 1 April 2026.

• Section 67 of the Income-tax Act, 2025 is the charging provision for capital gains. It provides that any profits or gains arising from the transfer of a capital asset effected in a tax year shall be chargeable to income-tax under the head “Capital gains”.
• Section 72 of the Income-tax Act, 2025 is the mode of computation provision, the successor to Section 48 of the 1961 Act. It computes the income by deducting from the full value of the consideration (a) expenditure incurred wholly and exclusively in connection with such transfer, and (b) the cost of acquisition of the asset and the cost of any improvement.

Nothing in that structure permits the deduction of a debt discharged out of the consideration. The deduction heads are exhaustive, and “repayment of my loan” is not among them. The Attili N. Rao reasoning therefore carries across the statutory transition unchanged. Where indexation applies to the cost of acquisition, the relevant multiplier for the current year is the Cost Inflation Index for FY 2026-27, notified at 384.

What Actually Is Deductible When a Lender Sells Your Property

Advisers frequently give up too early on this and let a client be assessed on the gross auction price. The deductions that survive are narrow but real:

1. Expenditure incurred wholly and exclusively in connection with the transfer. Where the sale is conducted by the lender, this can include brokerage or auctioneer’s charges, statutory advertisement costs of the sale notice, and stamp and registration expenses actually borne by the seller. Obtain the lender’s appropriation statement, which almost always itemises these.
2. Cost of acquisition and cost of improvement, with indexation where the asset is long-term. Reconstruct these from the original purchase deed, stamp duty receipts, and contemporaneous evidence of construction or improvement spend. This is where the real relief lies in most distress sales, because the property was usually bought many years earlier.
3. A mortgage created by the previous owner and cleared by the current owner, per R. M. Arunachalam. Check the chain of title before conceding the point.
4. Reinvestment reliefs, in theory. These are the cruel ones in a distress sale, because they require the taxpayer to put money into a new residential house or into specified bonds within prescribed periods, and in a forced sale there is no money to put anywhere. Consider these only where a part of the consideration was actually released to the owner.

The Cash-Flow Trap, and the Compliance Checklist That Avoids It

The genuine damage in these cases is rarely the tax rate. It is the sequence. The transfer happens, the liability crystallises, the cash goes to the lender, and then an advance tax obligation and a return-filing obligation arrive for a taxpayer with no cash. Interest for deferment and shortfall of advance tax accrues on top. The following sequence prevents most of that.

1. Compute the exposure before the sale closes, not after. As soon as a recall notice or a possession notice lands, model the capital gains on the expected realisable value. This is a one-hour exercise and it changes the negotiation.
2. Negotiate a tax carve-out in the settlement. When a one-time settlement or a negotiated sale is on the table, ask for a defined portion of the consideration to be released to the owner against the tax liability. Lenders do agree to this where the alternative is a contested sale, and it is far easier to obtain before the appropriation than after.
3. Collect the documentation at the point of sale. Sale certificate or conveyance, the lender’s appropriation statement, the auction notice, and evidence of any expenses borne. These become unavailable surprisingly quickly once the account is closed.
4. Check the stamp duty valuation. Where the consideration in a distress sale is below the stamp duty value of the property, the deeming provision for immovable property substitutes the higher figure. A forced sale is precisely the situation in which this bites, and it needs to be identified early so that a valuation reference can be sought where the facts support it.
5. Track the tax deducted at source by the buyer. On a transfer of immovable property above the prescribed threshold, the purchaser is required to withhold tax on the consideration. In an auction the successful bidder often overlooks this, or deposits it against the wrong permanent account number. Reconcile it against the annual information statement before filing, in the same way you would reconcile any third-party reported data appearing in your AIS.
6. Report the transfer in the return even if no money was received. Non-reporting is the single most common way this becomes a penalty proceeding rather than a demand. The return filing due dates for the current assessment year apply normally to a taxpayer in this position.

Who Is Affected

Founders and promoters. If personal or family property secures a company facility, the tax on enforcement lands on the individual owner, not on the company whose debt it was. That exposure sits outside the company’s balance sheet and is almost never disclosed in a cap table review or a diligence pack.

Third party mortgagors and guarantors. The Kerala ruling is directly about you. Securing a friend’s, relative’s, or associate company’s borrowing with your own property gives you all of the downside of a sale and none of the proceeds, plus the tax.

MSME proprietors and partners. Where business premises or a residence has been offered as collateral, an enforcement event creates a personal income tax liability at the same moment the business is under maximum stress.

Chartered Accountants. Two practice points. First, do not concede the gross consideration; build the cost of acquisition record. Second, screen the chain of title for a mortgage created by a previous owner, because that single fact converts a non-deductible payment into cost of acquisition.

Frequently Asked Questions

If I never received the sale proceeds, why am I taxed on them?

Because the asset sold was yours, so the consideration accrued to you first. The lender’s appropriation of that consideration is an application of an amount that had already become yours, in discharge of an obligation you had voluntarily undertaken. That is the ratio of CIT v. Attili N. Rao, (2001) 252 ITR 880 (SC), and it is what the Kerala High Court applied on 9 July 2026.

Does it make a difference that the loan was somebody else’s?

No. That was the precise argument in the Kerala case, where the mortgage secured a third party’s facility, and it was rejected. The Court held that the owner had willingly created the mortgage knowing that default would cost him the property, so the absence of proceeds followed from his own contract.

Is a SARFAESI auction sale a “transfer” for capital gains purposes?

Yes. A sale by a secured creditor in exercise of its enforcement rights transfers the owner’s interest in the property. The identity of the person executing the sale does not change the character of the event, which is what the Kerala High Court meant in saying that the taxability of the capital appreciation is not altered by the legal mechanism of the sale.

Can the mortgage debt ever be deducted?

Only where the mortgage was created by the previous owner and you discharged it in order to acquire an absolute interest in the property. That payment is treated as part of your cost of acquisition, per R. M. Arunachalam v. CIT, (1997) 227 ITR 222 (SC). A mortgage you created yourself, whether for your own borrowing or for a third party’s, is not deductible, per V. S. M. R. Jagdishchandran v. CIT, (1997) 227 ITR 240 (SC).

What can I realistically do once the lender has already sold the property?

Three things. Reconstruct cost of acquisition and improvement with documentary support, since this is usually where the largest reduction sits. Extract the appropriation statement to claim transfer-related expenditure. And approach the Assessing Officer early on the payment schedule rather than waiting for recovery proceedings, because a demand raised against a taxpayer with no realisable assets is a very different conversation when it is opened by you.

Source and Verification Note

In line with our citation policy, the sourcing behind this note is stated openly, including its limits.

• Supreme Court authorities, primary instrument obtained. The full text of Commissioner of Income-Tax v. Attili N. Rao, decided 11 October 2001, Bench of Bharucha and Brijesh Kumar JJ., reported at (2001) 252 ITR 880 (SC), was retrieved and read on 11 August 2026, and the passage quoted above is verbatim from the judgment. The distinction between a mortgage created by a previous owner and one created by the assessee was verified against the text of the Bombay High Court judgment in CIT v. Roshanbabu Mohammed Hussein Merchant, which states the citations as R. M. Arunachalam v. CIT, (1997) 227 ITR 222 (SC) and V. S. M. R. Jagdishchandran v. CIT, (1997) 227 ITR 240 (SC).
• Income-tax Act, 2025 section numbers, individually verified. Section 67 (Capital gains) and Section 72 (Mode of computation of capital gains) were each checked against the section text on 11 August 2026 before being cited. No section number in this note has been asserted from memory.
• Kerala High Court judgment, reported source. The case particulars used here are Giju Purapadathil Mathai v. Commissioner of Income Tax, ITA No. 106 of 2026, Kerala High Court, Division Bench of Devan Ramachandran and Basant Balaji JJ., judgment dated 9 July 2026, reported at 2026 TAXSCAN (HC) 1176. The judgment text was accessed through a law reporting service and not from the Kerala High Court’s own website, which we could not reach for this document on the retrieval date. Readers relying on this in a live matter should obtain the certified copy before citing it in proceedings.
• Deliberately not asserted. The assessment year in dispute before the Kerala High Court is not stated here, because the reported source does not carry it. The specific section numbers of the Income-tax Act, 2025 dealing with the stamp duty value deeming rule and with tax deducted at source on the transfer of immovable property are referred to at concept level only, and are not asserted, because they were not individually verified for this note.

Where This Leaves You

The law here is settled, it is unfavourable, and it is entirely predictable. That is precisely why it is manageable. The taxpayer in the Kerala case lost not because the assessment was aggressive but because the tax consequence of the mortgage he signed was never priced in at the time he signed it, or at the time the bank moved.

If you have property standing as security for any borrowing, your own or anyone else’s, the exposure is quantifiable today, before there is a default, and the negotiation over a tax carve-out is available today, before there is an appropriation. Both become far harder afterwards.

If you are working through a stressed borrowing, a personal guarantee, or a lender enforcement where family or promoter property is at risk, talk to an expert before the sale is concluded rather than at return-filing time. You can book a quick call here to discuss your situation with Tax Update India.

Disclaimer: This article is published by Tax Update India for general information and educational purposes. It is a summary of a judicial decision and of statutory provisions as they stood on 11 August 2026, and it is not legal, tax, or professional advice. Judicial decisions turn on their own facts, and the application of the principles discussed here depends entirely on the chain of title, the terms of the security documents, and the facts of the transfer in your case. Please obtain advice specific to your circumstances, and verify all citations against the certified judgment and the bare Act, before acting or refraining from acting on anything stated above.

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CA Adityavikram Banka

Founder & Director at A S Banka Advisors Private Limited

The author is a Practicing CA, Founder of A. S. Banka Advisors Private Limited & Partner of Dhiraj & Dheeraj.

You can reach out to the author on : info@asbanka.com

www.asbanka.com

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