Tax Insights
from India Tax & Regulatory Services
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Delhi bench of the Tribunal allows deduction as bad debt, of income wrongly offered to tax in earlier year as capital gains but not
recovered
June 9, 2020
In brief
The Delhi bench of the Income-tax Appellate Tribunal (Tribunal) upheld the write-off of non- recoverability of subsidiary share sale proceeds as bad debt, although the corresponding income was taxed under the head capital gains in the earlier year. Relying on judicial precedents, the Tribunal reiterated that if in an earlier assessment year, a taxpayer has offered and the tax officer (TO) has assessed the income under a particular head of income, although the same was liable to be assessed under a different head of income, there is no embargo on the taxpayer or TO to consider income from the same source under the correct head in a subsequent year.
In detail
Facts
• The taxpayer company1 is engaged in the real estate business.
• As an industry-wide accepted practice, the taxpayer, because of regulatory hurdles, acquired plots of land through various subsidiaries that later handed over such plots or development rights to the taxpayer for development.
• Thereafter, the taxpayer would apply for change land use (CLU) and other permissions from the Government to start project development. The income
1 ITA No. 5169/ Del/ 2017
from such development was always offered to tax as business income.
• The taxpayer classified such investment in subsidiaries as “long-term investment”
as per the disclosure norms under the Companies Act, although the subsidiaries owned a land bank and were incorporated only to acquire plots of land as part of the real estate business.
Factually, this was treated as business investment.
• As part of a business venture, the taxpayer decided to divest one such investment to a buyer who agreed to acquire the shares, subject to the taxpayer obtaining a CLU
and other clearances for the plot of agricultural land held by the subsidiary.
• The buyer discharged a part of the consideration and the balance was payable subject to the taxpayer obtaining the CLU and other permissions.
The total consideration consisted of (a) capital gain on the sale of land through shares and (b) business income from the provision of services towards CLU and other permissions.
• However, the taxpayer offered gains made on the basis of the entire
consideration on this transaction of sale of shares
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under the head “capital gains,”
on accrual basis.
• Subsequent to the above, the State Government acquired a major part of the land and because of a government order, the taxpayer could not obtain the CLU and other permissions, which resulted in the investor walking away from the deal and refusing to pay the balance consideration.
• In the subsequent year, the taxpayer claimed the amount irrecoverable from the investor as bad debt under the head
“business or profession.”
However, the TO allowed the loss as capital loss.
Issue before the Tribunal Whether the bad debts claimed by the taxpayer are allowable, considering that in the earlier year, the corresponding income had been offered to tax under the head “capital gains” and not as business income?
Taxpayer’s contentions
• The substance of the share sale transaction was the sale of land and the rendering of services in connection with the CLU and other clearances, which was purely in the nature of its business activity.
Therefore, bad debt is in the nature of business activity and is allowable.
• Income can be said to accrue only when the right to it receive has arisen, which in the instant case, was dependent on obtaining the necessary permissions.
• Taxes were paid on unrealised profits that were neither accrued nor received.
• The TO is duty bound to assess the income under the correct provisions of the law, even if a taxpayer has applied the wrong provisions. Even if the taxpayer has incorrectly
declared the entire amount as capital gain, it does not mean that the taxpayer cannot claim under the correct head in the year in which the actual loss has been incurred, which in this case was business income/
business loss.
• Although the income had been incorrectly assessed under the head “capital gains” in the earlier year, it cannot act as an impediment to the TO for assessing the income under the correct head in the subsequent year.
• The TO in the subsequent year should determine whether the loss of the previous year may be set off against the profits of that year.
Revenue’s contentions
• The amount not recoverable by the taxpayer was not trade receivable but receivable on the sale of shares, held as investment and not as stock- in-trade, which was in the nature of capital loss and not business loss.
• Once the taxpayer admits that the character of income on the sale of shares is in the nature of capital, assessable under the head “capital gains,” then the taxpayer cannot change this to claim it is on revenue account, assessable as business income.
• The amount written off cannot be allowed as bad debt, as income in the earlier year was not taxed under the same head, i.e., income from business and profession.
• The taxpayer had offered no corresponding business income in the earlier year.
• The taxpayer did not revise the earlier year’s computation of income to offer the gains under the head “business or profession” instead of “capital gains.”
Tribunal’s ruling
• The taxpayer is purely carrying out a real estate business and obtaining a CLU and other clearance is part of its core business activities.
• Any income or loss arising from the activities carried out by the taxpayer is ostensibly assessable under the head
“business or profession.”
• The substance of the
transaction of shares was the sale of the underlying asset agricultural land, and more importantly, the services of CLU, which has made the asset more valuable. Thus, income was mainly because of its business venture and core business activities, and ostensibly, they were assessable under the head
“business income.”
• If the taxpayer in the earlier year has offered income under a different head, either under an erroneous presumption of law or mistake, the taxpayer cannot be estopped from claiming that the income was actually assessable under a different head in the subsequent year.
• The TO is required to draw correct conclusions, regardless of the position of the taxpayer, because the TO decides the factual and legal inferences to be drawn.
• Acquiescence by the taxpayer by offering any income under a different head cannot act as an estoppel against the taxpayer or an embargo on his claim that income is taxable or not under the particular head.
• The claim of income or loss or any deduction has to be examined afresh in the year in which it is claimed. Thus, the TO has to determine the claim regarding the allowability of bad debts or business loss in
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the year in which the loss is claimed. The assessment of the corresponding income as capital gain in an earlier year will not be binding on the taxpayer. It is always open to the taxpayer to highlight that it is to be assessed under the correct head, which is
“business income.”
• The TO can review the facts of the case and redetermine the taxability of income and the claims to be allowed against the same in the subsequent years. If there is certain mistake or wrong decisions has been rendered in earlier years, the same cannot be perpetuated for the
subsequent year and it will not be a legal impediment,
although the assessment for the earlier years has attained finality.
• There is no requirement under the Act that the bad debt has
to accrue out of income under the same head “income from business or profession” to be deducted as income. Thus, the contention of Revenue that income was not taxed under the same head does not hold good.
• Here, the taxpayer is fastened with tax liability on
hypothetical income, which is not received in the subsequent year. In this situation, a justice-oriented approach is warranted, as the taxpayer has incurred a genuine loss in this year and is denied set off merely on the grounds of technicality that the income was offered under a different head in an earlier year.
• Thus, the law as culled out from various judgments is that the bad debt or loss claimed in this year has to be determined in this year only, without distributing the earlier
assessments, which have attained finality.
• Therefore, the claim of bad debt made in this year is allowable as business loss.
The takeaways
The judgment reiterates the principle that the taxpayer offering any income under a particular head of income in one year cannot act as an estoppel against the taxpayer in a subsequent year to claim that income taxable under a different head of income. It further held that the TO of the subsequent year must determine whether the loss of the previous year may be set off against the profits of that year.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
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