Twin Conditions Need To Be Satisfied For Invocation Of Jurisdiction Under Section 263 Of The Income Tax Act

CAUSE TITLE:
The Commissioner of Income Tax 7 Versus M/s. Paville Projects Pvt. Ltd.

DATE OF JUDGMENT:
APRIL 06, 2023

JUDGE(S):
HON’BLE JUSTICE M.R. SHAH and HON’BLE JUSTICE A.S. BOPANNA

PARTIES:
Appellant: The Commissioner of Income Tax 7
Respondent: M/s. Paville Projects Pvt. Ltd.

SUBJECT

IMPORTANT PROVISIONS

The Income Tax Act 1961

Section 50A Where the capital asset is an asset in respect of which a deduction on account of depreciation under clause (i) of sub-section (1) of section 32 has been obtained by the assessee in any previous year, the provisions of sections 48 and 49 shall apply subject to the modification that the written down value, as defined in clause (6) of section 43, of the asset, as adjusted, shall be taken as the cost of acquisition of the asset.

Section 55(1)(b)- For the purposes of sections 48 and 49,—

(b) "cost of any improvement",—

1. in relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing or right to carry on any business or profession shall be taken to be nil ; and
2. in relation to any other capital asset,—

(i) where the capital asset became the property of the previous owner or the assessee before the 1st day of April, 2001, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset on or after the said date by the previous owner or the assessee, and

(ii) in any other case, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property, and, where the capital asset became the property of the assessee by any of the modes specified in sub-section (1) of section 49, by the previous owner,

but does not include any expenditure which is deductible in computing the income chargeable under the head "Interest on securities", "Income from house property", "Profits and gains of business or profession", or "Income from other sources", and the expression "improvement" shall be construed accordingly.

Section 263(1)- (1) The 88[Principal Chief Commissioner or Chief Commissioner or Principal Commissioner] or Commissioner may call for and examine the record of any proceeding under this Act, and if he considers that any order passed therein by the Assessing Officer 89[or the Transfer Pricing Officer, as the case may be,] is erroneous in so far as it is prejudicial to the interests of the revenue, he may, after giving the assessee an opportunity of being heard and after making or causing to be made such inquiry as he deems necessary, pass such order thereon as the circumstances of the case justify, 90[including,—

(i) an order enhancing or modifying the assessment or cancelling the assessment and directing a fresh assessment; or

(ii) an order modifying the order under section 92CA; or

(iii) an order cancelling the order under section 92CA and directing a fresh order under the said section].

BRIEF FACTS

• The respondent assessee who was engaged in the business of manufacturing filed his income tax return for the assessment year 2007-08 wherein a property sale for Rs. 33 Crore of ‘Paville House’. This building was constructed on land purchased by the assessee in 1972.
• There was a checkered history of litigation between the shareholders of the company (who are the family members) in the company law board and the High Court which ultimately culminated in Arbitration.
• During the arbitration, an interim award was passed whereby an amicable settlement in the term of ‘family settlement’. As per the interim award, three shareholders were paid Rs. 10.35 crore rupees each.
• The above-mentioned property was sold to discharge encumbrances from the sale proceeds and pay the shareholders as per the interim arbitral award.
• The property was sold for Rs. 33 Crores. Gains arising therefrom amounting to Rs. 1,21,16,695/- were shown as “long-term capital gains”. The computation was accepted by the AO whereby cost of removing encumbrances was taken as cost of improvement and deduction was claimed to remove encumbrances on the computation of capital gains. Capital gains tax was paid on the balance amount.
• The assessment was completed in the year 2019 by the AO accepting “long-term capital gains”as per the sheet attached in the computation of income. A notice was issued by the Commissioner of Income Tax u/s 263 of the Income Tax Act (hereinafter referred to as the ‘IT Act’) to show cause why this assessment order should not be set aside u/s 263 of the IT Act. It was eventually held that the assessment order passed by the AO u/s 143(3) of the IT Act was prejudicial to the interests of the revenue on the issue relating to deduction of Rs.31.05 Crores claimed by the assessee as cost of improvement and was set aside.
• The claim of the assessee that the said payment was made towards the settlement of litigation and must be which amounted to discharge of encumbrances was not accepted by the CIT as according to him it did not fall within the definition of section 55(1)(b).
• According to the CIT, this expense neither constituted capital expenditure nor resulted in any additions or alterations that provide an enhanced value of an enduring nature to the capital asset. CIT also held that payment was not made by the assessee to remove encumbrances. The commissioner also held that Sections 50A and 55(1)(b) have not been complied with and the assessment order has not been passed in accordance with provisions of the IT Act.
• The assessee approached the Income Tax Appellate Tribunal (ITAT). ITAT relied upon the judgment of the SC in Malabar Industrial Co. Ltd. Vs. CIT [(2000) 2 SCC 718] and concluded that the CIT wrongly invoked his jurisdiction u/s 263 of the IT Act. It observed that there was no error in the order and every loss of revenue pursuant to AO’s order cannot be considered to be prejudicial to the interests of revenue when two views were possible and AO took a view which CIT did not agree with.
• The ITAT also allowed the assessee’s claim of deduction of payment made to the shareholders relying upon the decision of the Bombay High Court in CIT Vs. Smt. Shakuntala Kantilal.
• The department appealed against the order of ITAT which was dismissed by the High Court of Bombay. Hence, the present appeal.

CONTENTIONS ON BEHALF OF THE APPELLANT

• The High Court has materially erredin dismissing the appeal against the order of ITAT.
• The HC has not appreciated the fact that the view taken by AO in allowing theexpenses of Rs. 31.05 crores while computing the capital gain from sale of land was against the law as the payments made to the shareholders are neither expenses nor have any relation to the asset under consideration.
• It was also submitted that the High Court did not appreciate that the assessee’s contention that the payments were made in the settlement of litigation and had to be considered as payments towards the ‘discharge of encumbrances’ and therefore, requires to be considered as a cost of improvement on the said property is bad in law.
• It was submitted that payment of Rs. 31.05 crores to the shareholders did not lead to an acquisition of any interest in the property held by the assessee and that the interest of the assessee was absolute. Therefore, the order passed by the AO was prejudicial to the interests of the revenue and was rightly set aside by the CIT u/s 263 of the IT Act and ought not to have been set aside by ITAT. It was submitted that the assessee was the absolute owner of the property and there was no encumbrance preventing its sale.
• The litigation between the family members which culminated into arbitration through which they were paid Rs. 10.35 crores each had nothing to do with the improvement of the property. The only concern of the shareholders was that the sale proceeds should first be used for making payments to them as per the arbitral award.
• It was further submitted that even otherwise, as part of the asset sold was utilized for the assessee’s business and capital gains on that part had to be taxed as per section 50A of the IT Act and hence, the order of the CIT cannot be completely set aside.
• CONTENTIONS ON BEHALF OF THE RESPONDENT
• No error has been committed by the High Court in upholding the order of ITAT.
• Order passed by the AO was a well-reasoned one passed after scrutiny of the IT returns filed by the Assessee. The view taken by the AO was a plausible one and hence was not prejudicial to the interest of revenue.
• The view taken by the AO on claim of deduction was judicially supported by the decision of the High Court of Bombay in the case of Smt. Shakuntala Kantilal. It was submitted that the Commissioner failed to appreciate that unless the shareholders’ claims were satisfied there would not have been a sale of the entire portion of the property.

ANALYSIS

The counsel for assessee heavily relied on the judgment in Malabar Industrial Co. Ltd. (supra) wherein on the interpretation of section 263 of the IT Act it was observed that in order to exercise the jurisdiction under Section 263(1) of the Income tax Act, the Commissioner has to be satisfied of twin conditions, namely, (i) the order of the Assessing Officer sought to be revised is erroneous; and (ii) it is prejudicial to the interests of the Revenue. If one of them is absent, recourse cannot be taken to that section. It was observed that the scheme of the act is to levy and collect tax in accordance with the provisions of the act and this task is entrusted to the Revenue. If due to an erroneous decision of the income tax officer, revenue loses tax lawfully payable by a person, it will be prejudicial to the interests of revenue.

Only when two views are possible to be taken by AO, and the AO takes the view not beneficial to the department, the order will not be prejudicial to the interests of revenue.

CONCLUSION

The Hon’ble court applied these principles to the facts of the present case and held that the order passed by the AO was erroneous and it cannot be said that the commissioner wrongly exercised the jurisdiction under section 263 of the Act. The assessment order resulted in loss of revenue in form of tax.

Hence, the Apex court allowed the appeal and set aside the judgment of the High Court of Bombay which upheld the order of ITAT.

Learn the practical aspects of Criminal Law Drafting HERE, IBC HERE, CrPC HERE, CPC HERE, IPC HERE, Evidence Act HERE, NDPS Act HERE, Family Laws HERE, DV Act HERE