Karnataka HC allows set off of past business loss against gain arising from sale of capital asset used for business

This Tax Alert summarizes a Karnataka High Court (HC) decision, dated 23 February 2021, in the case of Nandi Steels Ltd. v. ACIT^[1] (Taxpayer), wherein the issue was whether business losses of earlier years (past business losses) can be set off against capital gains which arose on sale of capital assets used for business purposes under the provisions of the Indian Tax Laws (ITL).

The ITL provides for a mechanism of set off and carry forward of losses incurred in the course of business. As per the provisions of the ITL, past business loss can be set off only against profits and gains of any business or profession carried on by a taxpayer. Furthermore, any income on transfer of capital asset which is used for business purposes, is taxed under a separate head of capital gains, whereas income from regular business transactions is taxed under the head profits and gains from business or profession (PGBP).

Special Bench (SB) of the Bangalore Income Tax Appellate Tribunal (Tribunal), in the Taxpayer’s case, had ruled that past business losses cannot be set off against capital gains arising on sale of capital assets used for business purposes since such capital gains cannot be regarded as profits and gains of the business carried on by the Taxpayer.

However, on the Taxpayer’s further appeal, the HC ruled in favor of the Taxpayer and allowed set off of past business losses against capital gains on sale of capital assets used for business. The HC held that the legislature has referred “profits and gains from any business” in the set off provision and has not specifically referred to income which is taxable under the head PGBP. The HC relied on the ratio of the Supreme Court (SC) ruling in the case of Cocanada Radhaswami Bank Ltd. ^[2], which permitted set off of past business losses against income which has attributes of business income (income from securities held as stock-in-trade in that case), even if it is taxable under any other head of income (income from securities in that case).

Sale of Carbon credit is not taxable.

Since the Carbon credit is not an asset generated in the process of carrying of a business but is a ticket to emit a particular amount of carbon dioxide or other greenhouse gases into the environment. Therefore, the excess credit if any when sold will tantamount to capital receipts and not revenue receipts.

THE COMMISSIONER OF INCOME TAX, COMPANY CIRCLE, TIRUPUR VERSUS PRABHU SPINNING MILLS (P) LIMITED, MADRAS HIGH COURT, T.C.A.No.471 of 2015, Dated July 8, 2021

Decision

‘The aforesaid shows that the Andhra Pradesh High Court has confirmed the view of the Tribunal that Carbon Credit is not an offshoot of business, but an offshoot of environmental concerns. No asset is generated in the course of business, but it is generated due to environmental concerns. It was also found that the carbon credit is not even directly linked with the power generation and the income is received by sale of the excess carbon credits. It was found that the Tribunal has rightly held that it is capital receipt and not business income.’

Choice of the Form of consideration in a JDA doesn’t negate claims of cost of Acquisition or Indexation

The assessee, a healthcare company, was the owner of land in Gurgaon, Haryana.

The assessee entered into a Joint Development Agreement (JDA) for development of a part of the land parcels held by assessee. It was agreed that upon the completion of the development, the assessee will have the right to choose either possession of part of the built-up area or consideration in lieu. The underlying land was given to the builder on a long term lease.

Upon completion, the assessee chose consideration and offered the same as long term capital gain after adjusting the indexed cost of acquisition of proportionate cost of the land parcel.

• The Assessing Officer (AO) disallowed the claim of ccost of acquisition and indexation on the ground that the land was still appearing in the balance sheet of the assessee.
• The Ld. CIT (A) allowed the benefit of capital gain including cost of acquisition. He, however, restricted the indexation till AY 2008-09 i.e., the year of the JDA as against AY 2011-12 i.e., the assessment year.
• The Ld. CIT (A) further held that land was deemed to have been converted to stock-in-trade in AY 2008-09 as the JDA was a venture in the nature of business.

Both the assessee as well as the Department filed appeal.

On the issue of capital gains

The ITAT Delhi held that, the essence of a JDA is a barter where the person hands over the land and receives constructed portion in return. Further, the computation of gains arising from JDA is to be made after taking into account cost of land transferred to the builder. Merely because the land is continued to be reflected in the Balance Sheet of the assessee would not have any adverse implication on the computation of long term capital gains as the accounting treatment in the books of account cannot override the determination of real income under the provisions of Income Tax Act, 1961.

On the issue of indexation

The ITAT Delhi held that,

1. The assesssee company is in and continues to carry on the business of providing healthcare services.
2. The subject land has been continuously reflected as capital asset in the Balance Sheet of the assessee since acquisition by the assessee.
3. In the JDA, there was no indication whatsoever that the JDA was executed for exploiting the land on commercial lines.

Therefore the ITAT Delhi held that there is no scope of applicability of section 45(2) of the IT Act to the facts of the present case and allowed the AO to allow the benefit of indexation of cost of acquisition till AY 2011-12 i.e. the year of assessment of capital gain.

Implementation of Risk Management Systems (RMS) for processing of Duty Drawback claims

The Central Board of Indirect Taxes and Customs (CBIC) has decided to initiate implementation of Risk Management System (RMS) for processing of shipping bills related to duty drawback claims with effect from 26 July 2021. The procedure for implementation shall be as under:

• The RMS will process the shipping bill data after the Export General Manifest (EGM) is filed electronically and will provide required output to ICES for selection of shipping bills for risk based processing of duty drawback claims.
• The shipping bills with claim for duty drawback will be routed on the basis of risk evaluation through appropriate selection criteria.
• Subsequent to RMS treatment, ICES will be informed for each shipping bill whether for the processing of the drawback claim, a particular shipping bill will be facilitated without intervention or will be routed to the proper officer (i.e. Superintendent / Appraising Officer or Assistant / Deputy Commissioner) for further action.
• For shipping bills routed to the said customs officers for drawback processing, all necessary checks shall continue to be undertaken by the customs officers as before.
• Certain documents that may be required to accompany the drawback claim can be attached to the shipping bill electronically on e-Sanchit with the required e-Sanchit documents codes.        

In addition to above, the RMS also envisages post clearance audit (PCA) of the duty drawback shipping bills. The development of an electronic module for PCA is underway. Till such time, the current instructions for audit as stipulated in the manual for Customs Post Clearance Audit, 2018 shall continue to be followed.

Marginal relief under Income Tax.

Marginal relief for individuals where the total income is more than Rs.50 Lakhs but does not exceed Rs.1 crore.
Suppose an individual has a total income of Rs.51 Lakhs in FY 2020-21. He will have to pay taxes inclusive of a surcharge of 10% on the tax computed i.e., the total tax payable will be Rs. 14,76,750. But if he would have earned only Rs. 50 lakhs, then the tax liability would have been Rs.13,12,500 only (excluding cess). For earning an extra Rs.1,00,000, he will end up paying income tax of Rs.1,64,250. The individual will get a marginal relief of the difference amount between the excess tax payable on higher income ie (Rs.14,76,750 minus Rs.13,12,500 = Rs.1,64,250 ) and the amount of income that exceeds Rs. 50 Lakhs i.e. (Rs.51,00,000 minus Rs.50,00,000 = Rs.1,00,000).  The marginal relief will be Rs.64,250 (Rs.1,64,250 minus Rs.1,00,000).  Hence, the income tax liability on the income of Rs. 51,00,000 will be Rs.14,12,500.

CESTAT upholds levy of service tax on expenses recovered by Venture Capital Fund from the Contributors

This Tax Alert summarizes a recent ruling¹ of Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Bangalore. The issue relates to applicability of service tax on recovery of various expenses by Venture Capital Fund (VCF) from the contributors.

The Tribunal observed that: 

• Trust qualifies as a juridical person and is liable to service tax for providing taxable service. 

• The principle of mutuality does not apply as VCF is engaged in commercial activities, and it uses discretionary powers for the benefit of certain class of investors. 

• VCF is rendering the service of portfolio management or asset management under Banking and other Financial Services (BOFS) and consideration is in the form of withholding dividends/ profits distributable to the contributors.  

• Carry Interest (CI) is neither interest nor return on investment. It is a portion of the consideration retained by VCF for the services rendered. 

• The amount of loss provided by way of accounting entries cannot be treated as amounts retained by VCF for service to the contributors.

Thus, CESTAT confirmed the levy of service tax on the amounts retained by VCF towards expenses and also in respect of distribution of Carry interest. 

Comments 

• While the ruling deals with the matter in case of Venture Capital Fund, it is likely to impact other similar investment pooling vehicle structures, both onshore and offshore. Decision may also have potential exposure on the transactions undertaken by funds during the subsequent period under Service tax as well as GST.  

• CESTAT has provided partial relief by allowing eligible CENVAT credit to be reduced from the total tax demand. This may, however, need to be analyzed in light of different scenarios, particularly where such entities are not registered or have not filed returns in view of no tax position. 

• Observations of the Tribunal on the nature of Carry Interest could trigger dispute over its taxability and compliance issues, both under direct and indirect tax statutes. 

• Considering the larger impact of the ruling, it may be imperative for the stakeholders to engage with the Government and seek clarity in the matter. This might help in avoiding any unwarranted litigation.    

• It is interesting to note that in the recent Budget, specific provision was inserted retrospectively under GST to do away with the doctrine of mutuality. However, the same has not yet been made effective. 

No reversal of input tax credit on inherent loss during manufacturing process: Madras HC

The Madras High Court observed that under the GST law, goods lost, stolen, destroyed, written off or disposed by way of gifts or free samples indicate loss of goods that are quantifiable and involve external factors or compulsions. The loss that is occasioned by the process of manufacture cannot be equated to any of the instances. Therefore, it held that the reversal of the input tax credit (ITC) sought by the revenue is misconceived as loss during the process of manufacture and is not contemplated or covered by the situations adumbrated under the GST law restricting ITC. Thus, the orders seeking reversal of ITC claimed were set aside.     

Our comments

As the GST law provides certain restrictions, the eligibility to avail input tax credits has been a subject matter of dispute and extensive litigation.

The Apex Court, under the erstwhile regime, had held that an exact mathematical equation between the quantity of raw material used and the raw material found in the finished product is not possible and, therefore, credit, in respect of lost inputs, cannot be denied.This is a welcome ruling by the Madras HC and shall provide required relief to the manufacturing sector and will set precedence in similar matters.

CBDT issues rule prescribing methodology for determining short term capital gains and written down value for block of intangible asset comprising goodwill

This Tax Alert summarizes the rule inserted in the Income tax Rules, 1962 by Notification dated 07 July 2021 (Notification) issued by the Central Board of Direct Taxes (CBDT), which lays down computation mechanism for determining capital gains and written down value (WDV) for block of intangible asset comprising  goodwill. This is pursuant to amendment made by Finance Act 2021 with effect from tax year (TY) 2020-21 to deny depreciation on goodwill of business or profession.

The Notification inserts a new rule (Rule 8AC) which provides that where goodwill is the only asset in block of intangible assets on which depreciation is claimed up to 31 March 2020, then the WDV of such block of intangible assets as on 1 April 2020 will need to be reduced by the WDV of goodwill computed as the difference between actual cost of goodwill less depreciation allowable on such goodwill thereby resulting in Nil WDV of block of intangible assets.

Where goodwill is one of the assets in intangible block, then the WDV of intangible block of asset as on 1 April 2020 needs to be reduced by the standalone WDV of goodwill computed as the difference between actual cost of goodwill and depreciation allowable on such goodwill.

Where standalone WDV of goodwill is higher than aggregate of opening WDV of entire intangible block of asset as on 1 April 2020 and actual cost of any intangible asset acquired in TY 2020-21, then the excess shall be deemed to be capital gain arising from the transfer of short-term capital asset.

However, where the block of intangible block of asset comprises of goodwill alone, then any cessation of block of intangible due to reduction of goodwill component will not give rise to capital gains or capital loss.

While the statutory provision, which empowers CBDT to notify the Rule was enacted by Finance Act, 2021 (FA 2021) with effect from TY 2020-21, the Notification is silent on the effective date of new Rule. The new Rule 8AC is published in Official Gazette on 7 July 2021. Its applicability to TY 2020-21 to which it should intended to apply will be a highly contentious issue since it is not explicitly notified to come into effect from 1 April 2021 onwards.