CIT-7 Vs. Paville Projects Pvt ltd

Case snapshot

Sections / provisions: See packaged judgment

Questions before the Court / Tribunal

• Capital gains: whether payment to shareholders to settle internal dispute can be treated as cost of improvement of company property.
• What factual, statutory and procedural conditions control the relief?
• How does the operative order apply to the parties and the challenged proceeding?

Material facts and procedural background

The Commissioner of Income Tax 7 …Appellant(s)

3. The respondent assessee was engaged in manufacture and export of garments, shoes etc. It filed its income tax return for the AY 2007-08 wherein it showed sale of the property / building “Paville House” for an amount of Rs.33 Crores. That, the building “Paville House” was constructed by the assessee on the piece of land which was purchased in the year 1972. The said house of the company was duly reflected in the balance sheet of the company.

3.1 It appears that there had been litigation between shareholders of the Company being family members. Litigations in the Company Law Board and the High Court culminated in arbitration. In the arbitration proceedings, an interim award was passed whereby an amicable settlement termed as “family settlement” was recorded between the parties. As per the interim award, three shareholders viz. (1) Asha, (2) Nandita and (3) Nikhil were paid Rs.10.35 Crores each. According to the assessee,

“Paville House” was sold to discharge encumbrances from the sale proceeds to pay off the shareholders and therefore, the said discharge of encumbrances was “cost of improvement”. As observed hereinabove, “Paville House” was sold for an amount of Rs.33 Crores. The assessee showed gains arising therefrom amounting to Rs.1,21,16,695/- as “long term capital gains” in the computation of their income for AY 2007-08. The working computation of capital gains was accepted by the AO, whereby the cost of removing encumbrances claimed (Rs.10.33 Crores paid to three shareholders pursuant to the interim award) was taken as “cost of improvement” and the deduction was claimed to remove encumbrances on computation of capital gains. On the balance amount capital gain tax was offered and paid. The assessment was completed on 15.12.2019 by the AO under Section 143(3) of the Income Tax Act (for short “IT Act”) accepting the “long term capital gains” as per sheet attached in computation of income.

263 of the IT Act to show cause as to why the assessment order should not be set aside under Section 263 of the IT Act. The Commissioner vide its order dated 24.11.2011 held that the assessment order passed under Section 143(3) of the IT Act was erroneous and prejudicial to the interest of the revenue on the issue relating to deduction of Rs.31.05 Crores claimed by the assessee as cost of improvement while computing long term capital gains. The claim of the assessee that the said payment was made by them towards settlement of litigation, which according to the assessee amounted to discharge of encumbrances and required to be considered as cost of improvement, was not accepted by the Commissioner as according to him it did not fall under the definition of “cost of improvement” contained in Section 55(1)(b) of the IT Act. According to the Commissioner, the expenses claimed by the assessee neither constituted expenditure that is capital in nature nor resulted in any additions or alterations that provide an enhanced value of an enduring nature to the capital asset. The Commissioner also held that the payment as contended, was not made by the

Appellant / assessee submissions

4. Shri Balbir Singh, learned ASG appearing on behalf of the Revenue has vehemently submitted that the High Court has materially erred in dismissing the appeal preferred by the Revenue and confirming the order passed by the ITAT by which the ITAT set aside the order passed by the Commissioner passed in exercise of powers under Section 263 of the IT Act.

4.1 It is submitted that the High Court has not at all

appreciated the fact that the view taken by the AO in allowing the expenses of Rs.31.05 Crores while computing the capital gain from sale of the land was erroneous and not as per the law as payments made to shareholders are neither expenses nor the said payments have any relation to the asset under consideration. It is further submitted that the High Court has also not properly appreciated that the claim of the assessee that amount of Rs.31.05 Crores paid by it in lieu of settlement of litigation would amount to discharge of encumbrances and therefore, requires to be considered as cost of improvement on the said property is bad in law. It is submitted that payment of Rs.31.05 Crores paid to the shareholders did not lead to acquisition of any interest in the asset already acquired by the assessee. It is submitted that the rights already enjoyed by the assessee on the said property were absolute. It is submitted that therefore the assessment order passed by the AO was erroneous, bad in law and prejudicial to the interest of the revenue and therefore, the same was rightly set aside by the Commissioner under Section 263 of the IT Act, which ought not to have been set aside by

4.2 It is further submitted that Commissioner rightly observed that the assessee company was the clear owner of the property and that there was no encumbrance preventing the sale of the said property. The family dispute among the three shareholders brother and two sisters, which resulted in a settlement by way of arbitration award, as per which the three shareholders became entitled to Rs.10.35 Crores each for transfer of shares as well as relinquishment of any right or claim to additional shares in the company had nothing to do with the improvement in the property. It is submitted that shareholders only concern was that the sale proceeds should first be utilized for making payments to them as per the arbitration award. It is submitted that therefore both, the Tribunal as well as the High Court have erred in concluding that the payment of Rs.10.35 Crores were admissible as deduction.

Revenue / respondent submissions

4. Shri Balbir Singh, learned ASG appearing on behalf of the Revenue has vehemently submitted that the High Court has materially erred in dismissing the appeal preferred by the Revenue and confirming the order passed by the ITAT by which the ITAT set aside the order passed by the Commissioner passed in exercise of powers under Section 263 of the IT Act.

5.5 It is further submitted by learned Counsel appearing on behalf of the assessee that in the case of Malabar Industrial Co. Ltd. (supra), this Court has held that if the order is erroneous but is not prejudicial to the interest of the Revenue, the Commissioner cannot exercise the revisional jurisdiction under Section 263 of the IT Act. It is submitted that it is further observed and held that every loss of revenue as a consequence of an order of AO cannot be treated as prejudicial to the interest of revenue. As observed and held, if the AO has

Court / Tribunal analysis and reasoning

9. Mr Abraham relied on the judgment of the Division Bench of the High Court of Madras in Venkatakrishna Rice Co. v. CIT [(1987) 163 ITR 129 (Mad)] interpreting “prejudicial to the interests of the Revenue”. The High Court held:

Operative decision and relief

4.4 It is further submitted that even otherwise as part of the asset sold was used in the business of the assessee and hence, capital gains on that part of the asset sold is required to be taxed as per the provisions of Section 50A of the IT Act and hence, the entire order of Commissioner of Income Tax could not have been set aside. Making above submissions it is requested to allow the present Appeal.

7. In the present case, the Commissioner, in exercise of the powers under Section 263 of the Income Tax Act and in exercise of the revisional jurisdiction, set aside the assessment order by specifically observing that the assessment order was erroneous as well as prejudicial to the interest of the Revenue. However, the High Court by the impugned judgment and order has set aside the order passed by the Commissioner by observing that the Commissioner wrongly invoked the powers under Section 263 of the Act.

8. In view of the above and for the reasons stated above, present appeal succeeds. The impugned judgment and order passed by the High Court is hereby quashed and set aside and that the order passed by the Commissioner passed in exercise of powers under Section 263 of the Income Tax Act is hereby restored.

In result, present appeal is allowed. However, in the facts and circumstances of the case, there shall be no order as to costs.

Ratio and legal principle

• The packaged judgment addresses Capital gains: whether payment to shareholders to settle internal dispute can be treated as cost of improvement of company property. The precise proposition must be read with the Court/Tribunal's reasoning and operative directions.
• Reliance depends on matching the statutory version, jurisdiction, procedural stage and material evidence recorded in the judgment.

Why this judgment matters

This decision is relevant to practitioners and affected parties dealing with capital gains: whether payment to shareholders to settle internal dispute can be treated as cost of improvement of company property. Its value lies in showing how the adjudicating forum connected the applicable rule to the proved facts and procedural posture.

Practitioner action points

• Match the statutory version, jurisdiction, procedural stage and decisive evidence before relying on the result.
• Verify current appellate, review and SLP history and any later amendment or controlling authority.
• Attach the complete judgment to the working paper or filing and cite the paragraph/page supporting the proposition.

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Section / provision impact

• See the statutory provisions identified in the packaged judgment.

Case network

Similar issue / useful comparison

• JM Financial Ltd. v. Dy. CIT - ITAT Mumbai - F Bench
• Mrs. Usha Eswar v. ITO - Court / Tribunal to be verified
• Adityaraj Builders v. State of Maharashtra - Bombay High Court

Different outcome / possible distinction

• Zainul Abedin Ghaswala v. NFAC - Operative order controls
• ITO v. Rajni D. Saini - Operative order controls

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