No extra benefit can be claimed beyond the return of income
Introduction
In the tax controversy arena, Income-tax Appellate Tribunal (ITAT), plays a significant role, as it is the final fact-finding authority. In some tax disputes, the outcome is entirely based on the facts involved. Thus, it is important for the ITAT to go in depth with respect to the facts involved. Recently, the ITAT Delhi in the case of Nikesh Arora vs. Deputy Commissioner of Income-tax[i] has arrived at its ruling in favor of the taxpayer, which was entirely driven by the facts involved. The ITAT also dealt with some interesting aspects with respect to the period of holding, nature of the capital asset and taxability in the hands of a taxpayer, when a claim is made beyond the return of income.
In this article, we have discussed the ruling of the ITAT in the ensuing paragraphs:
Facts
The taxpayer is a tax resident of USA and for the AY 2017-18 has filed its return of income declaring long-term capital gains on transfer of convertible preference shares of two Indian subsidiaries. During the assessment proceedings, the tax officer (TO) disputed the period of holding on the basis that the employment agreement was a draft agreement through which the shares were acquired. Accordingly, the TO regarded the gains as short-term capital gains instead of long-term capital gains. The TO further disallowed the cost of acquisition on the ground that the shares were transferred to the taxpayer as part of the salary compensation, which was offered to tax in the USA. Thus, there is no tax base in India for claiming cost of acquisition by the taxpayer. The taxpayer approached the Disputes Resolution Panel (DRP), however, DRP directed not to interfere with the draft assessment order of the TO.
On appeal before the ITAT, the taxpayer took the following arguments including without prejudice arguments:
Period of holding
- The capital assets acquired by the taxpayer, whether shares or rights or interest, were assigned to the taxpayer pursuant to an assignment agreement dated 29.12.2014, and not pursuant to the employment agreement dated 20.05.2015, as contended by the TO.
- The right to acquire legal title over shares was acquired by the taxpayer on 29.12.2014.
- The expression “held” as used in the definition of short-term capital asset, does not refer to legal ownership of the capital asset. The definition of short-term capital asset deals with the period of holding for various situations as well.
- As per the meaning of the term “held”, the date on which the taxpayer acquired the interest in the capital asset would be reckoned as the starting point for determining the period of holding. This would be the position, irrespective of whether the taxpayer acquired prefect legal title over the capital asset or not.
- The entity through which the rights in the shares were assigned to the taxpayer was merely holding shares in their names, though the beneficial owner of the shares was the taxpayer.
- Thus, the taxpayer was holding the shares for more than 24 months till the date of transfer i.e., 01.02.2017, which is the date of termination agreement.
Nature of the capital asset
- On the nature of the capital asset acquired by the taxpayer, as a without prejudice argument, it was contended that what was acquired by the taxpayer was not the ownership in any shares, but a right to acquire the shares.
Taxability of the capital gains
- Situs of the capital asset i.e., right to acquire shares is outside India, as the agreements granting such right have been entered outside India.
- As the taxpayer has transferred his interest/rights over the shares, which is situated outside India, capital gains is not taxable in India.
- Additionally, it was submitted by the taxpayer that if the capital asset is regarded as shares, then the taxpayer has no objection to suffer tax liability on long-term capital gain arising out of sale of shares.
Ruling of the ITAT
In order to set the facts right, the ITAT dealt in detail with the chronological events that had occurred and concluded that pursuant to the employment agreements, only a promise to grant certain financial benefits was made. Thus, the contention of the TO that the agreement was a draft agreement is of no relevance to determine the period of holding, as no right or shares were acquired by the taxpayer.
The rights or interest were granted pursuant to the assignment agreement, which had a reference in the termination agreement as well, through which the transfer took place. Basis these facts, the ITAT concluded that the rights and interest in the shares were acquired by the taxpayer by virtue of the assignment deed dated 29.12.2014.
The ITAT noted that the critical issue which needs to be examined is what is the capital asset that is being held by the taxpayer. Based on the factual finding, the Indian companies had confirmed that the taxpayer’s name neither appears as a shareholder in the records of the company, nor any dividend has been issued to the taxpayer. The shares of the Indian companies were never transferred to the taxpayer, which fact has been conceded by the taxpayer in one of its submissions. Thus, the ITAT concluded that the shares were never transferred to the taxpayer and what the taxpayer held were certain rights and interest in the shares, which got extinguished by virtue of the termination agreement.
The ITAT also held that since the taxpayer acquired rights and interest and not shares, the same did not qualify as long-term capital asset, since the rights and interest were not held for a period of more than 36 months.
On the taxability of capital gains, the ITAT held that what was transferred was certain rights or interest, but not any shares of Indian companies. Thus, capital gains derived by the taxpayer was not through a capital asset situated in India. The source of the rights or interest was through an agreement which was executed in the USA.
Thus, the situs of the capital asset transferred by the taxpayer was located outside India and therefore, income earned on transfer of such capital asset is not taxable in India.
Conclusion
Based on the factual analysis undertaken by the ITAT, it was concluded by the ITAT that “we hold that the location of the asset transferred by the assessee, being situated outside India, the capital gain derived would not be taxable in India. However, it is a fact that the assessee had filed a return of income in India voluntarily offering to tax the capital gain derived by treating it as long term capital gain Therefore, the alternative contention made by the assessee for the first time before learned DRP and before us as well, to the effect that the asset transferred, being certain right and interest located outside India, is not taxable in terms of section 9(1)(i) would be available to the assessee only as a defense to support the claims made by him in the return of income and not for claiming any extra benefit beyond the return of income. The return of income filed by the assessee offering to tax the long term capital gain is strictly in compliance with the terms of termination agreement. Therefore, the assessee is entitled for relief only to the extent of claims made in the return of income”.
Thus, the ITAT directed the TO to accept the capital gains offered by the taxpayer in the return of income. On the cost of acquisition issue raised by the TO, the ITAT held that since it has been held that the claim of the taxpayer as per the return of income be accepted, this issue becomes academic.
Our Comments
The Delhi ITAT has certainly pronounced an interesting ruling, which deals with various issues including the nature of the capital asset and period of holding. The ITAT has set a good precedent on the non-taxability of capital gains, by concluding that as the agreement for acquisition of capital asset was executed outside India, the situs of the capital asset is situated outside India.
A significant issue which has time and again been discussed is whether an additional claim made by a taxpayer can be entertained without filing of the revised return of income. In this regard, the Hon’ble Supreme Court of India has in the case of Goetze (India) Ltd vs. CIT[ii], held that the assessing officer cannot entertain a new claim or deduction unless a revised return is filed by the assessee, whereas the Appellate Authorities can entertain such new claim or deduction with appropriate proof even without filing of a revised return of income. The Hon’ble Kerala High Court in the case of Raghavan Nair vs. ACIT[iii] had directed the assessing officer to allow the claim of the assessee, even without filing of the return of income.
In the same context, the Hon’ble Supreme Court of India in the case of CIT vs. Shelly Products[iv], has observed that“Similarly, if he has by mistake or inadvertence or on account of ignorance, included in his income any amount which is exempted from payment of income-tax, or is not income within the contemplation of law, he may likewise bring this to the notice of the assessing authority, which if satisfied, may grant him relief and refund the tax paid in excess, if any. Such matters can be brought to the notice of the concerned authority in a case when refund is due and payable, and the authority concerned, on being satisfied, shall grant appropriate relief”.
The aforementioned jurisprudence does support a taxpayer to make an additional claim not only before the assessing officer, but also before the Appellate Authorities including ITAT. In this ruling, though the ITAT had held that the capital gains is not taxable, however, considering the taxpayer had filed its return of income offering the income for taxation in India, it was entitled for relief only to the extent of claims made in the return of income and not beyond that. While holding that the claim made in the return of income will only be considered, the ITAT had not given any reasoning on the basis of which this conclusion was arrived at. It would be interesting to see, how this issue will be dealt with by the High Court, if the ITAT order is challenged.
Lastly, documentation and determining taxability at the stage of conceptualization of the transaction does play a very significant role. In the present case, filing of the return of income was strictly in compliance of the termination agreement and nothing more than that. If the taxability was determined at the time of entering of the termination agreement itself, the scenario would have been different for the taxpayer. Thus, upfront determination of the taxability plays a very significant role.
Author: Vidushi Maheshwari
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[i] ITA No.1008/Del/2022
[ii] ([2006] 157 Taxman 1 (SC))
[iii] [2018] 89 taxmann.com 212 (Kerala)
[iv] [2003] 129 Taxman 271 (SC)