Sale Proceeds used to Settle Family Disputes not Deductible from Capital Gains: SC

Case Details: CIT v. Paville Projects (P.) Ltd. - [2023] 149 taxmann.com 115 (SC)

Judiciary and Counsel Details

• • M.R. Shah & A.S. Bopanna, JJ.

Facts of the Case

Assessee-company engaged in the manufacture and export of garments, shoes etc. The shareholders of the company were family members. Due to a dispute between the shareholders, the matter was carried to arbitration. In the arbitration proceedings, an interim award was passed whereby an amicable settlement termed as “family settlement” was recorded between the parties.

The company sold its house for Rs. 33 crores, and as per the interim award, three shareholders were paid Rs. 10.35 Crores each. As per the assessee, the house was sold to discharge encumbrances from the sale proceeds to pay off the shareholders. Thus, the said discharge of encumbrances was “cost of improvement”. Assessee paid taxes on balance amount of capital gains accordingly.

The Assessing Officer (AO) allowed the assessee’s computation during the assessment proceedings. However, the Commissioner of Income Tax (CIT) exercised the revisionary powers under section 263, considering the claim of such disbursement as cost of improvement as prejudicial to the revenue’s interest and denying the deduction for such disbursement.

High Court Held

The High Court held that one of the possible views was taken by the AO, and thus the execution of revisionary power under section 263 was invalid. The matter then reached the Supreme Court.

The Apex Court held that if, due to an erroneous order of the AO, the revenue is losing tax lawfully payable by a person, it will certainly be prejudicial to the interests of the revenue. However, only in a case where two views are possible, and the AO adopted one view, such a decision, which might be plausible and has resulted in the loss of revenue, such an order is not revisable under Section 263.

In the instant case, the CIT held that the assessee made a payment towards the settlement of litigation, which according to the assessee, amounted to the discharge of encumbrances and required to be considered as a cost of improvement, couldn’t be accepted. Said amount did not fall under the definition of “cost of improvement” contained in Section 55(1)(b).

According to the CIT, 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. Further, said payment was not made by the assessee to remove encumbrances.

Having gone through the assessment order and the order passed by the CIT, it was to be held that the assessment order was not only erroneous but prejudicial to the interest of the revenue. The erroneous assessment order has resulted in a loss of revenue in the form of tax.

The High Court committed a very serious error in setting aside the order passed by the CIT passed in the exercise of powers under Section 263. Thus, the order of the High Court was quashed, and the order passed by CIT under section 263 was restored.