2024 (2) TMI 581 - AT - Income Tax

Taxability of capital gains - denial of adjustments to full value of sale consideration towards amount lying in Escrow account while determining the LTCG - HELD THAT - We are of the opinion that the facts marshalled and case built up by the assessee is quite comprehensible and plausible. In accord with the view expressed in Dinesh Vazirani case 2022 (4) TMI 746 - BOMBAY HIGH COURT the taxability of amount retained in escrow account which is neither received nor likely to be received is contrary to position of law enunciated in s. 45 rws s. 48 - While the amount retained in escrow forms part of agreed consideration, such amount do not necessarily form part of full value of consideration received or accruing as result of transfer of capital asset as emanating from the facts of the case. The realisation of escrow amount in the instant case is contingent upon fulfilment of wide ranging conditions. The liabilities raised by virtue of escrow agreement are demonstrated to be substantially higher than the amount earmarked in escrow and hence funds have neither been released to the Assessee till date. When subsequent events after the filing of ROI are factored, such amount by way of escrow deposits can not be regarded as sale consideration accrued to the Assessee with reference to s. 48 of Act for the purposes of quantification of capital gains chargeable under s. 45 of the Act. We thus find merit in the case made out on behalf of the assessee and reversal of action of the CIT(A) and AO. As conceded on behalf of the assessee, the amount recovered out of escrow account by the assessee in the later years shall be liable to taxation in the respective years of receipt or accrual. The assessee shall be under legal obligation to pay taxes on accrual of such consideration dutifully in later years as and when arise. The AO while giving effect to this order may seek suitable indemnification and other safeguards to ensure taxation of escrow amount, as and when recovered. Disallowance u/s 14A - assessee has earned dividend income which was claimed as exempt u/s 10(34) - AO resorted to statutory formula provided in Rule 8D and computed disallowance u/s 14A - HELD THAT - We notice that the assessee has incurred Demat charges which is in the nature of direct expenses under Rule 8D(2)(i) of the Act. As regards on interest expenses, the assessee has demonstrated that own funds exceeds the corresponding investment yielding dividend income. The share capital along with reserves stands at Rs. 108.26 crore as against investment in share yielding dividend income at Rs. 33.35 crore. Thus, the disallowance of interest expenditure under Rule 8D(2)(ii) is not warranted. The disallowance under Rule 8D(2)(iii) is restricted to 0.5% of the average value of investment of Rs. 33.35 crore attributable to investment which yielded exempt income in terms of statutory formula. Assessee has made an ad hoc disallowance of 1/3 of salary of Chief Controller Account worked out to Rs. 1,99,857/- and other administrative expense of Rs. 1 lakh together to Demat charges of Rs. 3,21,949/-. For the purpose of suo motu disallowance, no basis has been given by the assessee for making such ad hoc disallowance. The AO thus shall be guided by the statutory formula as noted in the preceding paragraph. Decided partly in favour of assessee.

Summary

Issues Involved:
1. Taxability of capital gains with reference to the amount set apart in an escrow account.
2. Disallowance under Section 14A of the Income Tax Act concerning expenses attributable to exempt income.

Summary:

Issue 1: Taxability of Capital Gains with Reference to Amount Set Apart in Escrow Account

The assessee sold its shareholding in Modi Tyre Company Ltd. to Continental India Ltd. for a total agreed consideration of Rs. 117,61,90,000/-. A part of the sale consideration amounting to Rs. 25,48,16,450/- was kept in an Escrow Account to meet potential future liabilities. The assessee revised the computation of income, reducing the sale consideration to Rs. 92,13,73,510/- for determining capital gains, which the Assessing Officer (AO) found untenable.

The CIT(A) upheld the AO's decision, noting that the assessee itself declared the full sale consideration in its original return and did not revise the return. The CIT(A) observed that the liability on account of the Escrow amount cannot be carried forward to subsequent years based on self-imposed conditions by the assessee.

The Tribunal referred to the Bombay High Court's decision in Dinesh Vazirani vs. Pr.CIT, which held that the amount in escrow, not received by or accrued to the promoters, could not be considered as part of the full value of consideration for computing capital gains. The Tribunal found the facts in the present case identical to Dinesh Vazirani's case and held that the amount retained in escrow, which is neither received nor likely to be received, should not be taxed as capital gains in the year of transfer. The Tribunal allowed the assessee's claim for exclusion of the escrow amount from the full value of consideration.

Issue 2: Disallowance under Section 14A

The assessee earned dividend income of Rs. 3,35,50,000/- claimed as exempt under Section 10(34) of the Act and suo motu disallowed expenses amounting to Rs. 6,21,806/- under Section 14A. The AO computed disallowance at Rs. 1,09,31,500/- using the statutory formula in Rule 8D.

The CIT(A) upheld the AO's computation, stating that the ad hoc disallowance by the assessee was not in consonance with the law. The Tribunal observed that the assessee had sufficient own funds to cover the investment yielding exempt income, and thus, no interest disallowance was warranted. The disallowance under Rule 8D(2)(iii) was restricted to 0.5% of the average value of investment yielding exempt income. The Tribunal partly allowed the assessee's claim, reducing the disallowance.

Conclusion:

The appeal was partly allowed, with the Tribunal providing relief on the capital gains issue by excluding the escrow amount from the full value of consideration and partly allowing the claim concerning disallowance under Section 14A. The order was pronounced in the open Court on 08/02/2024.