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TMI Blog2024 (2) TMI 581X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) of the Act. The return filed by the assessee was subjected to scrutiny assessment under Section 143(3) of the Act. In the course of the scrutiny assessment, the Assessing Officer inter alia observed that the assessee has sold its shareholding in the wholly owned subsidiary, M/s. Modi Tyre Company Ltd. (MTCL) to M/s. Continental India Ltd. (CIL) on 15th July, 2011 for a total agreed consideration of ₹ 117,61,90,000/-. A Share Purchase Agreement (SPA) dated April 17, 2011 was executed for this purpose. As per the SPA, the enterprise value was agreed at Fifty Million Euro equivalent to gross sale consideration of ₹ 117,67,90,000/-. In such a transaction by way of sale of 100% equity by the assessee in the subsidiary company and thus involving sale of business for controlling interest in the company, a certain part of sale consideration was not directly paid to the seller assessee but was kept aside to meet certain contingencies which may arise in the next few years. This amount agreed at ₹ 25,48,16,450/- (3.75 million Euro) was kept aside in a Escrow Account (EA) with an Escrow Agent (Yes Bank Ltd.) with an instruction as to how the amount is to be utilized and pai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uently, the assessed income was enhanced by such disallowance. 5. The AO also enhanced the book profit computed by the assessee towards such expenditure stated to be relatable to exempt income under the MAT provisions codified under Section 115JB of the Act. The book profit under Section 115JB was accordingly increased towards such disallowance. 6. The AO also made certain other additions/disallowances with which we are not presently concerned. 7. Aggrieved, the assessee preferred appeal before the CIT(A). 7.1 The CIT(A) took note of the submissions made on account of denial of adjustments to full value of sale consideration towards amount lying in Escrow account while determining the LTCG but however did not find any force in the plea of the assessee. The CIT(A) broadly noted that the assessee itself declared full value of sale consideration at ₹ 117,61,90,000/- on account of sale of shares of wholly owned subsidiary, Modi Tyres Ltd. in its original return of income. The assessee also did not choose to revise the return. The assessee opted to amend the sale consideration and consequent taxable LTCG by reducing Escrow amount kept aside from the gross sale consid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was subject to adjustment and retention of ₹ 25.48 crore in Escrow Account in order to cover unascertained potential liabilities which, if known at the time of sale of shares, would have further changed the dynamics and decreased the amount of sale consideration. The potential liabilities identified included liabilities on account of indirect tax exposures on account of excise duty, CENVAT credit etc, contingent liability and other host of liabilities which may arise in future. As per clause 4.5 of the SPA, the parties to the agreement mutually agreed that the Escrow amount of ₹ 25.48 crore shall be paid by assessee into Escrow Account and such Escrow amount shall be utilized for payment of potential claims by following the due process in terms of SPA. As per clause 6.5, the assessee had also agreed to indemnify the purchaser from and against losses, liabilities, claims damages, costs on account of any breach of compliance of any covenant, undertaking and warranties etc. as per the terms stipulated in the SPA. An Escrow Agreement dated 12.07.2011 was entered and an Escrow account was opened to give effect to such understanding codified in the agreement. The Escrow Accou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... falls outside the ambit of expression full value of consideration received or accruing under Section 48 of the Act and thus could not be subjected to tax as income for the year under consideration. The ld. counsel asserted that the Escrow amount was kept and earmarked for the appropriation against the claim to be raised by the Continental Group. Such Escrow amount could not be regarded as part of full value of consideration to be liable to tax in the hands of assessee more particularly when substantial claims of more than ₹ 78.90 crore were identified and raised in the subsequent years against such Escrow arrangement. The ld. counsel observed that out of 25,48,16,328/-, the assessee has realised principal amount of ₹ 1,91,91,928/- in F.Y. 2013-14 only and therefore, the remaining amount of ₹ 23,56,24,400/- being the residual principal amount unaccrued and unreceived, should be held to be not liable for LTCG taxation. The liability to tax on amount lying in Escrow account would arise only in the year of accrual and receipt based on happening of events in future. The ld. counsel further submitted that the aforesaid residual principal amount has neither been recei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... offer any deduction on account of money set apart in Escrow account to meet potential liabilities which may or may not eventually arise. The ld. DR referred to paragraph 4.5 of the SPA and submitted that Escrow amount was agreed to be paid by the assessee into Escrow account for utilization against future claims. This is a clear case of application of sale consideration to guard against unascertained liabilities for which an Escrow Agreement was executed much later to the SPA Agreement on 12.07.2011. This act also reinforces the case of application of full consideration received or accrued. 11.2 The ld. DR submitted that the amount kept in Escrow account were for meeting claims that may arise on a future date and that the interest which accrued on the sums retained in the Escrow Account had been agreed to be belonging to the seller, i.e., the assessee and has to be paid to the assessee as per the instructions of the Escrow accounts. The assessee thus always had a right to receive the sums kept in the Escrow accounts although such amount was to be quantified after a specific period. On facts, the assessee has actually received certain interest on Escrow account in the later year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T-DR also submitted that Escrow Agreement was entered subsequent to SPA which signifies that a subsequent arrangement between the parties has been entered. The ld. CIT-DR submitted that in such kind of arrangement, the assessee as a normal incidence of business is liable for indemnification or breach of warranty for any losses regardless of Escrow Account or not. A mere opening of Escrow Account will not thus change the inherent character of application of income after its accrual. The Ld. DR also contends that there is no provision in law that permits the deferment of taxation to the later year and the charge of capital gain would fail in the later year for want of transfer required for application of s. 45 of the Act. 11.6 The ld. DR thus submitted that in the wake of provisions of Act and having regard to the various clauses of the SPA and EA, no fault can be found with the action of the lower authorities in denial of modified claim in departure with the income returned. The ld. CIT-DR also submitted that the claims have been quantified by assessee against the Escrow account before the Tribunal at this belated stage which cannot be vouched in the absence of any information to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed on gross sale consideration including amount in custody of escrow and not accrued per se, the assessee is entitled to raise claims not made in the ROI before the Appellate Authorities in accord with judicial dicta echoed in Goetze (India) Ltd. v. CIT, (2006) 284 ITR 323 (SC) and CIT vs. Jai Parabolic Springs Ltd., 306 ITR 42 (Del and other host of judgments. The assessee contends that in view of the complex and technical provisions contained in Indian Income Tax, it may not be unreasonable to expect the tax payers to miss on some of their rightful claims/concessions when they file their tax returns in the first instance. In view of settled position of law obliging the revenue to collect only legitimate tax on righteous income, we find force in the plea of assessee for admission of revised computation filed in the course of assessment for consideration whereby the quantum of chargeable capital gains has been sought to be modified and scaled down by excluding the Escrow amount set apart to meet the potential liabilities of the entity transferred as result of transfer of equity shares. 13.3 Adverting to core issue, we observe that it is a common business phenomenon that in most ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, who was a promoter of the company, agreed to sell shares of the company held by him along with other promoters for a total sale consideration of ₹ 155 crore. The SPA provided for specific promoter indemnification obligations. Such promoter indemnification obligations, the SPA provided that out of sale consideration at Rs. 155 crore, Rs. 30 crore would be kept in Escrow. If there was no liability as contemplated under the specific promoter indemnification obligations within a particular period, the amount of ₹ 30 crore would be released by the escrow agent to the selling promoters. A separate escrow agreement was entered into between the sellers, the buyers and the escrow agent. 14.1 The assessee filed his return of income in July, 2011 by computing capital gains on his proportion of the total sale consideration of ₹ 155 crore, including the amount kept in escrow, which had not been paid out but was still parked in the escrow account till the time the return was filed. The assessment was selected for scrutiny and an assessment order was passed u/s. 143(3) on 15th January, 2014 accepting the returned income. 14.2 Subsequent to the passing of such assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be disturbed, and even an annulment of the assessment would not impact the suo moto tax paid on the returned income. The Commissioner further was of the view that the contingent liability paid out of escrow account did not have the effect of reducing the amount receivable by the promoters as per the agreement. 14.5 The assessee filed a writ petition before the Bombay High Court against such order of the Commissioner rejecting the revision petition. 14.6 The Bombay High Court held that the order passed by the Commissioner was not correct and quashed the order. It observed that the Commissioner had failed to understand that the amount of ₹ 9.17 crore was neither received by the promoters nor accrued to the promoters, as this amount was transferred directly to the escrow account and was withdrawn from the escrow account. In the view of the High Court, when the amount had not been received by or accrued to the promoters, it could not be taken as the full value of consideration in computing capital gains from the transfer of shares of the company. 14.7 The Bombay High Court observed that the Commissioner had not understood the true intent and content of the SPA, and not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t receivable as per the agreement for the purposes of computing capital gains u/s. 48. As per the High Court, the Commissioner failed to understand or appreciate that the promoters had received only the net amount of ₹ 145.83 crore, i.e., ₹ 155 crore less ₹ 9.17 crore, and that such reduced amount should be taken as full value of consideration for computing capital gains u/s. 48. 14.11 The Bombay High Court also rejected the Commissioner's argument that the assessee's returned income could not be reduced by filing a revision petition u/s. 264. According to the High Court, section 264 had been introduced to factor in such situation as the assessee's case, because if income did not result at all, there could not be a tax, even though in bookkeeping, an entry was made for hypothetical income which did not materialise. Section 264 did not restrict the scope of power of the Commissioner to restrict a relief to assessee only up to the returned income. Where the income can be said not to have resulted at all, there was obviously neither accrual nor receipt of income, even though an entry may have been made in the books and account. Therefore, the Commissio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of ₹ 31.14 crore had accrued to the assessee immediately on the execution of the agreement for sale. 15.4 In first appeal, the Commissioner (Appeals) noted that the amount in the escrow account had been kept by the purchaser to indemnify against breach of warranty or other losses or on account of further litigation as a result of non-compliance to the conditions of the agreement by the assessee. The Commissioner (Appeals) therefore was of the view that the sum retained in the escrow account had not accrued to the assessee in the year under consideration. He therefore held that amount of ₹ 3.25 crore kept in escrow account had neither been received or accrued by/to the assessee during the year, and since the said amount had been subsequently received by the assessee after the stipulated period of agreement, it had been offered to tax by the assessee under the head capital gains in the year of its receipt. Therefore, holding that the Assessing Officer was not justified in taxing the amount in the year under consideration, the Commissioner (Appeals) deleted the addition of ₹ 3.25 crore. 15.5 Before the Tribunal, on behalf of the Revenue, it was contended that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der of the Assessing Officer. 15.8 Before the Madras High Court, on behalf of the assessee, attention was drawn to the Business Sale Agreement, and in particular, covenant No. 14 dealing with indemnities for other losses and covenant No. 15 dealing with retention sum for indemnities. The attention of the Court was also drawn to a second supplementary agreement where there was a reference to a charge of theft of electricity and demand raised by the State Electricity Board from the purchaser of the asset. These facts demonstrated that the intention behind retention of a certain sum in escrow account was to meet liabilities which may be fastened on to the purchaser on conclusion of the sale transaction. 15.9 On behalf of the assessee, reliance was placed on the following decisions: The Bombay High Court decision in the case of CIT vs. Hemal Raju Shete 239 Taxman 176, which was a case where certain amounts were set apart to meet contingent liabilities, and it was held that this amount was neither received nor accrued in favour of the assessee. The Supreme Court decision in the case of CIT vs. Hindustan Housing Land Development Trust Ltd. 161 ITR 524, where a similar v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 33 (Del). Smt D Zeenath vs. ITO 413 ITR 258 (Mad). 15.12 The decisions relied upon by the Revenue were rebutted by the assessee's counsel, that all those were cases relating to mortgage, and that the agreement between the assessee and the purchaser clearly showed that the retention money was neither received nor accrued in favour of the assessee during the relevant year. 15.13 The Madras High Court examined the provisions of the Business Sale Agreement and noted that the retention amount had been retained for the purpose of ensuring that sufficient funds would be available to indemnify the purchaser against any damages or losses arising from indemnification for breach of warranty, indemnification for other losses, unpaid accounts receivables, and other obligations to pay or reimburse the purchaser as provided under the agreement. It noted that admittedly, no indemnification had to be given under either of the four heads, and the entire amount was received by the assessee without any deduction and was offered for taxation by the assessee in the subsequent year. The High Court noted that the Commissioner (Appeals) had not specifically examined as to whether the enti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e liable to capital gains tax during the relevant year on the entire sale consideration as per the agreement. 16. On a nuanced consideration of covenants and conditions of business sale agreement, escrow agreement and attendant factual matrix in the present case qua the diverse judgments analysed in preceding paragraphs, we observe that the facts in the present case are identical to Dinesh Vazirani s case (supra). In the instant case also, a shadow has been cast on the legally enforceable right to receive of the assessee on such consideration set apart in the escrow account owing to staggering liabilities quantified post transfer of shares. The liability arising as quantified, far outweighs the amount lying in such escrow account. The assessee, on facts, have pointed out that it could not lay hands on the escrow amounts despite lapse of nearly a decade except recovery of an insignificant sum of ₹ 1.91 crore way back in Financial Year 2013-14. The assessee vehemently asserts any recovery out of escrow towards sale consideration is remote and far fetched owing to large scale disputed claims of overwhelming nature. As a measure of indemnification, the assessee however simulta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inesh Vazirani case, 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 of the Act. 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. 19. 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, t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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