While section 70 of the Income-tax Act, 1961 (IT Act) contains a provision for intra-head set off of losses, section 71 of the IT Act deals with inter-head set off. Where the losses carried forward cannot be set off against current year’s income, such losses can be carried forward to subsequent year. In respect of capital loss, the current year’s capital loss can only be set off against current year’s capital gains and the balance can be carried forward for eight years (to be set off against capital gains). Thus, only the net amount (post adjustment of current year and past year losses) is liable to tax. Where a taxpayer has earned exempt capital gain and also has brought forward long-term capital loss, a question may arise as to whether only the net amount should be exempted from tax or the gross amount, especially if the source of the exempt gain and loss is same. In other words, whether brought forward capital loss should be reduced by current year’s gains or the entire amount can be carried forward. In this regard, the Mumbai Tax Tribunal1 had an occasion to examine whether the brought forward losses of earlier year (the source of which is exempt in current year) should be adjusted against the current year’s income and that the balance remaining after set off can be carried forward to a subsequent year or not. We, at BDO in India, have summarised the ruling of the Tribunal and provided our comments on the impact of this decision
Facts of the case
Taxpayer, tax resident of Mauritius and registered with Securities Exchange Board of India as Foreign Institutional Investor (FII)2, and was engaged in the business of portfolio investment activity in the Indian capital market. During the Fiscal Year (FY) 2012-13. it had declared income of INR 17.39mn in its tax return. The Tax Officer observed that the taxpayer had claimed the capital gains earned on transfer of securities in India as exempt from tax in India under Article 13 of India-Mauritius Double Tax Avoidance Agreement (DTAA) and had also carried forward the capital losses pertaining to the same type and nature of income for set-off against future capital gains without setting off against the capital gain earned during the FY. The Tax Officer observed that pursuant to the India-Mauritius DTAA, capital gains arising to a taxpayer were neither taxable in India nor taxable in Mauritius as per the domestic tax laws there. The Tax Officer concluded that non-taxability of capital gain earned by the taxpayer was pursuant to section 90(2) of the IT Act, which allowed it to be governed by the provisions of India-Mauritius DTAA, therefore, it would not be permissible to a taxpayer to revert back to the provisions of the IT Act for the loss incurring capital gain transactions. The Tax Officer passed the draft assessment order under section 143(3) read with section 144C(1) declining the taxpayer’s claim for carry forward of capital losses.
Aggrieved, the taxpayer objected the draft order passed by the Tax officer before the Dispute Resolution Panel (DRP). The DRP held that once the capital losses were determined and allowed to be carried forward by the Tax Officer in a particular FY, the same could not be thereafter reviewed in the assessment proceedings of a subsequent year. If the Tax Officer’s decision was to be reviewed, it could only be done under the relevant provisions of the IT Act, which is section 263 of the IT Act or any other appropriate provision. Further, the DRP was of the view that as per clauses (a) and (b) of section 74(1) of the IT Act, capital losses that were brought forward by the taxpayer from preceding years were required to be first set-off against the capital gains for the year under consideration and only the balance amount of capital loss i.e. short term or long term could thereafter be carried forward. Accordingly, the DRP restricted carry forward of capital losses. Aggrieved, the taxpayer filed an appeal before the Tax Tribunal.
While allowing the entire brought forward capital losses to be carried forward, the Tax Tribunal observed that:
- The DRP’s view that brought forward the capital loss be first adjusted against exempt capital gains and only the balance amount of capital loss be carried forward is bereft of any reasoning.
- Reliance placed on Mumbai Tribunal decision in the case of Flagship Indian Investment Company (Mauritius) Ltd3 wherein it was held that the taxpayer was justified in claiming carry forward of capital losses of earlier years to subsequent years. In other words, the Tax Officer’s view that as the capital gains were exempt in terms of Article 13 of India-Mauritius DTAA, the capital losses would also be exempted, and hence the benefit of carry forward of capital losses without setting off against capital gains for the relevant fiscal year would not be available was held to be untenable.
- The view of the Tax Officer that as section 45 of the IT Act was rendered unworkable by virtue of the India-Mauritius DTAA, the “capital losses” would also not form part of the taxpayer's “total income” and thus, could not be computed under the IT Act, the Tribunal observed that this view had been arrived at by losing sight of the fact that the “capital losses” in question had been brought forward from the earlier years and had been determined and allowed to be carried forward by the Tax Officer while framing the assessment for FY 2011-12 and had not arisen during FY 2012-13. Accordingly, this contention of the Tax Officer was rejected.
- The DTAA cannot be thrust upon a taxpayer. In case the taxpayer during one year does not opt for the DTAA, it would not be precluded from availing the benefits of the said DTAA in the subsequent years. For this, reliance was placed on the Pune Tribunal’s decision in the case of Patni Computer Systems Ltd4.
The taxpayer who has earned exempt income and has carry forward losses could avail the benefit of this decision to contend that no part of the brought forward loss be set off against the capital gain earned during the year. Further, an important observation has been made by the Tax Tribunal that the taxpayer is free to select DTAA in one and in subsequent year(s). Thus, where a taxpayer has incurred loss and if he decides not to avail DTAA benefit, the tax officer cannot cast a responsibility on such a taxpayer to take the DTAA route and thereby deny the carry forward of loss. It is also imperative that this decision will also be helpful to contend that losses of earlier year’s cannot be denied in subsequent years. In this regard, support could also be taken of Supreme Court’s decision in the case of Manmohan Das5 wherein it was held that once the loss has been computed in earlier years and allowed to be carried forward, the Tax Officer while making assessment of any subsequent years, cannot question the right of the taxpayer to carry it forward.
1Goldman Sachs Investments (Mauritius) Limited vs DCIT(IT) (ITA No. 2201/Mum/2017)
2Foreign Portfolio Investment
3Flagship Indian Investment Company (Mauritius) Ltd vs ADIT (IT)-3(2), Mumbai (2010) 133 TTJ 792 (Mum)
4DCIT vs Patni Computer Systems Ltd (2008) 114 ITD 159 (Pune)
5CIT vs Manmohan Das (1966) 59 ITR 699 (SC)