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Issue for consideration
Under the provisions relating to set-off of brought forward business losses u/.s72, a brought forward business loss can be set off only against business profits of the current year, and not against income from any other source, including capital gains of the current year. Gains arising on sale of depreciable business assets forming part of a block of assets, though arising in the course of business, is taxable under the head ‘Capital Gains’ as a deemed shortterm capital gains on account of the specific provisions of section 50.
Section 50 reads as under:
“50. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications:
(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely:
(i) expenditure incurred wholly and exclusively in connection with such transfer or transfers;
(ii) the written down value of the block of assets at the beginning of the previous year; and
(iii) the actual cost of any asset falling within the block of assets acquired during the previous year,
such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;
(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written-down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.”
The issue has arisen as to whether brought forward business losses can be set off against deemed shortterm capital gains, arising on transfer of depreciable assets, taxable u/s.50, since such gain is really a type of business income. While the Bangalore and Rajkot Benches of the Tribunal have held that unabsorbed business loss cannot be set off against the gains arising u/s.50, the Mumbai Bench of the Tribunal has held that the business loss brought forward from earlier years can be set off against such capital gains chargeable u/s.50.
Kampli Co-operative Sugar Factory’s case
The issue had come up before the Bangalore Bench of the Tribunal in the case of Kampli Co-operative Sugar Factory Ltd. v. Jt. CIT, 83 ITD 460. In this case relating to A.Y. 1997-98, the assessee sold the assets of its sugar factory, including the depreciable assets but excluding investments and deposits and the liabilities. The assessee claimed that the sale was a slump sale and the gains thereon was not taxable, since section 50B introduced with effect from A.Y. 2000-01 was not applicable to the year under consideration.
The Assessing Officer broke up the consideration into two parts — one for the land, which was held taxable as a long-term capital gains after deducting the indexed cost of the land, and the other for the depreciable assets, which was held taxable as deemed short-term capital gains after deducting the written-down value of the block of assets. He also did not set off the brought forward business losses against such capital gains.
The Commissioner (Appeals), upheld the order of the Assessing Officer and denied the set-off of the unabsorbed business losses against the capital gains.
The Tribunal confirmed that the sale was not a slump sale and bifurcation of the consideration was justified but proceeded to further examine the issue as to whether the unabsorbed business loss could be set off against the short-term capital gains arising u/s.50. The Tribunal held that the business assets were also capital assets as defined u/s.2(14), giving rise to capital gains on their sale chargeable u/s.45. The Tribunal observed that prior to 1st April, 1988, a component of capital gains arising from the sale of business assets was treated as a business profit by the legal fiction of the then prevailing section 41(2) while section 50 charged the whole amount under the head ‘capital gains’. The Tribunal further noted that the deeming capital gains u/s.50 of the Act is restricted to the capital gains being short-term capital gains and did not deem a business income to be the capital gains u/s.50 of the Act. The Tribunal therefore held that the unabsorbed business losses could not be set off against the capital gains.
A similar view was taken by the Rajkot Bench of the Tribunal in the case of Master Silk Mills (P.) Ltd. v. Dy. CIT, 77 ITD 530, where the Tribunal held that unabsorbed business losses could not be set off against sales proceeds of scrap of building that was taxable u/s.50 as a short-term capital gains. In that case the business had been closed and the income could not be said to have arisen in the course of business.
Digital Electronics’ case
The issue recently came up before the Mumbai Bench of the Tribunal in the case of Digital Electronics’ Ltd. v. Addl. CIT, 135 TTJ (Mum.) 419.
In this case, the assessee sold the factory building and plant and machinery, and claimed set-off of unabsorbed depreciation and brought forward business loss against such short-term capital gains taxable u/s.50. It was claimed that though the income was taxable as capital gains, its character remained that of business income inasmuch as the gains arose on transfer of a business asset on which depreciation was allowed. Reliance was placed on the decision of the Mumbai Bench of the Tribunal in the case of J. K. Chemicals Ltd. v. ACIT, 33 BCAJ (April 2001) page 36 [ITA No. 3206/Bom./89 dated 1st November 1993], where the Tribunal had held on similar facts [though in the context of section 41(2) and capital gains] that the character of such income that arose on transfer of depreciable assets remained that of business income, though it was taxed as capital gains under a deeming fiction.
The Assessing Officer however disallowed such setoff. The Commissioner (Appeals) upheld the stand of the Assessing Officer, taking the view that there was no ambiguity in section 72, and that reliance could not be placed on erstwhile provisions of section 41(2).
The Tribunal, analysing the provisions of section 72, observed that the said section 72 stated that the losses incurred under the head ‘Profits and Gains of Business or Profession’ which could not be set off against income from any other head of income, had to be carried forward to the following assessment year and was allowable for being set off “against the profits, if any, of that business or profession carried on by him and assessable for that assessment year.” In other words, according to the Tribunal, there was no requirement of the gains being taxable under the head ‘Profits and gains of business or profession’ and thus, as long as gains were ‘of any business or profession carried on by the assessee and assessable to tax for that assessment year’, the same could be set off against loss under the head profits and gains of business or profession carried forward from earlier years. According to the Tribunal, the gains arising on sale of the business assets was in the nature of business income, though it was taxed under the head ‘Capital Gains’.
The Tribunal therefore held that the unabsorbed business losses could be set off against the capital gains charged to tax u/s.50.
Observations
The income from transfer of a depreciable asset, used for business, has its origin in business and is primarily characterised as a business income. This position in law was acknowledged specifically by old section 41(2) that is deleted w.e.f. 1-4-1988. Even the new section 41(2) provides for the similar treatment for taxing income on sale of depreciable assets used for generation and distribution of power under the head ‘profits and gains of business’.
The Income-tax Act contains provisions, for example, sections 8 and 22, which provide for an income to be taxed under a specific head of income though the same otherwise may have a different character. These provisions contain a deeming fiction and it is understood that they have a limited application.
The Supreme Court following its decisions in the cases of United Commercial Bank Ltd., 32 ITR 688 and Chhugandass & Co., 55 ITR 17, in the case of CIT v. Radhaswami Cocanada Bank Ltd., 57 ITR 306, had established this principle in the context of set-off of business losses against dividend income, which was then taxable under the head ‘Income from Other Sources’. It was noted by the Supreme Court that while one set of provisions, i.e., the nature of loss incurred by the assessee, classified the same on the basis of income being taxable under a particular head for the purpose of computation of the net income, the other set of provisions was concerned only with the nature of gains being from business and not with the head of tax. Their Lordships held that as long as the profits and gains were in the nature of business profits and gains, and even if these profits were liable to be taxed under a head other than income from business and profession, the loss carried forward could be set off against such profits of the assessee. The ratio of these decisions was again confirmed by the Supreme Court in the case of Western States Trading Co. Pvt. Ltd., 80 ITR 21.
Even in the context of section 50 gains, the Courts have consistently held that such gains, though taxed under a deeming fiction as short-term capital gains, are eligible for the benefit of exemption from taxation u/s.54E, 54EC, 54F, etc. on its reinvestment in the specified assets [see Assam Petroleum Industries Ltd., 262 ITR 587 (Gau.) Rajiv Shukla, 334 ITR 138 (Del.) and Ace Builders Pvt. Ltd., 281 ITR 210 (Bom.)]. The SLP against the last decision has been dismissed by the Supreme Court.
It is accordingly a fairly settled position in law that a benefit otherwise allowed in law under one provision shall not be denied by extending a fiction contained in any other provision of law unless specifically provided for. No such provision is found to be contained in the provisions of sections 70, 71 and 72 of the Act.
On a closer reading of section 72 one finds that it does not mandate that the income that is sought to be adjusted against the brought forward loss should be the one that is taxable under the head ‘profits and gains of business’. This precisely is brought out by the Mumbai Bench of the Tribunal by explaining that there is a distinct difference in the language employed in section 72 in the context of the loss that is to be carried forward, where the loss under the particular head of income is referred to, as against the context of the loss which it can be set off against, where the nature of income is referred to.
Looked at it from one more angle, the income that is sought to be taxed u/s.50 is to a large extent nothing but recoupment of depreciation that has been allowed as a deduction in computing the income under the head ‘profits and gains of business or profession’ and to the extent of the amount representing the recoupment should be considered as the business income.
The Mumbai Tribunal in the above-referred decision in J. K. Chemicals’ case was also impressed by the fact pointed out to the Tribunal that even the form of the Return of Income for the relevant year under consideration in that case provided for a set-off of brought forward business losses against the deemed short-term capital gains.
It is thus clear that in the case of capital assets of a business, the source of the income is really the business itself. It is by virtue of the fact that a business had been carried on that gains arises on sale of assets of that business. The character of the income is therefore that of business income, though there are specific provisions for taxing such gains as capital gains. Even a businessman would regard the character of such income as arising from his business.
Therefore, the view taken by the Mumbai Bench of the Tribunal in Digital Electronics case seems to be the better view of the matter.
