Arbitration award paid by sale of property not cost of improvement – Supreme Court

Arbitration award paid by sale of property not cost of improvement – Supreme Court holds assessment order as erroneous and prejudicial

ABCAUS Case Law Citation:
ABCAUS 3699 (2023) (04) SC

Important Case Laws relied upon by parties:
Malabar Industrial Co. Ltd. vs. CIT (2000) 2 SCC 718 (2000) 243 ITR 83 (SC)
CIT vs. Smt. Shakuntala Kantilal (1991) 190 ITR   56 (Bombay)
Chemosyn Ltd. vs. ACIT 2012 (25) Taxxman.com 325 (Bombay)

In the instant case, the Department had challenged the order passed by the Hon’ble High Court in dismissing its appeal and confirming the order passed by the ITAT by which the ITAT set aside the order passed under section 263 of Income Tax Act, 1961 (the Act) by the the Commissioner 

The assessee was a company. It filed its income tax   return showing sale of the property/building. The said building was constructed by the assessee on the piece of land purchased by it and the said house was duly reflected in the balance sheet of the company.

There had been a litigation between shareholders of the   Company being family members. Litigations travelled to the Company Law Board and the High Court culminating in arbitration.

In the arbitration proceedings, an interim award was passed whereby an amicable settlement termed as “family settlement” was recorded between the parties.  As per the interim award, three shareholders were paid award.

The said house was sold to pay off the shareholders and therefore the said payment was taken as the cost of   improvement in the computation of the long term capital gains (LTCG).

The assessment was completed by the AO under Section 143(3) of the Act accepting the “long term capital gains”.

However, Commissioner of Income Tax issued a notice to show cause as to why the assessment order should not be set aside under Section 263 of the Act.

The claim of the assessee that the said payment was made by them towards settlement of litigation, which   according to the assessee amounted to discharge of   encumbrances and required to be considered as cost of improvement, was not accepted by the CIT as according to him it did not fall under the definition of “cost of improvement” contained in Section 55(1)(b)of the Act.

The Commissioner vide its revisionary order held that the assessment order passed under Section 143(3) of the Act was erroneous and prejudicial to the interest of the revenue on the issue relating to deduction of cost of improvement.

The ITAT held that every loss of revenue as a consequence of AO’s order cannot be treated as prejudicial to the interest of the revenue, when two views were possible and AO took a view which CIT did not agree with. The ITAT also upheld the allowability of the assessee’s claim of deduction of payment made to the shareholders relying upon the decision of the High Court.

The Department’s appeal against the ITAT’s order was dismissed by the High Court confirming the ITAT’s findings.

Applying the law laid by the Apex Court to the facts of the case, their Lordships opined that the assessment order was not only erroneous but prejudicial to the interest of   the Revenue also as it resulted in loss to the Revenue.

Therefore, in the facts and circumstances of the case, it could not be said that the CIT exercised the jurisdiction under Section 263 not vested in it.

The Hon’ble Supreme Court held that the High Court committed a very serious error in setting aside the order passed by the Commissioner in exercise of powers under Section 263 of the Act.

Accordingly, the impugned judgment and order passed by the High Court was quashed and set aside and the order passed by the Commissioner under Section 263 of the Act was restored.

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