LOSS ON TRANSFER OF LONG-TERM SHARES AND UNITS

[C.A. DEV KUMAR KOTHARI]

Summary: On an analysis of the old and new provisions it is noticed that the shares in companies, units of mutual funds, other assets which are held as investment and are not treated or converted into stock-in-trade are considered as capital asset.

Exemption of  certain type of capital gains in certain circumstances is given for ‘any income arising on their transfer’ .The language used, and the purpose of the provisions like sub-section (33) and 38  in section 10 of the Act, and taking into consideration that the head of income “capital gains” is not an exempted head of income, the purpose of determination of loss, setoff and carry forward of loss etc. it appears to be a very reasonable view that loss under head capital gains suffered on transfer of  such assets  will be eligible for setoff and carry forward.

Long term capital loss is computed after indexation and it can be set off against LTCG even without indexation, when LTCG is taxable at special rates provided u/s112. Recently Tribunal has so held.

1. Units and shares are capital asset:

Units in this write-up means units issued by the Unit Trust of India under the Unit Scheme, 1964 referred to in Schedule I to the Unit Trust Of India (Transfer of Undertaking and Repeal) Act, 2002 and units issued by other mutual funds also which enjoy similar exemption. Such units are capital asset within the meaning of the tern ‘capital asset’ as defined in section 2(14) of the Income–tax, Act, 1961 ( the Act). Similar is case for shares held in companies or co-operative societies etc. The unit, shares etc.  have not been excluded from the definition of capital asset. We find that there are certain assets which have been excluded from the meaning of ‘capital asset’. In case of an asset which is not a capital asset any computation of capital gain is not required. Whereas shares and unit being capital asset, a computation is required of capital gain on its transfer.

2. Units, shares - capital gain’s computation and taxation:

On transfer of a unit, or shares held as a capital asset (not being stock-in-trade) computation of capital gains is required to be made. In case the unit is a long-term capital asset, then benefit of indexation as per proviso to section 48 with reference to relevant cost inflation index in the year of acquisition and the year of transfer is also required to be made. The computation shall be as per prescribed provisions and the A.O. can ask details of such computation and supporting documents to establish factual and legal position.

3. Section 10 (33)/ 10(38):

By the Finance Act, 2003 a new clause in section 10 has been inserted. Relevant part of the provision including heading, opening words and the clause of section reads as follows:

(Chapter III: “Incomes which do not form part of total income)

S. 10. Incomes not included in total income.

In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included:

XXXXX

(33) Any income arising from the transfer of a capital asset, being a unit of the Unit Scheme, 1964 referred to in Schedule I to the Unit Trust Of India (Transfer of Undertakings and Repeal) Act, 2002 (58 of 2002) and where the transfer of such asset takes place on or after the 1^st day of April, 2002.

Likewise S.10(38) relates to exemption of LTC gain on transfer of shares and units when the sale transaction is in specified circumstances and has been subject matter of payment of security transaction tax.

An analysis would show that:

1. Only capital gain has been exempted. Thus, business profit on sale of units or shares held, as stock-in-trade shall not be exempted.

2. The transfer should take place within prescribed eligible periods for respective transactions.   

Prior to insertions of these provisions capital gains on transfer of units and shares were taxable and loss was allowed. The purpose is to give a benefit of tax exemption and not to deny the benefit of set off of loss which was earlier available. The exemption is not allowed in case conditions are not met.

The empirical studies shows that in most of the cases the investors who held units for long time and particularly who have purchased  units at higher price suffered heavy  losses due to sale / redemption  price being lower than the cost and inflated cost as per inflation Index. Considering the purpose of insertion of Section 10(33) there cannot be assumption of any intention to deny the benefit of loss. Furthermore the units resulting in to loss if were purchased prior to insertion of S. 10(33), denial of loss adjustment will not be in right spirit. Similarly in case of shares and other units a benefit by way of exemption is given when specified conditions are met. The purpose of exemption to allow a relief to assessee from payment of tax. This relief cannot be made a burden on assessee by denying benefit of set off and carry forward and set off of loss arising from such units and shares even if conditions for exemption are met.

4. The expression ‘any income arising from transfer’:

The above expression is very important for the purpose of this write-up. The expression ‘any income arising’ in the context of exemption from taxation can mean only profit or gain that is some thing more than the cost of acquisition or the indexed cost of acquisition in case of long-term capital gain. A loss cannot be brought within the expression ‘any income arising’. A loss is not at all chargeable to tax, therefore there is no question of taxes on loss and hence there need not be any exemption and the provisions of exemption cannot be rationally extended to loss. 

Furthermore , from the heading of the chapter III, heading and the opening wordings used in section 10 also it is clear that what is to be excluded from inclusion in total income is certain incomes specified in the chapter. The items are in nature of receipts of money, profits, and gains generally covering positive figures. The exemption is only for positive figures, for negative figures no exemption is required.

5. The words income and loss are opposites:

1. The words income and loss are opposite words. The expressions like, profit gains etc have been defined in dictionaries just to mean some positive profit or gain. For example:

Oxford Dictionary:

Income: periodical receipts (usually total annual) from one’s business, lands, works, investments etc.

Profit: advantage, benefit, pecuniary gains, excess of returns over outlay.

Gain: increase of possessions etc; profit, advance, improvement, acquisition of wealth, sums acquired by trade etc; emoluments, winnings; increase in amount … 

Black’s Law Dictionary:

Income: The return in money from one’s business, labor, or capital invested; gains, profits, salary, wages, etc.

 ‘Income’ - section 2 (24) of the Income-tax Act, 1961 clearly shows that income includes only positive incomes arising in form of some receipts or profits or gains computed as per relevant provisions of the Act. None of the clauses can, by any stretch of imagination suggests that income includes loss.

Therefore, when we speak of income, and particularly chargeable income, we can envisage only a positive income and not a loss as a negative income. The concept income includes loss is a concept in the context of determination of taxable income of a period of time by taking into account incomes and losses and that concept is not applicable in charging sections.

6. Principle that `Profit includes loss’ has no application in context of S.10 (33):

As noted earlier, in the context of section 10(33) the principle that profit includes loss or that loss is a negative profit is not applicable. Because first of all this provision is applicable to a capital asset and not to an item which is not at all capital asset, then it is applicable to ‘any income arising from transfer of such capital asset. In case the cost of acquisition or the indexed cost of acquisition of Unit is more than the consideration accruing on sale or transfer, then there is no case of ‘income arising’ so section 10(33) will not apply.

7. The principle decided by the Supreme Court and statutory provision:

It was decided by the Supreme Court that for computing gross total income and total income, losses couldn’t be ignored. For that purpose, income includes loss. Thus, loss suffered has to be taken into account as negative incomes for the purpose of computing chargeable income. Similarly when income of any other person is required to be clubbed in the income of assessee, the loss of such other person will also have to be clubbed. In the case of CIT V J.H. Gotla [1985 -TMI - 5903 - SUPREME Court (SC)], it was held that for the purpose of section 16(3) of the Income-tax Act, 1962 (clubbing  provisions corresponding to section 64 of the 1961 Act) the term income shall include loss.

It was not ruled that for all purposes income include loss.

Now the principle has found statutory recognition by way of insertion of an explanation to section 64 of the Income-tax Act, 1961 as follows:

Explanation 2: For the purpose of this section, “income” includes loss.  

Thus, it is clear that the principle that income includes loss is limited in its application to section 64 only. This principle cannot be applied to other provisions including chapter III as there is no such Explanation.

8. In the context of charging section  the principal that ‘income includes loss’ will result in absurdity:

It would be wrong to say that income includes loss is a general or universal rule as it will be totally absurd and result into anomalous results. If loss of Rs.100 is a negative income and profit of Rs.100 is positive income the out come may be of two types:

The revenue may have to pay the assessee Rs.35 because the income is negative Rs.100 so tax will also be negative Rs.35 – a lottery indeed for loss maker.

Or

Tax loss of Rs. (100) the same way as profit of Rs. 100 say Rs.35 as income tax and increase after tax loss of assessee to Rs.135/-.                            

Let us take other case an individual has suffered loss of Rs one lakh, he is not required to file return of income, he can do so if he wants that the loss should be carried forward. If the loss of Rs. one lakh is called to be negative income, he may be required to file the return.

Thus, it is clear that income includes loss cannot be applied as general rule; it applies only in the context of clubbing provisions of section 64. Even for set off of loss the rule has no general application because set off is permitted by specific provisions and not by the general rule that income included loss.

Old provisions Vis a Vis new provisions:

In the case CIT V Harprasad & Co. P. Ltd [1975 -TMI - 6439 - SUPREME Court], the assessee sought to carry forward loss under the head `capital gains’ for the assessment year 1955-56. In that year, any income falling under the head  `capital gains’ was not at all taxable, even in subsequent year any income falling under the head ‘capital gains” were not taxable under the old provision of Income-tax Act, 1922. In that case the rational and reasoning was that there must be purpose of computing the loss (under the head capital gains). The purpose can be to set off the loss or carry forward the loss.

If due to head itself being tax free there is no need to compute the loss as it will neither be set off nor carried forward for set off in future, because in subsequent year also the head ‘capital gain’ was exempt. So the assessee was denied the benefit of computation of loss and carry forward of the same under the head ‘capital gains’.

In view of these reasoning it was also held that the concept of carry forward of loss does not stand in VACUUM, it involves the notion of set-off, its sole purpose is to set off the loss against the profits (of the year) or of a subsequent year. It presupposes the permissibility and possibility of the carried forward loss being absorbed or set off against the profits or gains, if any of the subsequent year. Set-off implies that the tax is exigible and the assessee wants to adjust the loss against profits to reduce the tax demand. That if such set-off is not permissible or possible owing to the income or profit of the subsequent year being from a non-taxable source, there would be no point in allowing loss to be “carried forward”. Conversely, if the loss arising in the previous year was under the head not chargeable to tax, it could not be allowed to be carried forward and absorbed against income in a subsequent year, from a taxable source.

In the Income-tax act, 1961 any head of income is not exempt. Exemption is of certain types of incomes or receipts, which may fall in one, or the other head of income. The assessee may have taxable income from other type of source falling under any head.  Restrictions, which the legislatures wanted to place on set-off or carry forward and set-off have been specifically provided by way of specific provisions in the Act. Therefore, unless there is a specific prohibition for set off or carry forward and set off in future, loss will have to be computed and it can be set-off in the same year or can be carried forward and set off in future.

There is purpose of computing loss on transfer of Units:

The assessee who makes profit or gain on transfer of units can claim exemption u/s 10 (33). However, for that purpose, the assessee will have to give a computation and prove that the income has accrued but it is exempt, for that purpose the Assessing Officer may ask for evidence to prove the date of acquisition, cost of acquisition, calculation of inflated cost of acquisition and sale price of unit to satisfy himself that the assessee has correctly computed exempted income and has not overstated the same. Now suppose an assessee suffers loss of profit on sale of Units, he can claim the loss to be set off against his other capital gains, and can also seek carry forward and set-off in future. This is so because:

(a) The head ‘capital gains’, is not an exempted head of income,

(b) There is no specific bar on set off or carry forward of such loss, and

(c) The expression `any income arising’, as used in section 10(34) covers only positive income and loss is not covered by the same.

(d) There is purpose of set off of loss – to set off against other capital gains in 

The same year or in subsequent years.

Therefore, applying the rules laid down in the case of Harprasad (supra.), it can be said that the loss on transfer of Units should be computed and allowed for set off against other capital gain as per law. The carry forward for set off against other capital gains in future will be subject to fulfillment of other conditions like filing of the return on loss within due date u/s 139(3) read with section 139(1).

Recent decision of ITAT

In Vipul A. Shah v. ACIT (ITA No 3190/Mum/2010) Mumbai ITAT dated 8 April 2011 the facts wer as follows:

The taxpayer was engaged in investment. During the assessment year 2004-05, the taxpayer had set off the indexed long term capital loss against non-indexed long term capital gains. The Assessing Officer did not allow the set off of indexed long term capital loss against non-indexed long term capital gains.

Issue for consideration by the Tribunal was  - Whether the indexed long term capital loss can be set off against non-indexed long term capital gains?

Observations and Ruling of the Tribunal

Computation provisions:  The provisions of section 48 to 55 of the Income-tax Act (“ITA”) refer to the mode of computation of capital gains including short-term as well as long term capital gains.

Set off provisions:  section 70(3) of the Act refers to setting of long term capital loss against the long term capital gains arrived at under a similar computation. The Tribunal observed that the above provisions relating to set off of long term capital loss against the long term capital gains existed much prior to the mode of computation of capital gain without applying the benefit of indexation.

·   A plain reading of the provisions of section 70(3) of the Act shows that the first part of the provision refers to a loss as computed under sections 48 to 55 of the Act in respect of any capital asset.

·   The second part of the provisions of section 70(3) of the ITA refers to income if any as arrived at under “similar computation”. Thus, the second part refers only to the mode of computation under sections 48 to 55 of the ITA and that would be the correct interpretation.

That it cannot be said that the second part of the provisions by using the expression “similar computation”, refers to a similar computation under either the second proviso to section 48 relating to indexed capital gains or proviso to section 112(1) relating to non-indexed capital gains.

The Tribunal accordingly held that indexed long term capital loss can be set off against non-indexed long term capital gains.

Authors point of view:

Computation of capital gain is to be made separately for each capital asset (or batch of capital asset bought at the same time and sold at the same time).

For example suppose assets a,b,c,d, and e were bought on same day and sold on the same day then computation can be made at on go, though preferably computation should be separate because assets are different. However, if there are different days of buying or selling then computation is to be made in respect of each asset according to days of acquisition and transfer.

Section 112 is a provision only for computing and levying tax at special rate. For applying such special rate it has been laid down that LTCG can be imposed at prescribed concessional rate, where specified circumstances exist, without inflating the cost of acquisition with CII.

As per computation provision one has to compute capital gains / loss after indexation. Suppose in some transactions there is loss after considering indexation, such loss shall be kept apart for set off and/or carry forward. The transactions which have resulted into LTCG even after applying CII, can only be considered u/s 112 and assessee can pay tax at prescribed rate on capital gains computed without applying CII. Suppose assessee has loss after indexation in some other transactions, such loss can be set off against income before indexation.

The ruling of Tribunal correctly lays down that indexed long term capital loss can be set off against non-indexed long term capital gains. It is hoped that the revenue shall accept the decision of Tribunal and will not indulge into unnecessary litigation by preferring appeal before the High Court.