2021 (9) TMI 1577 - HC - Income Tax

Set-off of brought forward business loss u/s. 72(1) against the deemed short-term capital gain assessed u/s. 50 - HELD THAT - Sub section (1) of Section 72 therefore provides that where for any assessment year the net result of the computation under the head profits and gains of business or profession is a loss to the assessee it shall be set off against the profits and gains if any of any business or profession carried on by him and assessable for that assessment year. Section 72(1) of the Act employs the expression computation under the head profits and gains of business or profession whereas Section 72(1) (i) does not use the said expression but it says against profits and gains if any of any business or profession . Therefore what is required to be seen is whether profits and gains against which the loss is sought to be set off was part of the business activity of the assessee or business asset of the assessee. Admittedly in this case the assessee had sold block of assets i.e. buildings / development factory building plant and machinery and had shown short term capital gain plus long term capital gain by sale of immovable property. The assessee was in the business of manufacturing metal containers and the computations of gain was under a different head nevertheless the profit or gain on sale of depreciable assets to extent of recoupment of depreciation is nothing but business income in substance. The assessee is entitled to set off brought forward loss against income which has the attributes of business income even though the same is assessible to tax under head other than profit and gain from business. We find support for this view from Alcon Developers 2021 (2) TMI 284 - BOMBAY HIGH COURT and Nandi Steels Ltd. 2021 (3) TMI 737 - KARNATAKA HIGH COURT - Decided in favour of assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Court was whether the set-off of brought forward business loss under Section 72(1) of the Income Tax Act, 1961, is permissible against the deemed short-term capital gain assessed under Section 50 of the Act, particularly when such capital gain arises from the sale of business assets and represents the recoupment of depreciation allowed in earlier years. The question arose in the context of whether such capital gains, though assessed under a different head, retain the character of business income for the purpose of set-off of losses.

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Whether brought forward business losses under Section 72(1) can be set off against deemed short-term capital gains assessed under Section 50, when such gains arise from the sale of business assets representing recoupment of depreciation.

Relevant Legal Framework and Precedents: Section 72(1) of the Income Tax Act provides that if the net result under the head "Profits and gains of business or profession" is a loss, such loss shall be carried forward and set off against profits and gains of any business or profession in subsequent years. Section 50 deals with the computation of capital gains on the transfer of depreciable assets, treating the gain as deemed short-term capital gain to the extent of depreciation recouped.

The Court noted the distinction in language within Section 72(1): the initial computation refers to "computation under the head profits and gains of business or profession," whereas the set-off in clause (i) refers to "profits and gains, if any, of any business or profession." This linguistic nuance necessitates examining whether the income against which the loss is sought to be set off retains the character of business income, notwithstanding its assessment under a different head.

Precedents cited include Principal Commissioner of Income Tax Vs. Alcon Developers and Nandi Steels Ltd. Vs. Assistant Commissioner of Income Tax, which support the proposition that income representing recoupment of depreciation on sale of business assets is to be treated as business income in substance, even if assessed under the head "capital gains."

Court's Interpretation and Reasoning: The Court emphasized that the assessee sold blocks of business assets such as buildings, factory buildings, and plant and machinery, generating short-term capital gains, and also sold immovable property yielding long-term capital gains. Although the gains were computed under the head "capital gains," the portion of gain representing the recoupment of depreciation is essentially business income.

The Court reasoned that since the income has the attributes of business income, the assessee is entitled to set off brought forward business losses against such income, even if it is assessed under a different head. The Court distinguished between the head of income under which the gain is assessed and the true nature and character of the income itself.

Key Evidence and Findings: The facts showed that the assessee was engaged in manufacturing metal containers and had sold depreciable business assets. The Assessment Officer had disallowed the set-off of carry forward business loss against capital gains, while allowing set-off of unabsorbed depreciation. The CIT (Appeals) upheld the disallowance, holding that capital gains cannot be set off against business loss under Section 72. The Tribunal, however, allowed the set-off, recognizing the business nature of the gains arising from sale of business assets.

Application of Law to Facts: Applying the legal provisions and precedents, the Court found that the Tribunal correctly allowed the set-off. The gain arising from sale of depreciable business assets, to the extent of recoupment of depreciation, is business income in substance and therefore eligible for set-off against brought forward business losses under Section 72(1).

Treatment of Competing Arguments: The Revenue contended that capital gains assessed under Section 50 cannot be treated as business income and thus brought forward business losses cannot be set off against such gains. The CIT (Appeals) supported this view. The Court rejected this argument, relying on the substance-over-form principle and authoritative precedents, holding that the character of income should prevail over the head under which it is assessed.

Conclusions: The Court concluded that the Tribunal was justified in allowing the set-off of brought forward business loss under Section 72(1) against the deemed short-term capital gain assessed under Section 50, as the latter represented recoupment of depreciation on business assets and thus bore the character of business income.

3. SIGNIFICANT HOLDINGS

The Court held: "The profit or gain on sale of depreciable assets to the extent of recoupment of depreciation is nothing but business income in substance. The assessee is entitled to set off brought forward loss against income which has the attributes of business income even though the same is assessible to tax under head other than profit and gain from business."

Core principles established include the recognition that the true nature and character of income must be examined beyond the head of income under which it is assessed, particularly for the purpose of set-off of losses under Section 72(1). The judgment affirms that deemed capital gains under Section 50, arising from sale of business assets and representing recoupment of depreciation, retain their business income character for set-off purposes.

The final determination was that the Tribunal's decision allowing set-off of brought forward business loss against deemed short-term capital gains under Section 50 was correct, and the appeal by the Revenue was dismissed accordingly.