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2024 (6) TMI 1459 - AT - Income TaxSet off of capital loss against income for the purpose of section 74 - assessee is entitled to get exemption under Article13(4) of DTAA - Whether the brought forward long-term capital losses and short-term capital losses can be set off against long-term capital gains (LTCG) exempt under Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA)? HELD THAT - Considering the plain reading of the section that capital loss after being carried forward can be set off only against income under the head capital gains. Therefore existence of a taxable income is a precondition for a set of losses against such income. In this appeal the gains of Rs.26, 36, 44, 954/- are admittedly exempt by virtue of article 13(4) of the treaty. The said gains therefore cannot be termed as income for the purpose of section 74 of the Act. We relied on the orders of Swiss Finance Corporation (Mauritius) Ltd 2022 (10) TMI 1208 - ITAT MUMBAI . In our considered view the answer is against revenue. The exempted income is not a part of taxable Gross Total Income. The non-grandfathered LTCG will be adjusted with brought forwarded loss following the order of Goldman Sachs Investments (Mauritius) Ltd. 2020 (9) TMI 1049 - ITAT MUMBAI . The orders which are relied on by the ld. DR are distinguishable. The impugned final assessment order is dismissed. Decided in favour of assessee.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Tribunal in this appeal are: (a) Whether the brought forward long-term capital losses (LTCL) and short-term capital losses (STCL) can be set off against long-term capital gains (LTCG) exempt under Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA), or whether such exempt gains should be excluded from the computation of income against which losses can be set off. (b) Whether the Assessing Officer (AO) and Dispute Resolution Panel (DRP) were correct in first adjusting the entire brought forward capital losses against exempt grandfathered capital gains and then treating the balance capital gains as exempt, or whether the losses should be set off only against taxable gains. (c) Whether the assessee is entitled to carry forward long-term and short-term capital losses determined and allowed in earlier assessment years, notwithstanding the exemption of capital gains under the DTAA in the current year. (d) The legal interplay between the provisions of the Income-tax Act, 1961 (the Act) relating to set off and carry forward of losses (notably Section 74) and the exemption granted under the DTAA, and the sequence of application of these provisions. (e) The correctness of the revenue's contention that capital gains should first be computed under the domestic law, including set off of losses, and only thereafter the DTAA exemption can be claimed, as opposed to the assessee's contention that exempt gains under the DTAA should not be considered as income for the purpose of set off of losses. 2. ISSUE-WISE DETAILED ANALYSIS Issue (a) and (b): Set off of brought forward capital losses against exempt capital gains under DTAA Legal Framework and Precedents: Article 13(4) of the India-Mauritius DTAA provides that gains derived by a resident of a Contracting State from alienation of property other than those specified in earlier paragraphs shall be taxable only in that State of residence. The assessee claimed exemption on grandfathered capital gains under this Article. Section 74 of the Act governs set off and carry forward of capital losses, permitting losses to be set off against capital gains. Precedents relied upon include decisions of coordinate benches of the ITAT Mumbai in cases such as Goldman Sachs Investments (Mauritius) Ltd, Swiss Finance Corporation (Mauritius) Ltd, and J.P. Morgan India Investment Company Mauritius Ltd, which held that exempt capital gains under the DTAA are not to be treated as income for the purpose of set off of brought forward capital losses. These decisions emphasize that the DTAA exemption excludes such gains from taxable income, and losses cannot be adjusted against exempt income. Court's Interpretation and Reasoning: The Tribunal noted that the AO and DRP erred in adjusting brought forward losses against exempt grandfathered capital gains. It held that exempt gains under Article 13(4) do not constitute income under the Act for the purpose of set off under Section 74. The Tribunal observed that the revenue's approach of first computing capital gains under the domestic law and then applying the treaty exemption is contrary to the established jurisprudence and the plain language of the DTAA. The Tribunal relied on the reasoning that since the exempt gains are not taxable in India, they cannot be considered as income against which losses can be set off. The brought forward losses, therefore, should be adjusted only against taxable capital gains (non-grandfathered gains) and not against exempt gains. Key Evidence and Findings: The assessee's returns and computations showed that brought forward losses were selectively set off against taxable gains only, excluding exempt gains. The revenue's notice challenged this selective adjustment. The Tribunal found no merit in the revenue's contention that the period of investments or date-wise sale of shares affects the manner of set off. Application of Law to Facts: Applying the legal framework, the Tribunal concluded that the exempt grandfathered capital gains of Rs. 26,36,44,954/- under Article 13(4) are not to be reduced by brought forward losses. The brought forward long-term capital losses and short-term capital losses should be set off only against the taxable capital gains arising in the year. Treatment of Competing Arguments: The revenue argued that capital gains must be computed under the Act first, including set off of losses, and then exemption under DTAA applies. It relied on Supreme Court decisions emphasizing computation of total income under the Act before treaty benefits. The Tribunal distinguished these precedents, noting that the treaty exemption operates as a bar on taxation in India and therefore such exempt gains cannot be considered income for loss adjustment. The Tribunal also noted that the revenue's reliance on cases where exempt income arose under the Act itself is not applicable here, as the exemption arises from the DTAA. Conclusion: The Tribunal allowed the appeal on these grounds, holding that brought forward capital losses cannot be set off against exempt capital gains under the DTAA. The exempt gains remain fully exempt, and losses are to be adjusted only against taxable gains. Issue (c): Entitlement to carry forward long-term and short-term capital losses determined and allowed in earlier years Legal Framework and Precedents: Section 74 of the Act permits carry forward and set off of capital losses subject to conditions. The Tribunal relied on earlier decisions including Goldman Sachs Investments (Mauritius) Ltd and Flagship Indian Investment Company (Mauritius) Ltd, which held that once capital losses are determined and allowed to be carried forward in an earlier assessment year, the AO cannot revisit or deny their carry forward in subsequent years, even if the capital gains in those years are exempt under the DTAA. Court's Interpretation and Reasoning: The Tribunal observed that the brought forward long-term capital losses of Rs. 7,63,95,386/- were duly determined and allowed to be carried forward by the AO in AY 2012-13. The DRP had also accepted the carry forward of these losses. The Tribunal held that the assessee is entitled to carry forward these losses to subsequent years and that they cannot be set off against exempt capital gains in the current year. Key Evidence and Findings: The record showed that the losses were allowed to be carried forward in scrutiny assessments under Section 143(3). The DRP's order confirmed the carry forward entitlement. The Tribunal found no justification for denying carry forward or forcing adjustment against exempt gains. Application of Law to Facts: The Tribunal applied the principle that losses determined and allowed in earlier years are sacrosanct and cannot be disturbed in subsequent years. It directed that the brought forward long-term capital losses be carried forward without adjustment against exempt gains. Treatment of Competing Arguments: The revenue contended that since capital gains under the DTAA are exempt, the losses relating to such gains should not be carried forward or adjusted. The Tribunal rejected this, emphasizing that losses were determined under the Act in earlier years, and the exemption in the current year does not affect their carry forward. Conclusion: The Tribunal allowed the carry forward of brought forward long-term and short-term capital losses without adjustment against exempt capital gains under the DTAA. Issue (d) and (e): Interplay between domestic law and DTAA in computation and exemption of capital gains and losses Legal Framework and Precedents: The Supreme Court and High Court decisions cited by the revenue emphasize that total income, including capital gains, is to be computed under the domestic Act first, and only thereafter the DTAA benefits can be invoked. However, coordinate bench decisions of the ITAT Mumbai have held that the DTAA exemption excludes such gains from taxable income and hence they cannot be considered for set off of losses. Court's Interpretation and Reasoning: The Tribunal reconciled these views by noting that the DTAA operates as a bar on taxation of certain capital gains in India. Therefore, gains exempt under the DTAA are not part of the assessee's income in India and cannot be used as a base for set off of losses under the Act. The Tribunal held that the sequence is that the DTAA exemption excludes certain gains from income, and only the taxable gains remain for consideration under the Act, including set off of losses. Key Evidence and Findings: The Tribunal relied on the clear language of Article 13(4) of the DTAA and consistent precedents that exempt gains are not taxable in India. It found the revenue's approach of first computing gains under the Act and then claiming exemption inconsistent with the treaty's purpose. Application of Law to Facts: The Tribunal applied the principle that the assessee may elect to be governed by the DTAA or the domestic law in a given year, and the tax treaty cannot be thrust upon the assessee. The assessee's claim of exemption under the DTAA was accepted, and the losses were to be set off only against taxable gains. Treatment of Competing Arguments: The revenue's reliance on Supreme Court decisions was acknowledged but distinguished on facts and treaty interpretation. The Tribunal emphasized that the treaty overrides domestic law to the extent of conflict and that the revenue's attempt to apply both simultaneously is impermissible. Conclusion: The Tribunal concluded that the DTAA exemption operates to exclude certain capital gains from income for the purpose of loss adjustment and taxation, and the domestic law provisions relating to set off and carry forward apply only to taxable gains. 3. SIGNIFICANT HOLDINGS "We are unable to comprehend that now when admittedly the short term and long term capital gains earned by the assessee from transfer of securities during the year in question are exempt under Article 13 of the India-Mauritius Tax Treaty, where would there be any occasion for seeking adjustment of the brought forward STCL against such exempt income." "The exempted income is not a part of taxable Gross Total Income. The non-grandfathered LTCG will be adjusted with brought forwarded loss, following the order of Goldman Sachs Investments (Mauritius) Ltd." "Once the capital loss was allowed to be carried forward by the AO in a scrutiny assessment order passed under section 143(3), the same could not have thereafter been reviewed in the assessment proceedings of any subsequent year." "It is for the assessee to examine whether or not, in the light of the applicable legal provisions and the precise factual position, the provisions of the IT Act are beneficial to him or that of the applicable DTAA. In any case, the tax treaty cannot be thrust upon an assessee." Core principles established include:
Final determinations:
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