2010 (11) TMI 1028 - AT - Income Tax

Tax Appeal: Set-off of Capital Loss against Gain & Disallowed Expenditure under Sections 10(38) & 14A

M/s ANG Securities Ltd. Versus The ITO, Ward VI (1), Ludhiana

M/s ANG Securities Ltd. Versus The ITO, Ward VI (1), Ludhiana - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether brought forward long-term capital losses on sale of shares are liable to be set off against long-term capital gains that are exempt under section 10(38) of the Income Tax Act, 1961. 2. Whether expenditure disallowable under section 14A can be estimated and disallowed where no finding is recorded that the expenditure was incurred for earning exempt income (dividend), and whether the Assessing Officer's estimate disallowance in the present facts is sustainable. ISSUE-WISE DETAILED ANALYSIS - SET-OFF OF BROUGHT FORWARD LONG-TERM CAPITAL LOSSES AGAINST 10(38) EXEMPT GAINS Legal framework: Chapter III and section 10(38) exclude specified long-term capital gains from total income. Section 14 defines heads of income. Provisions governing set-off/carry forward of capital losses (e.g., section 74 and related provisions) operate within the computation of total income and the aggregation mechanism provided by the Act. Section 70(3) (as discussed by the Tribunal) addresses set-off/aggregation rules among heads. Precedent treatment: The Tribunal has considered and applied the principle that income excluded from total income under section 10 does not enter the machinery for computing total income and therefore cannot be used as a head of income against which losses falling to be carried forward/set off under the regular provisions may be adjusted. A prior Bench decision of the Tribunal was relied upon by the assessee and accepted by the Court below as supportive of this view. Interpretation and reasoning: Once long-term capital gains from specified equity transactions are held to be exempt under section 10(38), they do not form part of total income and thus do not enter aggregation or computation under sections that permit set-off of losses. The Assessing Officer's adjustment of carried forward long-term capital losses against income characterized and accepted as exempt under section 10(38) was held to be contrary to the statutory scheme: exempt income does not enter the 'machinery section' for computing total income and cannot be used as an income head to extinguish carried forward losses. The Tribunal reasons that allowing such set-off would nullify the express exclusion enacted by section 10(38) and would be inconsistent with the object and purpose of that provision. Ratio vs. Obiter: The finding that exempt income under section 10(38) does not enter total income and therefore cannot be matched against carried forward long-term capital losses is treated as the ratio decidendi for the issue decided. References to prior Tribunal reasoning are used as supporting precedent and form part of the operative ratio on this point. Conclusion: Brought forward long-term capital losses on sale of shares cannot be set off against long-term capital gains exempt under section 10(38). The assessee is entitled to carry forward such losses for adjustment in subsequent years against taxable income under the same head, and the Assessing Officer is directed not to adjust carried forward losses against 10(38) exempt gains. ISSUE-WISE DETAILED ANALYSIS - DISALLOWANCE UNDER SECTION 14A Legal framework: Section 14A permits disallowance of expenditure incurred in relation to income which does not form part of the total income (e.g., exempt dividends), but such disallowance presupposes a finding that the expenditure was incurred for the purpose of earning exempt income. Precedent treatment: The authorities below applied section 14A to disallow an estimated portion of expenditure against dividend income, reducing allowable expenditure to the extent of dividend income and disallowing the balance. No specific adverse precedent was invoked by the Court; rather, the Court applied statutory requirements to the facts. Interpretation and reasoning: Disallowance under section 14A is contingent on a finding that expenditure was incurred for earning exempt income. Where dividend income is small (Rs. 30,754 in the facts) and the Assessing Officer disallows a larger estimated amount (Rs. 2,09,953) without recording the requisite finding that the expenditure was incurred for earning that exempt income, such estimate-based disallowance is not sustainable. The Tribunal finds absence of necessary fact-finding that the expenditure related to exempt income and therefore allows the expenditure claimed by the assessee in entirety. Ratio vs. Obiter: The decision that an estimate disallowance under section 14A is impermissible in the absence of a finding that the expenditure was incurred for earning exempt income is operative and forms the ratio for the issue resolved in the judgment. Conclusion: The estimate disallowance of Rs. 2,09,953 under section 14A is deleted; the expenditure incurred is allowed in full because there is no recorded finding that the expenditure was incurred for earning exempt dividend income. CROSS-REFERENCES AND APPLICATION The conclusions on issue one (non-set-off against 10(38) exempt gains) directly inform the relief granted: carried forward long-term capital losses remain available for future set-off under the head of capital gains when taxable gains arise. The conclusion on issue two reinforces the requirement that section 14A disallowances must be founded on a factual finding linking expenditure to exempt income and cannot be sustained on mere estimation without such finding.