2025 (7) TMI 660 - AT - Income Tax

Taxpayer can strategically set off business loss against other income under section 71(2) for optimal tax benefit

ITAT Mumbai held that taxpayer can exercise option to set off business loss against income from other sources under section 71(2) for optimal tax benefit. ... Tax Planning - Set off of Loss - Disallowance of deduction under chapter VI-A inspite of Bank Interest taxed under the head 'Other Sources' - set-off under section 71(2) - AR emphasised that, section 71(2) does not restrict the assessee from exercising the option to set off the business loss in the first instance against the income from other sources to the extent beneficial to the assessee - HELD THAT:- As from language of section 71 the heading indicates “Set off of loss from one head against the income from another”. The Ld.AR emphasised applicability of sub section 2 to the present facts of the case. On perusal of the same, it is clear that, there is no sequence prescribed therein to set off loss under a particular head of income. Sub section (2) gives option to the assessee to set off any loss, other than the loss under the head “Capital Gains”, against income under any head, including capital gains. Per contra we also are conscious of the restrictive nature of set off u/s. 70 of the Act. On joint reading of section 70 and section 71 it is clear that, if there is a loss from one source, it has to be set off against income under the same source first. As per the section 70 of the Act and if such loss cannot be set off then section 71 comes into operation that provide for the loss to be set off against income under in other head. Thus u/s. 70 the set off is qua the source whereas u/s. 71 the set off would be head wise. In the present facts of the case as there is no business income for the year under consideration. Therefore, section 70 as no role to play. The applicable provision would be then section 71 of the Act as there is income earned by the assessee under the head, “Income from other sources & capital gains”. Sub section (1) of section 71 will not be applicable as it deals with a situation where assessee has no income under the head “Capital Gains”. In the present facts the assessee has income under the head “Capital Gains”. Coming to subsection (2) there is no rule prescribed to set off loss against income under any other head and income under the head “capital gains”. Sub clause(2) does not provide any particular mode to set off the loss that should be followed. As we analyse the competition of assessee, it is noted that, it is perfect tax planning encompassed within the 4 corners of the Income tax Act. We do not find any error in such computation adopted by the assessee, as it is supported by the provisions of the statute. ARrelied on the decision of Opus Reality Development Ltd. [2016 (6) TMI 530 - ITAT DELHI] wherein similar issue was considered by following the decision of Hon’ble Pune Tribunal [2006 (1) TMI 228 - ITAT PUNE-A] We accordingly the direct the Ld.AO to grant the deduction under Chapter VI-A as computed by the assessee. Assessee appeal allowed. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal are:(a) Whether the deduction of Rs. 1,93,000/- under Chapter VI-A is allowable against bank interest income of Rs. 9,38,459/- taxed under the head 'Income from Other Sources' when business losses have been set off against capital gains in the same assessment year;(b) Whether the assessee is entitled to first set off the business loss of Rs. 11,60,579/- against long-term and short-term capital gains of Rs. 1,02,52,055/- in the absence of any prescribed sequence of set-off under section 71(2) of the Income Tax Act, 1961;(c) Whether the Income Tax filing system (CPC software) can hinder or deny the taxpayer's claim for rebate or set-off of business loss with capital gains income as permitted under section 71(2);(d) Whether the Additional/Joint Commissioner of Income Tax (Appeals) erred in adjudicating an issue (set-off of business loss with capital gains) which was neither disputed by CPC nor appealed before her;(e) The applicability and interpretation of section 71(2) of the Income Tax Act, 1961 concerning set-off of losses from one head of income against income from another, specifically relating to business loss and capital gains.2. ISSUE-WISE DETAILED ANALYSISIssue (a) and (c): Deduction under Chapter VI-A against income from other sources and impact of CPC softwareRelevant legal framework and precedents: Section 80A(1) of the Income Tax Act mandates that deductions under Chapter VI-A are allowed from gross total income computed in accordance with the provisions of the Chapter, which excludes long-term capital gains. Judicial pronouncements such as CIT vs. Vegetable Products Ltd. (1973) have held that deductions under Chapter VI-A cannot be allowed when gross total income consists solely of long-term capital gains.Court's interpretation and reasoning: The Tribunal noted that the assessee claimed deduction of Rs. 1,93,000/- under Chapter VI-A against income from other sources (bank interest). The CPC disallowed this deduction, and the CIT(A) upheld the disallowance, reasoning that after set-off of business loss against capital gains, the gross total income comprised taxable long-term capital gains, against which Chapter VI-A deductions are not permissible.The Tribunal observed that CPC's software operates strictly under statutory provisions and does not have discretionary power to deny legitimate claims. However, the legal provisions and judicial precedents clearly disallow deduction under Chapter VI-A where gross total income includes long-term capital gains.Key evidence and findings: The assessee's gross total income included income from other sources (Rs. 9,38,459/-), business loss (Rs. 11,60,579/-), and long-term capital gains (Rs. 1,02,45,891/-). The CPC disallowed the Chapter VI-A deduction claimed on bank interest income. The CIT(A) confirmed this disallowance based on statutory interpretation and case law.Application of law to facts: Since the business loss was set off against capital gains, the resulting gross total income was predominantly capital gains income, which is excluded from the base for Chapter VI-A deductions under section 80A(1). Therefore, the deduction was rightly disallowed.Treatment of competing arguments: The assessee argued that the deduction was valid as it related to income from other sources and that CPC software's denial was a technical deficiency. The Tribunal rejected the argument regarding software deficiency, emphasizing that statutory provisions govern the allowance of deductions.Conclusion: The disallowance of deduction under Chapter VI-A was upheld as per the provisions of the Income Tax Act and judicial precedents.Issue (b) and (e): Right to set off business loss against capital gains under section 71(2)Relevant legal framework and precedents: Section 71 of the Income Tax Act governs the set-off of losses from one head of income against income from another. Sub-section (2) states that where the net loss under any head other than capital gains exists and the assessee has income under capital gains, such loss may be set off against income under any head including capital gains. However, judicial precedents from various High Courts (Calcutta, Delhi, Madras) have held that business losses cannot be set off against long-term capital gains as Section 71 does not permit such set-offs.Court's interpretation and reasoning: The CIT(A) followed the restrictive interpretation, relying on judicial decisions that exclude long-term capital gains from permissible heads against which business losses can be set off. The assessee contended that section 71(2) does not prescribe any sequence or restriction and therefore permits set-off against capital gains.The Tribunal analyzed the language of section 71, noting that sub-section (2) does not prescribe any sequence for set-off and explicitly allows set-off of losses (other than capital gains losses) against income under any head including capital gains. The Tribunal also considered the interplay of section 70 (which restricts set-off to the same source of income) and section 71 (which allows head-wise set-off), concluding that section 71(2) applies here as there was no business income but income under other sources and capital gains.Key evidence and findings: The assessee set off business loss partly against income from other sources and partly against long-term capital gains to reduce tax liability and claim Chapter VI-A deductions. The Tribunal found this to be a legitimate tax planning within the statute.Application of law to facts: The Tribunal held that section 71(2) confers an option to the assessee to set off losses against any head of income including capital gains, unless specifically prohibited. No such prohibition exists in the statute for business losses against capital gains. The Tribunal also relied on decisions of the Pune and Delhi Tribunals supporting this interpretation.Treatment of competing arguments: The Revenue relied on the CIT(A) and judicial precedents disallowing set-off of business losses against long-term capital gains. The Tribunal distinguished these by focusing on the explicit wording of section 71(2) and the absence of any prescribed sequence or prohibition.Conclusion: The Tribunal allowed the assessee's right to set off business loss against capital gains under section 71(2), recognizing the assessee's option and the validity of the tax planning.Issue (d): Jurisdiction of the CIT(A) to decide undisputed and unappealed issuesRelevant legal framework: Principles of appellate jurisdiction require that an appellate authority should decide only the issues raised in appeal and disputed by the parties.Court's interpretation and reasoning: The assessee contended that the CIT(A) erred in dealing with the issue of set-off of business loss with capital gains, which was neither disputed by CPC nor appealed before her. The Tribunal noted this contention but did not find it determinative given the broader issues involved and the need to clarify the legal position.Key evidence and findings: The issue was addressed by the CIT(A) despite no appeal or dispute on that point. The Tribunal acknowledged this procedural aspect but focused primarily on the substantive legal questions.Application of law to facts: Although the CIT(A) may have exceeded jurisdiction by adjudicating an unappealed issue, the Tribunal considered the matter on merits to provide clarity.Treatment of competing arguments: The Revenue did not contest this procedural objection. The Tribunal implicitly recognized the procedural lapse but prioritized substantive justice.Conclusion: The Tribunal proceeded to decide the substantive issues despite the CIT(A)'s jurisdictional overreach.3. SIGNIFICANT HOLDINGSThe Tribunal made the following significant determinations:'Section 71(2) of the Income Tax Act, 1961, being worded in a manner that gives an option to the assessee, does not prescribe any particular sequence for set-off of losses against income under different heads, including capital gains. Therefore, the assessee is entitled to set off business losses against income under the head 'Capital Gains' unless specifically prohibited by the Act.''The deduction under Chapter VI-A is allowable only from gross total income computed excluding long-term capital gains. Where the gross total income comprises taxable long-term capital gains after set-off of business loss, deduction under Chapter VI-A cannot be claimed.''The CPC's denial of deduction under Chapter VI-A is in accordance with statutory provisions and judicial precedents; any alleged software deficiency does not warrant allowance of the deduction.''While the CIT(A) may have erred in adjudicating an issue not appealed or disputed before her, the Tribunal has considered the matter on its merits to clarify the legal position.''The assessee's method of bifurcating business loss to first set off against income from other sources and then against capital gains is a permissible tax planning within the four corners of the Income Tax Act.'Accordingly, the appeal was allowed with directions to grant the deduction under Chapter VI-A as computed by the assessee and to recognize the set-off of business loss against capital gains under section 71(2).