Treaty-exempt capital gains cannot be reduced by domestic loss set-off when the DTAA exemption keeps them outside taxable income.

Capital gains exempt under the India-Mauritius DTAA do not enter the computation of total income under the Income-tax Act, so domestic set-off provisions cannot be used to adjust long-term capital losses against those exempt gains. Applying section 90(2), the more beneficial treaty position prevails over the Act, and an exempt income stream cannot be brought into the computation machinery indirectly through loss adjustment. The Tribunal therefore held that long-term capital loss from shares acquired before 1 April 2017 could not be set off against treaty-exempt long-term capital gains from similar share transfers, and the carry-forward of long-term capital loss had to be recomputed accordingly.

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Issues: Whether long-term capital loss from sale of shares acquired prior to 01.04.2017 could be set off against long-term capital gains on sale of shares acquired prior to 01.04.2017, where such gains were exempt under Article 13(4) of the India-Mauritius DTAA.

Analysis: The assessee, being a Mauritius tax resident, was entitled to treaty benefit for the capital gains. Once the gains were held to be exempt under the treaty, they did not enter the computation of total income under the Act. Applying section 90(2) of the Income-tax Act, 1961, the more beneficial treaty position prevailed, and the domestic set-off provisions could not be used to tax an exempt stream indirectly by adjusting losses against it. The Tribunal followed its earlier coordinate bench view that income not forming part of total income cannot be brought into the computation machinery for adjustment against losses from a separate source.

Conclusion: The long-term capital loss could not be set off against the treaty-exempt long-term capital gains. The assessee was entitled to recomputation of carry forward of long-term capital loss accordingly.

Ratio Decidendi: Where capital gains are exempt under a applicable tax treaty and therefore do not enter computation of total income, domestic set-off provisions cannot be applied to adjust capital losses against such exempt gains.

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