Supreme Court Remands Income Tax Case: Determination of Business Income vs. Capital Gains in Property Development (4 May 2023)

Introduction

Date of the Judgment: 4 May 2023

Citation: Civil Appeal No. 2565 of 2022

Judges: M.R. Shah, J. and B.V. Nagarathna, J.

When a real estate company sells development rights, should the resulting income be considered a regular business transaction or a capital gain? This question was at the heart of a recent case before the Supreme Court of India. The court examined whether the Income Tax Appellate Tribunal (ITAT) and the Bombay High Court correctly classified the income from the sale of development rights by Glowshine Builders & Developers Pvt. Ltd. The Supreme Court, finding errors in the lower courts’ assessments, has sent the case back to the ITAT for a fresh review.

The bench comprised Justices M.R. Shah and B.V. Nagarathna. The judgment was authored by Justice M.R. Shah.

Case Background

The case revolves around the assessment year 2009-10, concerning the financial year 2008-09. Glowshine Builders & Developers Pvt. Ltd. (the assessee) entered into an agreement on 6 May 2008, with M/s Kirit City Homes Pvt. Ltd., to sell development rights for a property in Vasai for ₹15,94,06,500. However, this transaction was not initially disclosed in the assessee’s income tax return. The assessee later claimed that they had entered into a rectification deed on 30 May 2008, reducing the value of the development rights to ₹5,24,27,354.

The Assessing Officer (AO) noticed the discrepancy and questioned why the full amount of ₹15,94,06,500 was not declared. The assessee stated that the reduced amount of ₹5,24,27,354 had been offered to tax in the assessment year 2008-09. The AO, however, treated the transaction as a short-term capital gain and added the amount of ₹15,94,06,500 to the assessee’s income for the assessment year 2009-10. The Commissioner of Income Tax (Appeals) upheld the AO’s decision.

Timeline:

Course of Proceedings

The Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s (AO) decision, agreeing that the transaction should be treated as a capital gain for the assessment year 2009-10. The CIT(A) also rejected the assessee’s claim that the transfer of development rights occurred in the financial year 2008-09, based on a Memorandum of Understanding (MOU) dated 27 December 2007.

The Income Tax Appellate Tribunal (ITAT), however, reversed the decisions of the AO and CIT(A). The ITAT concluded that the assessee was engaged in the business of building and development and that the sold development rights were part of its inventory, not a capital asset. The ITAT also accepted that the sale consideration was ₹5,24,27,354, as per the rectification deed and the MOU, and that this income had already been declared in the assessment year 2008-09.

The High Court of Judicature at Bombay dismissed the appeal filed by the Revenue, stating that no substantial questions of law were involved.

Legal Framework

The primary legal issue revolves around the classification of income from the sale of development rights, specifically whether it should be treated as business income or capital gains. The applicability of Section 50C of the Income Tax Act, 1961, is also in question. This section deals with the determination of the full value of consideration for the transfer of immovable property.

The Assessing Officer (AO) initially invoked Section 50C, arguing that despite the reduction in the agreement value, the market value should be considered as the sale consideration. However, the assessee argued that Section 50C was not applicable as the transaction involved the sale of stock in trade and not a capital asset.

Arguments

Arguments by the Revenue:

• The Revenue argued that the ITAT’s order was flawed and contradicted the facts on record. They pointed out that the assessee had taken inconsistent positions regarding the sale of development rights.
• The Revenue highlighted that the assessee’s ledger account showed a receipt of ₹15,94,06,500 on 31 March 2008, which was then reversed on the same day. The ITAT failed to address this entry and the subsequent claim of a rectification deed.
• The Revenue contended that the ITAT did not question the refund of the differential amount of ₹10,69,79,146, which was a crucial aspect of the case.
• The Revenue argued that the ITAT incorrectly concluded that the transaction was a sale of stock in trade, without considering factors like frequency and volume of trade.
• The Revenue submitted that even if the reduced amount of ₹5,24,27,354 was shown in the tax return for the assessment year 2008-09, the differential amount of ₹10,69,79,146 should still be assessed in the current year.

Arguments by the Assessee:

• The assessee claimed that they were engaged in the business of building and development since 1999-2000, with their balance sheets consistently showing work-in-progress/inventories.
• The assessee argued that they had entered into an MOU on 27 December 2007, for the sale of development rights at ₹5,24,27,354.
• The assessee stated that the initial development agreement incorrectly mentioned the sale consideration as ₹15,94,06,500, which was rectified by a deed of rectification on 30 May 2008.
• The assessee maintained that the transaction was correctly reflected in the assessment year 2008-09 as business income.
• The assessee contended that the ITAT had correctly considered all the facts and that the High Court had rightly dismissed the appeal.
• The assessee argued that since the land was held as stock-in-trade, Section 50C of the Income Tax Act, 1961 was not applicable.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a separate section. However, the core issues that the Court addressed can be summarized as follows:

1. Whether the Income Tax Appellate Tribunal (ITAT) was correct in holding that the transaction was a sale of stock in trade rather than a capital asset.
2. Whether the ITAT and the High Court were correct in not considering the differential amount of ₹10,69,79,146 arising from the reduction in the sale consideration.
3. Whether the High Court was correct in dismissing the appeal by the Revenue, stating that no substantial questions of law were involved.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Cases:

• Mantri Techzone Private Limited Vs. Forward Foundation and Ors.; (2019) 18 SCC 494 – The assessee relied on this case to argue that the findings of fact by the ITAT should not be interfered with by the High Court.
• Raja J. Rameshwar Rao Vs. Commissioner of Income Tax, Hyderabad (1961) 42 ITR 179 – The assessee relied on this case to argue that even a single venture can be regarded as in the nature of trade or business.

Legal Provisions:

• Section 50C of the Income Tax Act, 1961 – This section deals with the determination of the full value of consideration for the transfer of immovable property. The AO initially invoked this section, while the assessee argued against its applicability.
• Section 143(3) of the Income Tax Act, 1961 – This section relates to scrutiny assessments. The assessee argued that their assessments under this section in previous years had acknowledged their business as that of a builder and developer.

Authority Analysis

Judgment

The Supreme Court, after considering the arguments and the records, found that the ITAT had not adequately considered the relevant factors in determining whether the transaction was a sale of stock in trade or a capital asset. The Court also noted that the ITAT had failed to address the differential amount of ₹10,69,79,146.

The Court observed that the ITAT did not examine the total sales made by the assessee during the relevant period and previous years. The Court also noted that the High Court had failed to appreciate the inherent contradictions in the ITAT’s order.

The Supreme Court held that the ITAT should have considered multiple factors, such as the frequency and volume of trade, and the nature of the transaction over the years, before concluding that the transaction was a sale of stock in trade.

The Court further observed that once an amount is received and recorded in the books of accounts, it should be treated as income unless it is shown to be refunded or returned. The ITAT had failed to consider this aspect.

The Supreme Court therefore quashed and set aside the judgments of the High Court and the ITAT and remanded the matter back to the ITAT for fresh consideration.

How each authority was viewed by the Court:

• Mantri Techzone Private Limited Vs. Forward Foundation and Ors.; (2019) 18 SCC 494: While the Court acknowledged the principle that findings of fact should not be interfered with, it distinguished the case by stating that the ITAT’s findings were perverse and not based on proper consideration of facts.
• Raja J. Rameshwar Rao Vs. Commissioner of Income Tax, Hyderabad (1961) 42 ITR 179: The Court acknowledged the principle that even a single venture can be considered a business, but it did not directly apply this principle in its decision.
• Section 50C of the Income Tax Act, 1961: The Court did not make a final determination on the applicability of this section, leaving it for the ITAT to decide based on whether the transaction was a sale of stock in trade or a capital asset.
• Section 143(3) of the Income Tax Act, 1961: The Court noted that the assessee relied on past assessments under this section to support their claim of being a builder and developer, but did not make any conclusive finding on the same.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the procedural lapses and inadequate reasoning of the ITAT. The Court emphasized the need for a thorough examination of all relevant factors before classifying a transaction as either a sale of stock in trade or a capital asset. The Court was also concerned about the ITAT’s failure to address the differential amount and the fact that the ITAT did not question the refund of the differential amount.

Fact:Law Ratio Analysis:

Logical Reasoning

Key Takeaways

• The classification of income from the sale of development rights as either business income or capital gains depends on a thorough examination of the facts and circumstances of each case.
• The Income Tax Appellate Tribunal (ITAT) must consider multiple factors, including the frequency and volume of trade, and the nature of the transaction over the years, before classifying a transaction.
• The ITAT must address all relevant aspects of the case, including the differential amounts arising from any changes in the sale consideration.
• The High Courts should carefully examine the orders of the ITAT and should not dismiss appeals where substantial questions of law are involved.
• The mere recording of inventory in the books of accounts is not sufficient to conclude that a transaction is a sale of stock in trade.
• When an amount is received and recorded in the books of accounts, it should be treated as income unless it is shown to be refunded or returned.

Directions

The Supreme Court directed the Income Tax Appellate Tribunal (ITAT) to reconsider the appeal afresh, taking into account the observations made in the judgment. The ITAT was directed to consider the relevant factors while determining whether the transaction was a sale of stock in trade or a capital asset.

Specific Amendments Analysis

No specific amendments were analyzed in this judgment.

Development of Law

The ratio decidendi of this case is that the classification of income from the sale of development rights requires a thorough examination of all relevant facts and circumstances, and that the ITAT must consider multiple factors before concluding that a transaction is a sale of stock in trade. The judgment also clarifies that the ITAT must address all aspects of the case, including the differential amounts arising from any changes in the sale consideration.

This judgment reinforces the principle that the mere recording of inventory in the books of accounts is not sufficient to conclude that a transaction is a sale of stock in trade. It also emphasizes the need for the ITAT to provide well-reasoned orders based on a comprehensive analysis of the facts and evidence.

Conclusion

In conclusion, the Supreme Court remanded the case back to the Income Tax Appellate Tribunal (ITAT) for a fresh review. The Court found that the ITAT had not adequately considered the relevant factors in classifying the transaction as a sale of stock in trade and had failed to address the differential amount arising from the reduction in the sale consideration. The Supreme Court emphasized that a thorough examination of all relevant facts and circumstances is necessary to determine whether a transaction is a sale of stock in trade or a capital asset.