The Hindu Business Line : An angle of perception

CONFLICTING judgments in courts are not uncommon. And this is not a phenomenon peculiar to courts. It is well-known that the thinking of economists and sociologists are inevitably coloured by their political leanings. In the judicial system, precedents constitute a merit as well as a demerit. They contribute to the strength of the system to the extent they reduce litigation. They tend to be baneful when the beaten track is followed without serious application of mind and what is wrong persists for long till it is righted by the apex court or by legislation.

Capital gains or `income from other sources'?

In CIT vs D. P. Sandu Bros Chembur Pvt. Ltd (2005 273 ITR 1), the apex court pointed out that in the CIT vs B. C. Srinivasa Setty (1981 128 ITR 294) case it was held that all transactions encompassed by Section 45 of the Income-tax Act, 1961 must fall within the computation provisions of Section 48 of that Act. If the computation method as provided under Section 48 could not be applied to a particular transaction, it must be regarded as never intended by Section 45 to be the subject of the charge.

In other words, an asset which is capable of acquisition and for which it is possible to envisage a cost would be covered by the provisions pertaining to the head `capital gains' as opposed to assets in the acquisition of which no cost at all can be conceived. This principle was followed by several High Courts with reference to the consideration received on surrender of tenancy rights. The courts held that if the cost of tenancy right cannot be determined, the consideration received by reason of surrender of such tenancy rights cannot be subjected to capital gains tax.

The logic on which the apex court's ruling in the Srinivasa Setty case (supra) was based is assailable on several grounds, including the following in particular:

`Income', for the purposes of the Act, has been defined in clause (24) of Section 2 as inclusive of `profits and gains' [sub-clause (i)] as well as "any capital gains chargeable under Section 45" [sub-clause (vi)]. This shows that the definition of `income' is not exhaustive though it includes the items singled out for clarification in sub-clauses (i) to (xii) of clause (24) of Section 2.

It is also obvious that the expression `profit and gains' is not exclusively limited to business profits or capital gains but may serve to depict either of them. It may not be proper to infer that if the cost of an intangible asset that is sold is not ascertainable, there can be no income under the head `capital gains', because if the seller of the assets is in equity, entitled to claim its cost or any deductible expenditure, he should claim or allowed by the court to claim it for arriving at his real gains, instead of declaring that the absence of a procedure or means for computing taxable income takes the income out of the mischief of clause (24) of Sections 2 and 14 of the Act. The onus of establishing any deductible expenditure rests on the taxpayer who can have no cause for grievance that he has been charged to tax unreasonably, since he has a whole gamut of appellate authorities and can go right up to the Supreme Court for redressal. If he cannot prove the cost, it will simply be taken as `nil'.

Once income is identified under clause (24) of Section 2, it has to be fitted into the classes or categories for which Section 14 provides. It appears logical to hold that any item of income which does not lend itself to depiction as income falling under the head A to E of Section 14 must be treated as income under the residuary head, viz., `Income from other sources' rather than being allowed to go tax-free, on the ground that income chargeable in the ordinary course to tax under any particular head, say, capital gains, is deemed to be vested with the implied right to exemption from tax if no machinery or procedure for any deductions from it like its cost has been spelt out in the relevant sections of the Act dealing with that category of income.

If the law has not specified that any particular expenditure would be an admissible deduction from the gross receipt, the natural conclusion would be that no expenditure can be claimed by the assessee and not that the assessee will escape tax altogether on the income. If equity called for any deduction, the doctrine of `real' income may warrant any reduction that is germane and fair. Any other treatment will be open to challenge as not in conformity with recognised principles of construction of a statute. Total freedom from tax for any income which is identified as such, may frustrate the objects of clause (24) of Sections 2 and 15 instead of advancing them.

In such cases, it may not be correct to assume that the impugned `profits and gains' of the assessee should be conferred the benefit of tax exemption merely because the cap of `capital gains' does not appear to fit the assessee. It is not a benefit of doubt in a case of alleged offence but tax escapement by an amount which is indisputably `income' or in any event `profits and gains' in its character though the procedure for its reception/accommodation under the label of `capital gains' is non-existent. Can the legislature be taken to have abetted the avoidance of tax in such circumstances? Should public interest suffer for the defaults of any of those who are entrusted with the duty or responsibility of safeguarding it? It is difficult for the man in the street to see eye to eye with the courts in regard to this issue. As the common man sees it, `profit and gains' which may fall under more than one head should be given the classification that on the facts of the case may be most appropriate to them.

The assessee cannot be permitted to evade the tax net altogether if there is any difficulty in accommodating his gains under any particular `head' merely because they have some, though not all the features associated with that `head'. Acquisition of tenancy or leasehold right will depend on the terms of the owner-tenant or lessor-lessee contract and the duration of that contract. Will it not defeat the purpose of clause (24) of Sections 2 and 14 if a receipt is recognised as income but allowed to escape tax on that basis.

But the problem is not as simple as that. In the D. P. Sandu Bros Chembur (P) Ltd case (supra), the Supreme Court expressed its agreement with the views that a tenancy right is acquired with reference to a particular date, that it is also possible that it may be acquired at a cost and that it is ultimately a question of fact.

In A. R. Krishnamurhty vs CIT (1989 176 ITR 417), the Supreme Court pointed out that the cost of acquisition of leasehold rights could be determined but in the Sandu Bros case, the Income-tax Department's stand before the High Court had been that the cost of acquisition of tenancy rights was incapable of being ascertained. The Supreme Court dismissed the Departmental appeal with the following observations:

"There is no dispute that a tenancy right is a capital asset the surrender of which would attract section 45 or that the value received would be a capital receipt and assessable if at all only under item E of section 14. That being so, it cannot be treated as a casual or non-recurring receipt under section 10(3) and be subjected to tax under section 56. The argument of the appellant that even if the income cannot be chargeable under Section 45, because of the inapplicability of the computation provided under Section 48 it could still impose tax under the residuary head is thus unacceptable. If the income cannot be taxed under Section 45 it cannot be taxed at all [S. G. Mercantile Corporation (P) Ltd vs CIT (1972 83 ITR 700 SC)].

"Furthermore, it would be illogical and against the language of Section 56 to hold that everything that is exempted from capital gains by the statute could be taxed as a casual or non-recurring receipt under Section 10(3) read with Section 56. We are fortified in our view by a similar argument being rejected in Nalinikant Amabalal Mody vs SAL Narayan Row — 1966 61 ITR 428 SC 432, 435."

The amendment to Section 55 by the Finance Act, 1994 with effect from April 1, 1995, to the effect that if the cost of acquisition of a capital asset could not in fact be determined the cost would be taken as nil reflects reality. It is difficult to comprehend why the `cost of acquisition' of tenancy right could not be taken to be nil in accordance with the undisputed facts of the case and the entire receipt from the lessor or owner of the property could not be treated as income in conformity with the actual position.

In any case, if the assesse's (that is, the lessee's) gains could not be assessed to tax as capital gains because there was no quantifiable cost, what else could it be except income under the residuary classification, that is, income other than items conforming to the different heads set out in Section 14. There was no justification for the court proceeding on the assumption that Section 14 was a charging section and in the absence of a declaration in Section 4 that all income caught by the definition in clause (24) of Section 2 would be liable to tax, Section 14 should be taken to be an adjunct/clarification/Explanation to clause (24) of Section 2 throwing out any income which cannot be quantified under the provisions covering the head of income, as income not liable to tax.

Section 14 and the various provisions made in Chapter IV in pursuance of the classification in Section 14 cannot be taken to delimit the scope of income or determine whether it is liable to tax or not. There is another alternative approach to the problem that does not appear to have been presented to the court in this context. Section 14 is in the nature of a signpost. All income caught within the net spread by clause (24) of Section 2 is liable to tax since the purpose of the definition was only to spell out what was liable to tax.

Once income is identified, Section 14 indicates where and how it should be dealt with. Any income which lends itself to assessment without difficulty under the specified heads should be computed accordingly. If there is a hitch, for example, cost of acquisition not determinable in the sale of goodwill or leasehold interest or tenancy right, Section 56, which is the residuary provision for all income not strictly conforming to the requirements of the other heads, is required to take care of.

To hold that Section 14 determines taxability is to render clause (24) of Sections 2 and 56 meaningless. The law on the issue calls for reconsideration by the apex court. Section 14 should not be allowed to provide a tax shelter for income which cannot be readily accommodated for any reason under the heads `profits and gains from business and profession', `salaries', `income from property' and `capital gains'. It may be mentioned, in this connection, that income by way of compensation for surrendering tenancy cannot escape tax after the amendment to sub-section (2) of Section 55 by the Finance Act, 1994.

(By arrangement with Corporate Law Adviser, New Delhi.)

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