The Hindu Business Line : The drag of capital losses

It is trite knowledge that capital expenditure is not deductible in computing taxable income. Deduction can be claimed for losses that are incidental to business. Often this becomes a debatable issue. The assessee claims a loss as a deduction on the ground that it arises from the carrying on of a business. However, courts have taken a cautious view in these matters and held that if a loss is capital in nature, it cannot be claimed as a deduction from the taxable income, even if it arises from the carrying on of a business.

Irrecoverable advances

Generally, capital losses arise where sums are advanced to third parties and they become irrecoverable. Unless the assessee is carrying on a money-lending business, there can be no justification for deduction of such amounts.

An authoritative decision on this point is of the Apex Court's in Hasimara Industries Ltd. v. C.I.T. (231 I.T.R. 842). In this case, the company advanced money to an associate concern to enable it to modernise its factory. This amount became irrecoverable. While the Assessing Officer disallowed it as a capital loss, the Appellate Commissioner held it to be deductible.

The Tribunal found that the amount was treated by the assessee as a capital investment in view of a resolution of the board of directors. Hence, the loss was capital, making it ineligible for deduction. The High Court upheld the Tribunal's view on the ground that the amount given to the associate concern was a capital advance. Though the amount was given in the course of carrying on the business, deductibility of such amount is not permissible under any provision of the Income-Tax Act, 1961. This view was upheld by the Supreme Court, which followed its earlier decision in the same company's case, Hasimara Industries Ltd. v. C.I.T. (230 I.T.R 927), and held that the loss could not be claimed as a deduction from taxable income.

In Greaves Ltd. v. C.I.T. (251 I.T.R. 190), the assessee entered into an agreement with its sister company, assigning its doubtful debts for a specified amount. Subsequently, the assessee merged with its sister concern. The specified amount for which the debt was assigned was claimed as a revenue loss. The Bombay High Court held that this loss could not be deducted from the taxable income. According to the Court, this loss did not arise from any business or trading activity. This loss was also not incurred on grounds of commercial expediency.

Money on call

Another interesting decision is of the Gujarat High Court in Kailash Investments (P.) Ltd. v. C.I.T. (2006; 153 Taxman 430). In this case, the company was to receive call money towards shares issued to another company. The latter company assigned its liability to pay the amount of call money to a third company which agreed to pay in eight equal instalments. When part of the call money was not paid by the third company, the assessee agreed to convert the outstanding call money into a fixed amount receivable immediately, subject to a discount of 12 per cent. On receiving the outstanding amount, the assessee claimed the discount as a deductible loss. Alternatively, the company claimed the loss as a deduction under Section 57(iii). An additional alternative claim was made to treat the discount as a capital loss under Section 45 of the Act.

The Assessing Officer, the Commissioner (Appeals) and the Appellate Tribunal disallowed the claim of the assessee. The Gujarat High Court held that the discount could not be claimed as a business loss under Section 28 of the Act. The reason was that the issuance of share capital and receipt of call money had no connection with any loss related to the business carried on by the assessee. The Court also disallowed the claim under Section 57(iii) on the ground that the loss could not be regarded as having been incurred for the purpose of earning any income under Section 56 of the Act.

Before the Gujarat High Court, the assessee submitted that there was transfer of the original debt when the terms were modified and the assessee agreed to give a discount. The assessee contended that this resulted in extinguishment of a part of the debt. Hence, it was a transfer of a capital asset and the capital loss could be claimed as a deduction. The assessee relied on the decisions in C.I.T. v. Minor Bababhai (128 I.T.R.1;Guj.) and C.I.T. v. Grace Collis (248 I.T.R 323;S.C.).

The Gujarat High Court in the case of Kailash Investments held that the ratio of these two decisions was not applicable to the facts of the case. The main issue before the Court was that call money was receivable by Kailash Investments. The only change that took place as a result of assignment of the debt was in relation to the terms of payment and the period. The nature of payment, namely, call money towards shares issued, remained the same.

According to the Court, the amount which the assessee was to receive was a liability. This amount was not an asset. In the absence of any asset, there could be no question of extinguishment of rights therein. Thus, it could not be said that there was transfer of a capital asset under Section 2(47) of the Act.

Hence, the Court held that the claim of the discount as a capital loss under Section 45 was not sustainable because a capital loss under the head "Capital Gains" can only arise when there is transfer of a capital asset. The loss representing the discount in respect of call money did not arise from the transfer of any capital asset.

These decisions clearly lay down the proposition that any amount which is in the nature of a capital loss cannot be claimed as a deduction either under the head "Profits and Gains of Business or Profession" or "Income from Other Sources". The allowability of the loss under the head "Capital Gains" is subject to the fulfilment of the important condition of transfer of a capital asset. Therefore, mere diminution in the value of a capital asset would not give an assessee the benefit of deduction of a loss.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)

More Stories on : Taxation | Courts/Legal Issues

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Rupee reverses

Stormy monsoon session ahead

Crystal-gazing the GST

Power stretching

A little fire is quickly trodden out

The drag of capital losses

A problem of bifurcation

Interest on refunds

We can't afford to put capitalism on autopilot mode