COMMISSIONER OF INCOME TAX 7 versus M/S PAVILLE PROJECTS PVT. LTD. on 6 April 2023

1. Feeling aggrieved and dissatisfied with the impugned judgmentand order dated 18.09.2017 passed by the High Court of Judicature, atCBombay in ITA No.78 of 2015 by which the High Court has dismissedthe said appeal preferred by the Revenue, the Revenue has preferredthe present Appeal.

2. The relevant assessment order concerning the present appealis Assessment Year 2007-08.

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D3. The respondent assessee was engaged in manufacture andexport of garments, shoes etc. It filed its income tax return for the AY2007-08 wherein it showed sale of the property / building “Paville House”for an amount of Rs.33 Crores. That, the building “Paville House” wasconstructed by the assessee on the piece of land which was purchasedin the year 1972. The said house of the company was duly reflected inEthe balance sheet of the company.

3.1 It appears that there had been litigation between shareholdersof the Company being family members. Litigations in the Company LawBoard and the High Court culminated in arbitration. In the arbitrationproceedings, an interim award was passed whereby an amicableFsettlement termed as “family settlement” was recorded between theparties. As per the interim award, three shareholders viz. (1) Asha, (2)Nandita and (3) Nikhil were paid Rs.10.35 Crores each. According tothe assessee, “Paville House” was sold to discharge encumbrances fromthe sale proceeds to pay off the shareholders and therefore, the saidGdischarge of encumbrances was “cost of improvement”. As observedhereinabove, “Paville House” was sold for an amount of Rs.33 Crores.The assessee showed gains arising therefrom amounting toRs.1,21,16,695/- as “long term capital gains” in the computation of theirincome for AY 2007-08. The working computation of capital gains wasaccepted by the AO, whereby the cost of removing encumbrancesH

claimed (Rs.10.33 Crores paid to three shareholders pursuant to theinterim award) was taken as “cost of improvement” and the deductionwas claimed to remove encumbrances on computation of capital gains.On the balance amount capital gain tax was offered and paid. Theassessment was completed on 15.12.2019 by the AO under Section 143(3)of the Income Tax Act (for short “IT Act”) accepting the “long termcapital gains” as per sheet attached in computation of income.

3.2 However, a notice dated 24.10.2011 was issued by theCommissioner of Income Tax-7 under Section 263 of the IT Act to showcause as to why the assessment order should not be set aside underSection 263 of the IT Act. The Commissioner vide its order dated24.11.2011 held that the assessment order passed under Section 143(3)of the IT Act was erroneous and prejudicial to the interest of the revenueon the issue relating to deduction of Rs.31.05 Crores claimed by theassessee as cost of improvement while computing long term capital gains.The claim of the assessee that the said payment was made by themtowards settlement of litigation, which according to the assessee amountedto discharge of encumbrances and required to be considered as cost ofimprovement, was not accepted by the Commissioner as according tohim it did not fall under the definition of “cost of improvement” containedin Section 55(1)(b) of the IT Act. According to the Commissioner, theexpenses claimed by the assessee neither constituted expenditure that iscapital in nature nor resulted in any additions or alterations that providean enhanced value of an enduring nature to the capital asset. TheCommissioner also held that the payment as contended, was not madeby the assessee to remove encumbrances.

3.3 The Commissioner also held that provisions of sections 50Aand 55(1)(b) of the IT Act have not been complied with and theassessment order is not framed in consonance with the provisions of theIT Act and thus the assessment order was erroneous and prejudicial tothe interest of the revenue. Consequently, the Commissioner set asidethe assessment order passed by the AO with a direction to the AO torecompute the capital gains of the assessee in consonance with theprovisions of the IT Act as discussed in the order.

3.4 The assessee approached the Income Tax Appellate Tribunal(for short “ITAT”) by way of filing ITA No.16/MUM/2012 against theorder passed by the Commissioner, passed under Section 263 of the ITAct. The ITAT relying upon the decision of this Court in the case of AB

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AMalabar Industrial Co. Ltd. Vs. CIT [(2000) 2 SCC 718 : (2000)243 ITR 83 (SC)] concluded that the Commissioner wrongly invokedthe jurisdiction under Section 263 of the IT Act. The ITAT also observedthat there was no error on facts declared. The ITAT held that every lossof revenue as a consequence of AO’s order cannot be treated asprejudicial to the interest of the revenue, when two views were possibleBand AO took a view which CIT did not agree with. The ITAT alsoupheld the allowability of the assessee’s claim of deduction of paymentmade to the shareholders relying upon the decision of the Bombay HighCourt in CIT Vs. Smt. Shakuntala Kantilal [(1991) 190 ITR 56(Bombay)]. The ITAT relying on the Tribunal’s order (Bombay Bench)Cin Chemosyn Ltd. Vs. ACIT [2012 (25) Taxxman.com 325(Bombay)] held that the CIT’s observation of expenditure incurred forpayment of shareholders not being deductible as incorrect.

3.5 The Department’s appeal against the ITAT’s order has beendismissed by the High Court by the impugned judgment and order whereinDthe High Court has confirmed the ITAT’s findings. The High Court agreedwith the findings recorded by the ITAT that the claim for deduction ofRs.31.05 Crores was for ending the litigation and the litigation endedonly when the building was sold and the payment was made as per thedirection of the Company Law Board as well as the interim arbitralaward and therefore, the same was deductible under Section 55(1)(b)Eof the IT Act, as allowed by the AO.

3.6 Feeling aggrieved and dissatisfied with the impugned judgmentand order passed by the High Court dismissing the appeal preferred bythe Revenue and confirming the order passed by the ITAT by which theITAT set aside the order passed by the Commissioner passed underFSection 263 of the IT Act, the Revenue has filed the present appeal.

4. Shri Balbir Singh, learned ASG appearing on behalf of theRevenue has vehemently submitted that the High Court has materiallyerred in dismissing the appeal preferred by the Revenue and confirmingthe order passed by the ITAT by which the ITAT set aside the orderGpassed by the Commissioner passed in exercise of powers under Section263 of the IT Act.

4.1 It is submitted that the High Court has not at all appreciatedthe fact that the view taken by the AO in allowing the expenses ofRs.31.05 Crores while computing the capital gain from sale of the landHwas erroneous and not as per the law as payments made to shareholders are neither expenses nor the said payments have any relation to theasset under consideration. It is further submitted that the High Court hasalso not properly appreciated that the claim of the assessee that amountof Rs.31.05 Crores paid by it in lieu of settlement of litigation wouldamount to discharge of encumbrances and therefore, requires to beconsidered as cost of improvement on the said property is bad in law. Itis submitted that payment of Rs.31.05 Crores paid to the shareholdersdid not lead to acquisition of any interest in the asset already acquired bythe assessee. It is submitted that the rights already enjoyed by the assesseeon the said property were absolute. It is submitted that therefore theassessment order passed by the AO was erroneous, bad in law andprejudicial to the interest of the revenue and therefore, the same wasrightly set aside by the Commissioner under Section 263 of the IT Act,which ought not to have been set aside by the ITAT.

4.2 It is further submitted that Commissioner rightly observed thatthe assessee company was the clear owner of the property and thatthere was no encumbrance preventing the sale of the said property. Thefamily dispute among the three shareholders brother and two sisters,which resulted in a settlement by way of arbitration award, as per whichthe three shareholders became entitled to Rs.10.35 Crores each fortransfer of shares as well as relinquishment of any right or claim toadditional shares in the company had nothing to do with the improvementin the property. It is submitted that shareholders only concern was thatthe sale proceeds should first be utilized for making payments to them asper the arbitration award. It is submitted that therefore both, the Tribunalas well as the High Court have erred in concluding that the payment ofRs.10.35 Crores were admissible as deduction.

4.3 It is submitted that both, the ITAT as well as the High Courthave committed error in setting aside the order of the Commissioner onthe basis of the ratio laid down in the cases of Chemosyn Ltd. (supra)and Smt. Shakuntala Kantilal (supra), without appreciating that thefacts of the present case are not identical to the facts involved in therelied upon judgments.

4.4 It is further submitted that even otherwise as part of the assetsold was used in the business of the assessee and hence, capital gainson that part of the asset sold is required to be taxed as per the provisionsof Section 50A of the IT Act and hence, the entire order of Commissionerof Income Tax could not have been set aside.

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AMaking above submissions it is requested to allow the presentAppeal.

5. Present appeal is vehemently opposed by Shri FirozeAndhyarujina, learned Senior Advocate appearing on behalf of theassessee.B

5.1 It is vehemently submitted by learned Counsel appearing onbehalf of the assessee that in the facts and circumstances of the case,no error has been committed by the High Court in upholding the orderpassed by the ITAT setting aside the order passed by the Commissionerholding that the Commissioner wrongly exercised the revisional powersCunder Section 263 of the IT Act.

5.2 It is submitted that the High Court relying upon the law laiddown by this Court in the case of Malabar Industrial Co. Ltd. (supra)has specifically held that the Appellate Tribunal rightly considered theorders of assessment and the order of the Commissioner and thereafterDconcluded that Commissioner wrongly assumed the power under Section263 of the IT Act.

5.3 It is submitted that the order passed by the AO was a well-reasoned order passed after scrutiny of the return of income and theview taken by the AO was plausible view and therefore, the assessmentEorder cannot be considered to be erroneous and prejudicial to the interestof the Revenue, which was required to be taken in revision by theCommissioner under Section 263 of the IT Act.

5.4 It is submitted that view taken by the AO on allowability ofthe claim of deduction as cost of improvement was duly supported by aFjudicial decision of the Bombay High Court in the case of Smt.Shakuntala Kantilal (supra). It is submitted that as such theCommissioner failed to appreciate that unless the shareholders’ claimswere satisfied there would not have been a sale of the entire portion ofthe property. It was only to derive the benefit by sale of the encumbranceasset that the parties resorted to settlement through arbitration. TheGdispute being settled, payments having been made, the AO committedno error in allowing the claim of deduction as cost of improvement.

5.5 It is further submitted by learned Counsel appearing on behalfof the assessee that in the case of Malabar Industrial Co. Ltd.(supra), this Court has held that if the order is erroneous but is not H

prejudicial to the interest of the Revenue, the Commissioner cannotexercise the revisional jurisdiction under Section 263 of the IT Act. It issubmitted that it is further observed and held that every loss of revenueas a consequence of an order of AO cannot be treated as prejudicial tothe interest of revenue. As observed and held, if the AO has adoptedone of the courses permissible in law and it has resulted in loss of revenueor where two views are possible and the AO has taken one view withwhich CIT does not agree, it cannot be treated as erroneous orderprejudicial to the interest of revenue.

5.6 It is further submitted by the learned Counsel appearing onbehalf of the assessee on encumbrances that in the present case therewas arbitration proceeding between the shareholders of the companywhereof all the litigations came to an end and an interim arbitration awardwas entered into whereby the entire matter was amicably settled andthe settlement which is “Family Settlement” partook the character of aninterim award and later on achieved its finality on fulfillment ofcommitment. It is submitted that in the present case the shareholdershave been paid Rs.10.35 Crores each. It is submitted that the saidpayment was made by the Company for (i) smooth running and functioningof the business; (ii) to put an end to litigation amongst the shareholders;(iii) to preserve the assets of the company; (iv) to ensure that there iscontinuity and safeguard and, amicable settlement amongst the brotherand two sisters, who are the shareholders of the company and (v) toremove encumbrances on the property. It is submitted that therefore thepayment was necessitated and sanctioned and approved as per the ordersof the High Court and the arbitration award as well as shareholdersthemselves. It is submitted that infact in the interim award there was aspecific clause which entitles the Company to sell the assets to dischargethe liabilities. It is submitted that as per the arbitration award, the claimshave to be paid off of the shareholders. This was an encumbrance whichhas to be discharged pursuant to the orders of the Court and arbitrationaward. “Paville House” was therefore required to be sold to dischargethe encumbrances and from sale proceeds to pay off the shareholdersand therefore, the discharge of encumbrances was the cost improvement.It is submitted that therefore the amount paid to the shareholders whichwas rightly held to be to remove encumbrance, was rightly held to bededuction as claimed to remove encumbrance on computation of capitalgains.

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5.7 It is submitted that therefore the Commissioner wronglyassumed the jurisdiction under Section 263 of the IT Act on the groundthat the order passed by the AO was an erroneous and prejudicial to theinterest of the Revenue.

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Making above submissions and relying upon the decision of thisBCourt in the case of Malabar Industrial Co. Ltd. (supra), it is prayedto dismiss the present appeal.

6. Heard.

7. In the present case, the Commissioner, in exercise of the powersunder Section 263 of the Income Tax Act and in exercise of the revisionalCjurisdiction, set aside the assessment order by specifically observing thatthe assessment order was erroneous as well as prejudicial to the interestof the Revenue. However, the High Court by the impugned judgmentand order has set aside the order passed by the Commissioner by observingthat the Commissioner wrongly invoked the powers under Section 263of the Act.D

7.1 Learned counsel appearing on behalf of the assessee hasheavily relied upon the decision of this Court in the case of MalabarIndustrial Co. Ltd. (supra). It is true that in the said decision and oninterpretation of Section 263 of the Income Tax Act, it is observed andEheld that in order to exercise the jurisdiction under Section 263(1) of theIncome tax Act, the Commissioner has to be satisfied of twin conditions,namely, (i) the order of the Assessing Officer sought to be revised iserroneous; and (ii) it is prejudicial to the interests of the Revenue. It isfurther observed that if one of them is absent, recourse cannot be had toSection 263(1) of the Act. “What can be said to be prejudicial to theFinterest of the Revenue” has been dealt with and considered in paragraphs8 to 10 in the case of Malabar Industrial Co. Ltd. (supra), which areas under:-

“8. The phrase “prejudicial to the interests of the Revenue” isnot an expression of art and is not defined in the Act. UnderstoodGin its ordinary meaning it is of wide import and is not confined toloss of tax. The High Court of Calcutta in Dawjee Dadabhoy &Co. v. S.P. Jain [(1957) 31 ITR 872 (Cal)] , the High Court ofKarnataka in CIT v. T. Narayana Pai [(1975) 98 ITR 422 (Kant)],the High Court of Bombay in CIT v. Gabriel India Ltd. [(1993)203 ITR 108 (Bom)] and the High Court of Gujarat in CIT v.H

Minalben S. Parikh [(1995) 215 ITR 81 (Guj)] treated loss oftax as prejudicial to the interests of the Revenue.

9. Mr Abraham relied on the judgment of the Division Benchof the High Court of Madras in Venkatakrishna Rice Co. v. CIT[(1987) 163 ITR 129 (Mad)] interpreting “prejudicial to theinterests of the Revenue”. The High Court held:

“In this context, (it must) be regarded as involving a conceptionof acts or orders which are subversive of the administration ofrevenue. There must be some grievous error in the order passedby the Income Tax Officer, which might set a bad trend or patternfor similar assessments, which on a broad reckoning, theCommissioner might think to be prejudicial to the interests ofRevenue Administration.”

In our view this interpretation is too narrow to merit acceptance.The scheme of the Act is to levy and collect tax in accordancewith the provisions of the Act and this task is entrusted to theRevenue. If due to an erroneous order of the Income Tax Officer,the Revenue is losing tax lawfully payable by a person, it willcertainly be prejudicial to the interests of the Revenue.

10. The phrase “prejudicial to the interests of the Revenue”has to be read in conjunction with an erroneous order passed bythe Assessing Officer. Every loss of revenue as a consequenceof an order of the Assessing Officer cannot be treated as prejudicialto the interests of the Revenue, for example, when an IncomeTax Officer adopted one of the courses permissible in law and ithas resulted in loss of revenue; or where two views are possibleand the Income Tax Officer has taken one view with which theCommissioner does not agree, it cannot be treated as an erroneousorder prejudicial to the interests of the Revenue unless the viewtaken by the Income Tax Officer is unsustainable in law. It hasbeen held by this Court that where a sum not earned by a personis assessed as income in his hands on his so offering, the orderpassed by the Assessing Officer accepting the same as such willbe erroneous and prejudicial to the interests of the Revenue.(See Rampyari Devi Saraogi v. CIT [(1968) 67 ITR 84 (SC)]and in Tara Devi Aggarwal v. CIT [(1973) 3 SCC 482 : 1973SCC (Tax) 318 : (1973) 88 ITR 323] .)”

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A7.2 Thus, even as observed in paragraph 9 by this Court in thecase of Malabar Industrial Co. Ltd. (supra) that the scheme of theAct is to levy and collect tax in accordance with the provisions of theAct and this task is entrusted to the Revenue. It is further observed thatif due to an erroneous order of the Income Tax Officer, the Revenue islosing tax lawfully payable by a person, it will certainly be prejudicial toBthe interests of the Revenue. However, only in a case where two viewsare possible and the Assessing Officer has adopted one view, such adecision, which might be plausible and it has resulted in loss of Revenue,such an order is not revisable under Section 263.

7.3 Applying the law laid down by this Court in the case of MalabarCIndustrial Co. Ltd. (supra) to the facts of the case on hand and evenas observed by the Commissioner, the order passed by the AssessingOfficer is erroneous as well as prejudicial to the interest of the Revenue.Having gone through the assessment order as well as the order passedby the Commissioner of Income Tax, we are also of the opinion that theDassessment order was not only erroneous but prejudicial to the interestof the Revenue also. In the facts and circumstances of the case, it cannotbe said that the Commissioner exercised the jurisdiction under Section263 not vested in it. The erroneous assessment order has resulted intoloss of the Revenue in the form of tax. Under the Circumstances and inthe facts and circumstances of the case narrated hereinabove, the High ECourt has committed a very serious error in setting aside the order passedby the Commissioner passed in exercise of powers under Section 263 ofthe Income Tax Act.

8. In view of the above and for the reasons stated above, presentappeal succeeds. The impugned judgment and order passed by the HighFCourt is hereby quashed and set aside and that the order passed by theCommissioner passed in exercise of powers under Section 263 of theIncome Tax Act is hereby restored.

In result, present appeal is allowed. However, in the facts andcircumstances of the case, there shall be no order as to costs.

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Ankit Gyan

(Assisted by : Abhishek Pratap Singh, LCRA)

Appeal allowed.

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