The Supreme Court examined whether the Commissioner of Income Tax was justified in invoking the revisional jurisdiction under Section 263 of the Income Tax Act, 1961, to set aside an assessment order in which the Assessing Officer had allowed deduction of payments made to shareholders as “cost of improvement” while computing long-term capital gains.

The assessee had sold a property known as “Paville House” and, while computing long-term capital gains, claimed deduction of amounts paid to three shareholders pursuant to a family settlement recorded in arbitration proceedings. According to the assessee, the payments were made to discharge encumbrances on the property and therefore constituted “cost of improvement” under Section 55(1)(b) of the Act. The Assessing Officer accepted the computation and completed the assessment under Section 143(3).

The Commissioner, in exercise of powers under Section 263, held that the assessment order was erroneous and prejudicial to the interests of the Revenue. It was observed that the payments made to shareholders were neither capital expenditure nor did they result in any addition or alteration to the capital asset so as to enhance its value. The Commissioner further held that the family dispute among shareholders did not create any encumbrance on the property and that the payments had no nexus with the improvement of the capital asset. Accordingly, the assessment order was set aside with directions to recompute the capital gains in accordance with law.

The Income Tax Appellate Tribunal set aside the Commissioner’s order, holding that the Assessing Officer had taken a plausible view and that the Commissioner had wrongly assumed jurisdiction under Section 263. The High Court affirmed the Tribunal’s view.

The Supreme Court reversed the decisions of the Tribunal and the High Court. Applying the principles laid down in Malabar Industrial Co. Ltd. v. Commissioner of Income Tax, the Court held that for exercise of revisional jurisdiction under Section 263, the twin conditions of the assessment order being erroneous and prejudicial to the interests of the Revenue must be satisfied. On the facts of the case, the Court found that the Assessing Officer’s order allowing the deduction was unsustainable in law and had resulted in loss of revenue.

The Court held that payments made to shareholders pursuant to a family settlement did not amount to removal of encumbrances on the property and could not be treated as “cost of improvement” within the meaning of Section 55(1)(b). Since the assessment order was both erroneous and prejudicial to the interests of the Revenue, the Commissioner was justified in invoking Section 263.

Accordingly, the Supreme Court allowed the appeal, set aside the judgment of the High Court, and restored the order passed by the Commissioner under Section 263 of the Income Tax Act.

Source Link - https://api.sci.gov.in/supremecourt/2018/15489/15489_2018_4_1501_43248_Judgement_06-Apr-2023.pdf

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