The Supreme Court upheld the ruling that the money from the sale of the residence was not deductible as capital gains.

CIT v. Paville Projects (P.) Ltd. – [2023]

The assessee-company produces and exports shoes, clothing, and other goods. Family members were the company’s shareholders. The matter was submitted to arbitration as a result of a disagreement amongst the shareholders. An interim award was made throughout the arbitration process, and it recorded the parties’ agreeable “family settlement” agreement.

According to the interim award, three shareholders each received Rs. 10.35 crores after the company sold its home for Rs. 33 crores. According to the assessor, the residence was sold to remove liens so that the money from the sale could be used to reimburse the stockholders. Therefore, the aforementioned discharge of obligations constituted a “cost of improvement”. Assessee paid taxes in accordance with the balance of capital gains.

During the assessment process, the Assessing Officer (AO) permitted the assessee’s computation. However, the Commissioner of Income Tax (CIT) invoked the revisionary powers provided for in section 263 and rejected the allegation that the expenditure was a cost of improvement since it was detrimental to the revenue’s interests.

The execution of the revisionary power under section 263 was deemed unconstitutional by the High Court since it was determined that the AO had adopted one of the possible viewpoints. The Supreme Court was then involved in the case.

According to the Supreme Court, it will undoubtedly be detrimental to the interests of the revenue if it loses tax that is legitimately due from a person as a result of an incorrect order made by the AO. A decision like this, which might be tenable and has led to a loss of revenue, is not subject to revision under Section 263 unless there are two conceivable views and the AO adopted one of them.

The CIT ruled that the assessee’s payment for the litigation settlement in the present matter, which the assessee claimed amounted to the release of encumbrances and called for being taken into account as a cost of improvement, could not be recognised. The sum in question does not meet Section 55(1)(b’s definition of “cost of improvement”).

The CIT contends that neither the expenses that the assessee claimed to have incurred nor any additions or modifications that would have given the capital asset an improved value of an enduring nature were capital expenditures. Furthermore, the assessee did not make the aforementioned amount to release encumbrances.

After examining the assessment order and the CIT’s ruling, it was decided that the assessment order was not only incorrect but also detrimental to the interests of the revenue. Tax money has been lost as a result of the incorrect assessment order.

When it overturned the CIT’s order made in the course of exercising its Section 263 authority, the High Court made a grave mistake. As a result, the High Court’s ruling was overturned, and the CIT’s section 263 order was reinstated.