MODI RUBBER LTD.,NEW DELHI vs. ACIT, CIRCLE- 17(1), NEW DELHI

PER PRADIP KUMAR KEDIA-A.M. : The captioned appeal has been filed at the instance of the assessee against the order of the Commissioner of Income Tax (Appeals)-XXVIII, New Delhi (‘CIT(A)’ in short) dated 17.08.2018 arising from the assessment order dated 30.03.2015 passed by the Assessing Officer (AO) under Section 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2012-13.

I.T.A. No.6866/Del/2018 2

income at ₹12,62,27,390/- under Section 139(1) of the Act. The return filed by the assessee was subjected to scrutiny assessment under Section 143(3) of the Act. In the course of the scrutiny assessment, the Assessing Officer inter alia observed that the assessee has sold its shareholding in the wholly owned subsidiary, M/s. Modi Tyre Company Ltd. (MTCL) to M/s. Continental India Ltd. (CIL) on 15th July, 2011 for a total agreed consideration of ₹117,61,90,000/-. A Share Purchase Agreement (SPA) dated April 17, 2011 was executed for this purpose. As per the SPA, the enterprise value was agreed at Fifty Million Euro equivalent to gross sale consideration of ₹117,67,90,000/-. In such a transaction by way of sale of 100% equity by the assessee in the subsidiary company and thus involving sale of business for controlling interest in the company, a certain part of sale consideration was not directly paid to the seller assessee but was kept aside to meet certain contingencies which may arise in the next few years. This amount agreed at ₹25,48,16,450/- (3.75 million Euro) was kept aside in a Escrow Account (EA) with an Escrow Agent (Yes Bank Ltd.) with an instruction as to how the amount is to be utilized and paid to the seller depending upon the happening certain events. An EA dated 12.07.2011 was entered into between the seller- assessee, purchaser-CIL and Escrow Agent-Yes Bank Ltd. for this purpose. It was agreed between the parties that Escrow funds would be kept in fixed deposits and interest thereon would be reinvested and would become part of Escrow Account itself. Further, as per the EA, operation of the account was under joint instructions of the assessee and CIL and the amount available in the EA was, first, to be utilized towards any future liabilities. The Assessing Officer also observed that as per EA, the amount held in escrow account including interest was agreed to be released to assessee after 2nd year, 4th year and 8th year on certain agreed terms after adjustment of claim arising on account of potential liabilities in a manner prescribed therein. In the wake of the Escrow Account, where sum of ₹25,48,16,328/- was retained to meet the potential liability, if any, the assessee filed a revised computation of income in the course of assessment and made a downward revision of sale consideration to

I.T.A. No.6866/Del/2018 3

₹92,13,73,510/- in place of ₹1,17,61,90,000/- declared in ROI for the purposes of determination of capital gains. The Long Term Capital Gain (LTCG) on sale of 100% equity of Modi Tyres Ltd. determined at ₹38,55,75,851/- based on gross sale consideration of ₹117.61 crore was thus sought to be revised and reduced to ₹13,07,59,361/- by way of a revised computation. The Assessing Officer however found the revised claim of lower LTCG to be untenable and thus declined to entertain such revised computation of LTCG.

7.1 The CIT(A) took note of the submissions made on account of denial of adjustments to full value of sale consideration towards amount

I.T.A. No.6866/Del/2018 4

lying in Escrow account while determining the LTCG but however did not find any force in the plea of the assessee. The CIT(A) broadly noted that the assessee itself declared full value of sale consideration at ₹117,61,90,000/- on account of sale of shares of wholly owned subsidiary, Modi Tyres Ltd. in its original return of income. The assessee also did not choose to revise the return. The assessee opted to amend the sale consideration and consequent taxable LTCG by reducing Escrow amount kept aside from the gross sale consideration by way of revised computation at the fag end of the assessment proceedings by filing a letter dated 23.02.2015. With reference to Section 48 of the Act, the CIT(A) observed that it is immaterial whether the assessee has actually received full value of consideration or not and the taxability equally depends upon its ‘accrual’ as a result of transfer of capital asset. The liability on account of Escrow amount cannot be carried forward to subsequent year on account of self imposed conditions by the assessee. The CIT(A) observed that the claim of assessee towards reduction of ‘full value of consideration’ based on unascertained liability of future is not provided in the provisions of Act and thus not tenable in law. The CIT(A) thus declined to interfere with the action of the AO on this score.

7.2 As regards disallowance of expenditure attributable to exempt income under Section 14A of the Act, the CIT(A) referred to Rule 8D of the I.T. Rules and observed that ad hoc disallowance worked out by the assessee is not in consonance with the requirement of law. The CIT(A) accordingly held that the Assessing Officer has justifiably computed the disallowance under Section 14A of the Act. The CIT(A) thus declined to interfere.

7.3 The CIT(A) however reversed the addition made to the book profit under Section 115JB of the Act in the light of the decision rendered by the Special Bench in the case of ACIT vs. Vireet Investment Pvt. Ltd., [2017] 82 taxmann.com 415.

I.T.A. No.6866/Del/2018 5

Tribunal.

8.1 When the matter was called for hearing, the ld. counsel vehemently opposed the additions/disallowances made by the Assessing Officer and confirmed by the CIT(A) as noted above.

I.T.A. No.6866/Del/2018 6

required to be operated only for the purposes and the manner provided i.e., discharge part or whole of claims. The ld. counsel also adverted to clause 6.2 of EA which provides for manner of release of Escrow amount to assessee upto the expiry of 2 years, 4 years and 8 years etc and submitted that such release is subject to adjustment of claims arising on account of unascertained liabilities in the manner prescribed therein. As per the agreement, the assessee is prevented from appropriating the Escrow funds without the prior approval of the other party to the agreement in view of the joint instructions to follow.

I.T.A. No.6866/Del/2018 7

expression full value of consideration received or accruing under Section 48 of the Act and thus could not be subjected to tax as income for the year under consideration. The ld. counsel asserted that the Escrow amount was kept and earmarked for the appropriation against the claim to be raised by the Continental Group. Such Escrow amount could not be regarded as part of ‘full value of consideration’ to be liable to tax in the hands of assessee more particularly when substantial claims of more than ₹78.90 crore were identified and raised in the subsequent years against such Escrow arrangement. The ld. counsel observed that out of 25,48,16,328/-, the assessee has realised principal amount of ₹1,91,91,928/- in F.Y. 2013-14 only and therefore, the remaining amount of ₹23,56,24,400/- being the residual principal amount unaccrued and unreceived, should be held to be not liable for LTCG taxation. The liability to tax on amount lying in Escrow account would arise only in the year of accrual and receipt based on happening of events in future. The ld. counsel further submitted that the aforesaid residual principal amount has neither been received nor likely to be received in view of large claims to the tune of ₹78.94 crore cropped up in the subsequent year which far outweighs the accumulated balance in the Escrow account. The ld. counsel pointed out that the amount of ₹23,56,24,400/- lying in Escrow account and neither received during the Assessment Year 2012- 13 in consideration nor likely to be received in future considering huge claims lodged by Continental Group and hence appropriate relief by way of reduction of the full value of sale consideration towards unrealised sale consideration requires to be provided and consequent LTCG assessed requires to be modified.

10.1 The ld. counsel referred to and relied upon the decisions rendered in the case of Dinesh Vazirani vs. Pr.CIT (2022) 445 ITR 110 (Bom) which judgment in turn referred to the judgment rendered in the case of CIT vs. M/s. M.L. Raju Shete, 239 Taxman 176 (Bom).

10.2 On being enquired by the bench, the ld. counsel also referred to the judgment rendered in the case of Caborandum Universal Ltd. vs. ACIT,

I.T.A. No.6866/Del/2018 8

283 Taxman 312 (Mad.) and submitted that relief was denied to Assessee in that case in the context of all together different facts.

10.3 The ld. counsel thus urged for reversal of the action of the lower authorities and upholding the revised computation subject to adjustment on account of partial receipt of ₹1.91 crore received by the assessee out of Escrow account.

11.1 The ld. DR referred to Sections 45 and 48 of the Act and submitted that the incidence of taxation arises under the head ‘Capital Gains’ as soon as the full value of consideration stands ‘accrued’ as a result of transfer of capital asset subject to deduction of expenditure incurred wholly and exclusively in connection with such transfer and cost of acquisition of asset and any improvement therein etc. Section 48 of the Act which provides for mode of computation of capital gains does not offer any deduction on account of money set apart in Escrow account to meet potential liabilities which may or may not eventually arise. The ld. DR referred to paragraph 4.5 of the SPA and submitted that Escrow amount was agreed to be paid by the assessee into Escrow account for utilization against future claims. This is a clear case of application of sale consideration to guard against unascertained liabilities for which an Escrow Agreement was executed much later to the SPA Agreement on 12.07.2011. This act also reinforces the case of application of full consideration received or accrued.

11.2 The ld. DR submitted that the amount kept in Escrow account were

I.T.A. No.6866/Del/2018 9

for meeting claims that may arise on a future date and that the interest which accrued on the sums retained in the Escrow Account had been agreed to be belonging to the seller, i.e., the assessee and has to be paid to the assessee as per the instructions of the Escrow accounts. The assessee thus always had a right to receive the sums kept in the Escrow accounts although such amount was to be quantified after a specific period. On facts, the assessee has actually received certain interest on Escrow account in the later year. Hence, such EA did not per se change the agreed sale consideration finalized based on agreement between the assessee and Continental Group. Therefore, the quantification of deduction to be made from the sums lying in the Escrow would not postpone the charge of such income which was deemed to be accrued in the year of transfer in the light of Section 45 r.w. Section 48 of the Act. The ld. DR submitted that merely because entire sale consideration was not received at exclusive command at the time of transfer, by itself, would not mean that sale consideration has not accrued and the sale consideration cannot be deemed as income arising on sale of capital asset.

11.3 The ld. DR submitted that the right to receive profit in the year under consideration had accrued and thus capital gain tax liability did arise in the year under consideration as reported by the assessee itself in the return of income. The Assessee merely seeks to reduce the tax incidence based on a revised computation which has been justifiably denied by Revenue Authorities. Non-receipt of whole amount of lump sum consideration in the year under consideration is not an impediment for taxation once such amount has accrued to the benefit of the assessee. The ld. DR submitted that whatever apportionment or appropriation has been done in the subsequent years, would not have any bearing on the liability to tax for the year under consideration having regard to the accrual thereof in the hands of the assessee. The loss arising to assessee in the later years due to change in events and non-realisation requires to be claimed in those years in accordance with law.

I.T.A. No.6866/Del/2018 10

11.4 The ld. DR also submitted that a part of the amount, i.e., ₹1,91,00,000/- has been admittedly received in the subsequent years out of Escrow amounts in the same set up and a substantial sum of ₹4.43 crore has been received and earned towards interest by the assessee on such Escrow amount. The assessee has also offered such interest amounts in the subsequent years as admitted by the assessee. The ld. DR thus submitted that in view of the receipt of interest to the credit of the assessee on Escrow amount, the Escrow amount, in effect, always belonged to the assessee, subject to indemnification if any, that may occur after the income had already accrued to the assessee by virtue of such transfer of shares.

11.5 The ld. CIT-DR also submitted that Escrow Agreement was entered subsequent to SPA which signifies that a subsequent arrangement between the parties has been entered. The ld. CIT-DR submitted that in such kind of arrangement, the assessee as a normal incidence of business is liable for indemnification or breach of warranty for any losses regardless of Escrow Account or not. A mere opening of Escrow Account will not thus change the inherent character of application of income after its accrual. The Ld. DR also contends that there is no provision in law that permits the deferment of taxation to the later year and the charge of capital gain would fail in the later year for want of transfer required for application of s. 45 of the Act.

11.6 The ld. DR thus submitted that in the wake of provisions of Act and having regard to the various clauses of the SPA and EA, no fault can be found with the action of the lower authorities in denial of modified claim in departure with the income returned. The ld. CIT-DR also submitted that the claims have been quantified by assessee against the Escrow account before the Tribunal at this belated stage which cannot be vouched in the absence of any information to the Department in this regard. Without prejudice, a subsequent event cannot alter the factum of accrual of sale consideration at the threshold on entering arrangement for

I.T.A. No.6866/Del/2018 11

transfer of shares. The ld. DR thus submitted that no interference with the order of the CIT(A) is called for on first principles.

13.1 As noted in the preceding paragraphs, the assessee-company transferred its shareholdings of subsidiary company namely Modi Tyres to transferee namely CIL for an agreed consideration of ₹117,16,90,000/- which is backed by a share purchase agreement. An amount of ₹25,48,16,328/- was kept aside in Escrow with Escrow Agent namely Yes Bank Ltd. in terms of Escrow Agreement entered to this effect. Out of the Escrow amount set apart, the assessee claims to have realized and received ₹1,91,91,928/- in the Financial Year 2013-14. Thus, the assessee seeks to revise and reduce the sale consideration towards unrealised escrow amount and seeks exclusion of an amount of ₹23,56,24,562/- [₹ 254,81,69,490/- (-) ₹ 1,91,91,928/-] from the full value of consideration received or accrued as a result of transfer of shares for the purposes of arriving at chargeable capital gain under Section 45 r.w.s 48 of the Act.

I.T.A. No.6866/Del/2018 12

13.2 The assessee states and submits that notwithstanding higher capital gain tax offered in the return of income based on gross sale consideration including amount in custody of escrow and not accrued per se, the assessee is entitled to raise claims not made in the ROI before the Appellate Authorities in accord with judicial dicta echoed in Goetze (India) Ltd. v. CIT, (2006) 284 ITR 323 (SC) and CIT vs. Jai Parabolic Springs Ltd., 306 ITR 42 (Del and other host of judgments. The assessee contends that in view of the complex and technical provisions contained in Indian Income Tax, it may not be unreasonable to expect the tax payers to miss on some of their rightful claims/concessions when they file their tax returns in the first instance. In view of settled position of law obliging the revenue to collect only legitimate tax on righteous income, we find force in the plea of assessee for admission of revised computation filed in the course of assessment for consideration whereby the quantum of chargeable capital gains has been sought to be modified and scaled down by excluding the Escrow amount set apart to meet the potential liabilities of the entity transferred as result of transfer of equity shares.

13.3 Adverting to core issue, we observe that it is a common business phenomenon that in most mergers and acquisition transactions involving sale of a business or controlling interest in a company, a certain part of the sale consideration is not directly paid to the seller but is kept aside to meet certain contingencies which may arise in the next few years, such as contingent liabilities or potential liabilities. This amount is retained in an Escrow Account with an Escrow Agent with instructions as to how the amount is to be utilized and paid to the seller, depending upon the happening of certain events. The Escrow Agent in such arrangement holds liquid assets for the benefit of one or more parties who have entered into sale of business and disburse the liquid assets upon the fulfilment of a specific set of obligations on the part of both the parties under a contract on happening or non-happening of the contingent event. The issue that has arisen before the Tribunal is whether in such a

I.T.A. No.6866/Del/2018 13

situation where the money kept in the Escrow Account has been only partly released to the transferors in later years after the transfer of capital asset, the remaining amount has not been released to the seller assessee on the grounds that certain obligations/conditions un-fulfilled. The assessee claims that in the light of subsequent events of glaring nature, such amount staked in the Escrow Account is unlikely to be released to the assessee at all. To assuage such claim, the assessee submits that firstly; long time has elapsed since the transaction of sale and assessee could barely receive & realise ₹1.91 crore against the amount of ₹25.48 crore kept in Escrow and secondly; the purchaser namely Continental, as a matter of fact, has raised huge additional claims vide letter dated 12.07.2019 to the tune of ₹78,94,54,122/- as against the amount lying in the Escrow [together with the interest accrued thereon] of ₹33.10 crore as on 01.08.2023. The assessee thus contends that even today the amount lying in Escrow is far less than the corresponding claims of ₹78.94 crore raised by the purchaser, i.e., Continental and the chances of any recovery out of escrow are sorely dim and unlikely.

14.1 The assessee filed his return of income in July, 2011 by computing

I.T.A. No.6866/Del/2018 14

capital gains on his proportion of the total sale consideration of ₹155 crore, including the amount kept in escrow, which had not been paid out but was still parked in the escrow account till the time the return was filed. The assessment was selected for scrutiny and an assessment order was passed u/s. 143(3) on 15th January, 2014 accepting the returned income.

14.2 Subsequent to the passing of such assessment order, certain statutory and other liabilities arose in the company amounting to ₹9.17 crore relatable to the period prior to the sale of the shares. This amount of ₹9.17 crore was withdrawn by the company from the escrow account, and therefore the assessee received a lesser amount from the escrow account.

14.3 The assessee thereafter filed a revision petition u/s 264 with the Commissioner, stating that the assessment had already been completed taxing the capital gains at higher amount on the basis of sale consideration of ₹155 crore without reducing the consideration by ₹9.17 crore. It was claimed that since the amount of ₹9.17 crore had been withdrawn by the company from the escrow account, what the assessee received was lesser than that mentioned in the return of income and therefore the capital gain needed to be recomputed by reducing the proportionate amount deducted from the escrow account. It was pointed out that since the withdrawal from the escrow account happened after the completion of assessment proceedings, it was not possible for the assessee to make such a claim before the Assessing Officer or file a revised return. The assessee therefore requested the Commissioner to reduce the long-term capital gains by the proportionate amount withdrawn by the company from the escrow account of ₹9.17 crore.

14.4 The Commissioner rejected the revision petition on the ground that, from the sale price as specified in the agreement, only cost of acquisition, cost of improvement or expenditure incurred exclusively in connection with the transfer could be reduced in computing the capital

I.T.A. No.6866/Del/2018 15

gains, and that the agreement between the seller and buyer for meeting certain contingent liability which may arise subsequent to the transfer could not be considered for reduction from the consideration. The Commissioner further held that in the absence of a specific provision by which an assessee could reduce the returned income filed by him voluntarily, the same could not be permitted indirectly by resorting to provisions of section 264. The Commissioner relied on the proviso to section 240, which stated that if an assessment was annulled, the refund would not be granted to the extent of tax paid on the returned income. According to the Commissioner, this showed that the income returned by an assessee was sacrosanct and could not be disturbed, and even an annulment of the assessment would not impact the suo moto tax paid on the returned income. The Commissioner further was of the view that the contingent liability paid out of escrow account did not have the effect of reducing the amount receivable by the promoters as per the agreement.

14.5 The assessee filed a writ petition before the Bombay High Court against such order of the Commissioner rejecting the revision petition.

14.6 The Bombay High Court held that the order passed by the Commissioner was not correct and quashed the order. It observed that the Commissioner had failed to understand that the amount of ₹9.17 crore was neither received by the promoters nor accrued to the promoters, as this amount was transferred directly to the escrow account and was withdrawn from the escrow account. In the view of the High Court, when the amount had not been received by or accrued to the promoters, it could not be taken as the full value of consideration in computing capital gains from the transfer of shares of the company.

14.7 The Bombay High Court observed that the Commissioner had not understood the true intent and content of the SPA, and not appreciated that the purchase price as defined in the agreement was not an absolute amount, as it was subject to certain liabilities which might arise to the promoters on account of certain subsequent events. According to the

I.T.A. No.6866/Del/2018 16

Bombay High Court, the full value of consideration for computing capital gains would be the amount ultimately received by the promoters after the adjustments on account of the liabilities from the escrow account as mentioned in the agreement.

14.8 The Bombay High Court referred to the observations of the Supreme Court in CIT vs. Shoorji Vallabhdas & Co., 46 ITR 144, where the Supreme Court had held that income or gain is chargeable to tax on the basis of the real income earned by an assessee, unless specific provisions provide to the contrary. The Bombay High Court noted that in the case before it, the real income (capital gain) would be computed only by taking into account the real sale consideration, i.e., sale consideration after reducing the amount withdrawn from the escrow account.

14.9 The Bombay High Court observed that the Commissioner had proceeded on an erroneous understanding that the arrangement between the seller and buyer which resulted in some contingent liability that arose subsequent to the transfer could not be reduced from the sale consideration as per section 48. As per the High Court, the liability was contemplated in the SPA itself, and had to be taken into account to determine the full value of consideration. If the sale consideration specified in the agreement was along with certain liability, then the value of consideration for the purpose of computing capital gains u/s 48 was the consideration specified in the agreement as reduced by the liability. In the view of the High Court, it was incorrect to say that the subsequent contingent liability did not come within any of the items of reduction, because the full value of the consideration u/s. 48 would be the amount arrived at after reducing the liabilities from the purchase price mentioned in the agreement. Even if the contingent liability was to be regarded as a subsequent event, then also, it ought to be taken into consideration in determining the capital gain chargeable u/s 45.

14.10 The Bombay High Court expressed its disagreement with the Commissioner on his statement that the contingent liability paid out of

I.T.A. No.6866/Del/2018 17

escrow account did not affect the amount receivable as per the agreement for the purposes of computing capital gains u/s. 48. As per the High Court, the Commissioner failed to understand or appreciate that the promoters had received only the net amount of ₹145.83 crore, i.e., ₹155 crore less ₹9.17 crore, and that such reduced amount should be taken as full value of consideration for computing capital gains u/s. 48.

14.11 The Bombay High Court also rejected the Commissioner's argument that the assessee's returned income could not be reduced by filing a revision petition u/s. 264. According to the High Court, section 264 had been introduced to factor in such situation as the assessee's case, because if income did not result at all, there could not be a tax, even though in bookkeeping, an entry was made for hypothetical income which did not materialise. Section 264 did not restrict the scope of power of the Commissioner to restrict a relief to assessee only up to the returned income. Where the income can be said not to have resulted at all, there was obviously neither accrual nor receipt of income, even though an entry may have been made in the books and account. Therefore, the Commissioner ought to have directed the Assessing Officer to re-compute the income as per the provisions of the Act, irrespective of whether the computation resulted in income being less than the returned income. The Bombay High Court stated that it was the obligation of the Revenue to tax an assessee on the income chargeable to tax under the Act, and if higher income was offered to tax, then it was the duty of the Revenue to compute the correct income and grant the refund of taxes erroneously paid by an assessee.

14.12 The Bombay High Court therefore held that the capital gain was to be computed only on the net amount actually received by the assessee, and that he was entitled to refund of the excess taxes paid by him on the returned capital gains.

I.T.A. No.6866/Del/2018 18

130 taxmann.com 133(Mad) where a diverse view has been expressed on the treatment of escrow amount. In this case, the assessee sold an Electrocast Refractories Plant on a slump sale basis to another company for a total consideration of ₹31.14 crore. Out of the total consideration, an amount of ₹ 3.25 crore was deposited in an escrow account by the purchaser to meet any contingent liabilities. The assessee disclosed a long-term capital gain of ₹23.58 crore, taking the sale consideration at ₹ 27.89 crore instead of ₹ 31.14 crore.

15.1 The Assessing Officer noted that while it had sold the plant for a total sale consideration of ₹31.14 crore, it had considered only ₹ 27.89 crore as the full value of consideration for computation of long-term capital gain under s. 48 of the Act and thus asked the assessee to show cause as to why 31.14 crore should not be considered for computation of long-term capital gains.

15.2 The assessee explained that the difference between the consideration taken for computation of capital gains and that for which the plant was sold was an account of the fact that an amount of ₹3.25 crore was kept in an escrow account to meet any contingent liabilities.

15.3 The Assessing Officer recomputed the capital gains taking the consideration as ₹31.14 crore on the grounds that the amount of ₹3.25 crore kept in escrow account would only constitute an application of income and that the full consideration of ₹31.14 crore had accrued to the assessee immediately on the execution of the agreement for sale.

15.4 In first appeal, the Commissioner (Appeals) noted that the amount in the escrow account had been kept by the purchaser to indemnify against breach of warranty or other losses or on account of further litigation as a result of non-compliance to the conditions of the agreement by the assessee. The Commissioner (Appeals) therefore was of the view that the sum retained in the escrow account had not accrued to the assessee in the year under consideration. He therefore held that

I.T.A. No.6866/Del/2018 19

amount of ₹ 3.25 crore kept in escrow account had neither been received or accrued by/to the assessee during the year, and since the said amount had been subsequently received by the assessee after the stipulated period of agreement, it had been offered to tax by the assessee under the head capital gains in the year of its receipt. Therefore, holding that the Assessing Officer was not justified in taxing the amount in the year under consideration, the Commissioner (Appeals) deleted the addition of ₹3.25 crore.

15.5 Before the Tribunal, on behalf of the Revenue, it was contended that the amount kept in escrow account represented application of income and keeping the amount in escrow account was only a formality, as the entire amount of ₹3.25 crore had been received without any deduction towards claims/warranties, and had been offered to tax in a subsequent year.

15.6 The Tribunal, after examining the Business Sale Agreement, held that, the agreement had given legally enforceable rights to the parties with respect to the transfer of undertaking, the assessee had a right to receive the lump-sum consideration upon effecting the sale in the previous year, and there was effective conveyance of the capital asset to the transferee. The Tribunal further noted that the monies kept in the escrow account were for meeting claims that may arise on a future date, and that the interest which accrued on the sums retained in the escrow account had been agreed to be belonging to the seller, i.e., the assessee, and had to be paid to the assessee as per the instructions in the escrow account. Therefore, the Tribunal held that the assessee always had a right to receive the sums kept in the escrow account. Though they were to be quantified after a specified period, they did not change the agreed lump- sum sale consideration finalized based on the agreement between the parties. Therefore, the quantification of deductions to be made from the sums lying in the escrow account would not postpone the charge of such income which was deemed to be taxed in the year of transfer.

I.T.A. No.6866/Del/2018 20

15.7 The Tribunal rejected the argument of the assessee that the entire sale consideration was not received during the relevant year and could not be deemed as income of that year, holding that it was sufficient if, in the relevant year, profits had risen out of sale of capital assets, i.e. when the assessee had a right to receive the profits in the year under consideration, it would attract liability to capital gains tax. According to the Tribunal, it was not necessary that the whole amount of lump-sum consideration should have been received by the assessee in the previous year, and whatever the parties did subsequent to that year would have no bearing on the liability to tax as deemed income of the year under consideration. Reliance was placed by the Tribunal on the Madras High Court decision in the case of TV Sundaram lyengar and Sons Ltd vs. CIT 37 ITR 26, while upholding the order of the Assessing Officer.

15.8 Before the Madras High Court, on behalf of the assessee, attention was drawn to the Business Sale Agreement, and in particular, covenant No. 14 dealing with indemnities for other losses and covenant No. 15 dealing with retention sum for indemnities. The attention of the Court was also drawn to a second supplementary agreement where there was a reference to a charge of theft of electricity and demand raised by the State Electricity Board from the purchaser of the asset. These facts demonstrated that the intention behind retention of a certain sum in escrow account was to meet liabilities which may be fastened on to the purchaser on conclusion of the sale transaction.

15.9 On behalf of the assessee, reliance was placed on the following decisions:

• The Bombay High Court decision in the case of CIT vs. Hemal Raju Shete 239 Taxman 176, which was a case where certain amounts were set apart to meet contingent liabilities, and it was held that this amount was neither received nor accrued in favour of the assessee.

• The Supreme Court decision in the case of CIT vs. Hindustan Housing

I.T.A. No.6866/Del/2018 21

& Land Development Trust Ltd. 161 ITR 524, where a similar view was taken.

• The Madras High Court decision in the case of PPN Power Generating Co (P) Ltd vs. CIT 275 Taxman 143 in support of the alternative submission that in the subsequent year the amount had been offered for taxation…

• The Gujarat High Court decision in the case of Anup Engineering Ltd vs. CIT 247 ITR 457.

• Cases of CIT vs. Ignifluid Boilers (l) Ltd 283 ITR 295 (Mad), CIT vs. Associated Cables (P) Ltd 286 ITR 596 (Bom), DIT(IT) vs. Ballast Nedam International 215 Taxman 254 (Guj), and Amarshiv Construction (P) Ltd vs. Dy. CIT 367 ITR 659 (Guj), in the context of treatment of retention money withheld by the contractee.

15.10 On behalf of the Revenue, before the Madras High Court, it was argued that the Tribunal order was well considered and the factual aspects thoroughly analyzed. It was clearly brought out by the Tribunal on the facts that the retention money kept in the escrow account had accrued in favour of the assessee in the year under consideration. It was pointed out that the entire amount of ₹ 3.25 crore retained in the escrow account had been received by the assessee and offered for taxation in a subsequent year, with no deduction towards claims/warranties from the amount kept in escrow account. Attention was also drawn to the provisions of section 48, with the submission that if either the full value of the consideration had been received by the assessee during the year or it had accrued, that alone would be sufficient, and the subsequent act of the assessee and the purchaser by creating an escrow account would not change the character of receipt of the consideration.

15.11 Referring to the various clauses of the Business Sale Agreement, it was submitted that the facts clearly demonstrated that the amount retained in the escrow account, which was a subsequent arrangement

I.T.A. No.6866/Del/2018 22

between the parties, would have no impact for the purpose of computation of capital gains on the total sale consideration fixed under the agreement. On behalf of the Revenue, reliance was placed on the following decisions:

• The Supreme Court decision in the case of CIT vs. Attilli N Rao, 252 ITR 880 in the context of full price realised for the purpose of computation of capital gains.

• CIT vs. N M A Mohammed Haniffa 247 ITR 66 (Mad).

• CIT vs. George Henderson and Co. Ltd. 66 ITR 622 (SC).

• CIT vs. Smt. Nilofer I Singh 309 ITR 233 (Del).

• Smt D Zeenath vs. ITO 413 ITR 258 (Mad).

15.12 The decisions relied upon by the Revenue were rebutted by the assessee's counsel, that all those were cases relating to mortgage, and that the agreement between the assessee and the purchaser clearly showed that the retention money was neither received nor accrued in favour of the assessee during the relevant year.

15.13 The Madras High Court examined the provisions of the Business Sale Agreement and noted that the retention amount had been retained for the purpose of ensuring that sufficient funds would be available to indemnify the purchaser against any damages or losses arising from indemnification for breach of warranty, indemnification for other losses, unpaid accounts receivables, and other obligations to pay or reimburse the purchaser as provided under the agreement. It noted that admittedly, no indemnification had to be given under either of the four heads, and the entire amount was received by the assessee without any deduction and was offered for taxation by the assessee in the subsequent year. The High Court noted that the Commissioner (Appeals) had not specifically examined as to whether the entire amount of ₹3.25 crore had been received by the assessee without any deduction and offered for taxation,

I.T.A. No.6866/Del/2018 23

but had solely proceeded on the basis that the escrow account had been opened and amount retained as retention money to be utilized by the purchaser for indemnification or breach of warranty for any other losses. On this basis, the Commissioner (Appeals) had concluded that the retention sum retained in the escrow account had not accrued to the assessee during the relevant year.

15.14 According to the Madras High Court, the Terms and Conditions of the Business Sale Agreement were vivid and clear, the total sale consideration having been clearly mentioned. After fixing the full and final sale consideration, the parties mutually agreed to retain a specified quantum of money in an escrow account to meet any one of the exigencies as mentioned in the agreement. Therefore, according to the High Court, for all purposes, the entire sale consideration had accrued in favour of the assessee during the year under consideration. Possession of the asset was also handed over by the assessee. Besides, no deductions were made from the escrow account and the entire amount was received by the assessee and offered to tax.

15.15 According to the Madras High Court, the purchaser retaining a particular amount of money in the escrow account could not take away the amount from the purview of full consideration received or accruing in favour of the assessee for the purpose of computation of capital gains u/s. 48. Besides, the assessee had received the entire amount of ₹ 3.25 crore without any deduction. The right of the assessee over the amount retained in the escrow account had not been disputed. The Madras High Court observed that assuming certain payoffs were to be made from the retention money, that would not in any manner alter the full and total consideration received by the assessee pursuant to the business sale agreement. Given the factual position, according to the Madras High Court, undoubtedly the entire sale consideration had accrued in favour of the assessee during the relevant assessment year and, assuming that certain payment had been made from the amount retained in the escrow account, it would not change or in any manner reduce the sale

I.T.A. No.6866/Del/2018 24

consideration.

15.16 The Madras High Court therefore upheld the order of the Tribunal, holding the assessee liable to capital gains tax during the relevant year on the entire sale consideration as per the agreement.

I.T.A. No.6866/Del/2018 25

did not arise at all as the capital gain is chargeable in the year of transfer. In the backdrop of realisation of escrow amount in full, the Hon’ble Madras High Court held that the entire sale consideration including the amount placed in escrow was taxable in the year of transfer itself. The facts in Dinesh Vazirani case are on a different footing inasmuch as there was actually a deduction from the amount placed in escrow and the amount of consideration therefore, underwent a significant change. The amount kept in escrow account was ultimately never received as income by the seller as the amount was returned to the buyer. The issue in Dinesh Vazirani case was whether a revision of the assessment order was possible in view of such facts which arose due to subsequent events impacting the taxable capital gains. It was in this context that the Hon’ble High Court took a view that the real income had to be considered and not a notional income. Viewed in this light, the assessee is placed in the similar fact situation and thus entitled to claim exclusion of amount lying in escrow which cannot be said to have accrued to the assessee in the peculiar facts of the case as undertaken on behalf of the assessee, the Revenue shall entitled to tax such amount as capital gains in the year in which such amount is actually released, if any.

I.T.A. No.6866/Del/2018 26

demonstrated to be substantially higher than the amount earmarked in escrow and hence funds have neither been released to the Assessee till date. When subsequent events after the filing of ROI are factored, such amount by way of escrow deposits can not be regarded as sale consideration accrued to the Assessee with reference to s. 48 of Act for the purposes of quantification of capital gains chargeable under s. 45 of the Act.

21.1 As submitted on behalf of the assessee, the assessee has earned dividend income of Rs. 3,35,50,000/- which was claimed as exempt under Section 10(34) of the Act. The AO resorted to statutory formula provided in Rule 8D of the Income Tax Act, 1962 and computed disallowance at Rs.1,09,31,500/- under Section 14A of the Act. It is the case of the assessee that it has suo muto disallowed Rs.6,21,806/- attributable to exempt income under Section 14A of the Act. It was pointed out that the exempt income has been derived only from investment made long back in Financial Year 1993-94 in the company, namely, M/s. Gujarat Guardian Ltd. (GGL) against the investment of Rs.33,35,00,000/-. The assessee contended that no expenditure has been incurred for earning exempt income per se inasmuch as investment yielding exempt income were old

I.T.A. No.6866/Del/2018 27

investment made in the earlier years however on conservative basis which has made suo motu disallowance of Rs.6,21,806/- under Section 14A of the Act in the return of income. It was submitted that no disallowance of interest expenditure could have been made owing to sufficient own funds available with the assessee company and hence no interest could be attributed to such investment. Besides, only investment yielding dividend income are to be considered for computing average value of investment for the purpose of making disallowance out of both interest and administrative expenditure under clause (ii) and (iii) respectively under Rule 8D(2) of the Rules. The assessee further claimed that no objection of valid satisfaction has been recorded by the AO for making disallowance.

21.2 We notice that the assessee has incurred Demat charges amounting to Rs.3,22,000/- which is in the nature of direct expenses under Rule 8D(2)(i) of the Act.

21.3 As regards on interest expenses, the assessee has demonstrated that own funds exceeds the corresponding investment yielding dividend income. The share capital along with reserves stands at Rs.108.26 crore as against investment in share yielding dividend income at Rs.33.35 crore. Thus, the disallowance of interest expenditure under Rule 8D(2)(ii) is not warranted. The disallowance under Rule 8D(2)(iii) is restricted to 0.5% of the average value of investment of Rs.33.35 crore attributable to investment which yielded exempt income in terms of statutory formula.

21.4 At this stage, we also observe that the assessee has made an ad hoc disallowance of 1/3 of salary of Chief Controller Account worked out to Rs.1,99,857/- and other administrative expense of Rs.1 lakh together to Demat charges of Rs.3,21,949/-. For the purpose of suo motu disallowance, no basis has been given by the assessee for making such ad hoc disallowance. The AO thus shall be guided by the statutory formula as noted in the preceding paragraph.

I.T.A. No.6866/Del/2018 28

21.5 In the result, Ground no.2 is partly allowed.

Order pronounced in the open Court on 08/02/2024

Sd/- Sd/- [SAKTIJIT DEY] [PRADIP KUMAR KEDIA] VICE PRESIDENT ACCOUNTANT MEMBER DATED: /02/2024 Prabhat