Tax planning that benefits taxpayers not illegal, rules ITAT

If you are a tax-paying investor, you would probably know that capital gain occurs when you sell a capital asset for more than you paid for it. Stocks, bonds, precious metals, jewellery, and real estate are all examples of capital assets.  That said, capital gains are taxed differently depending on how long you held the asset before selling it. Long-term capital gains (LTCG) are taxed differently than short-term capital gains (STCG).

As per the provisions of the Income Tax Act, 1961, (IT Act), Short Term Capital Loss (STCL) of the current year can be set off both against STCG and LTCG. However, Long Term Capital Loss (LTCL) of the current year can only be set off against LTCG. Similar is the case with the carry forward and set of STCL and LTCL in subsequent years.

However, the issue came to the limelight when recently the Income Tax Appellate Tribunal (ITAT) determined that tax planning is not “illegal” and should not be overlooked by tax authorities just because it benefits taxpayers.

Case study

The issue of setting off losses from shares against gains from the sale of property rose to prominence due to a recent judgment of the Mumbai Income Tax Appellate Tribunal (ITAT) in the case of Michael E Desa versus Income Tax Officer International Taxation.

In this case, ITAT held that LTCL arising from a particular asset class could be set off against LTCG arising from another asset class. In this case, the assessee was an NRI who sold a property in India and earned LTCG. At the same time, he sold some shares of an unlisted company and incurred LTCL.

Michael E Desa is a non-resident Indian. He sold a property in the previous year in which he was a 50% co-owner and declared a long-term capital gain of Rs 95,12,556.  Additionally, he also disclosed Rs 1,11,87,578 long-term capital loss on the sale of certain shares in VCAM Investment Managers Pvt Ltd. (VCAM). According to the Assessing Officer, “the (this) long term capital loss was attributed on the basis of equity shares of VCAM (Investment Managers Pvt Ltd), which appear to be prima facie fraudulent and not allowable against any taxable income.”

“The Assessing Officer was of the view that LTCL on account of sale of equity shares of a company primarily appears to be fictitious and hence, is not entitled to be adjusted against any taxable income. According to the judgment, the Assessing Officer has primarily questioned the timing of booking the loss and selling these shares, which, even according to the Assessing Officer, are “worthless,” explained Suresh Surana, Founder, RSM India.

That said, The ITAT ruled that it is not for the Assessing Officer to take a call on how an assessee should organise his fiscal affairs to serve the interests of the revenue authorities.

“The Assessing Officer cannot disregard a transaction just because it results in a tax advantage to the assessee. Just as much as we cannot legitimize and glorify tax evasion through colourable devices and tax shelters, we cannot also deprecate and disapprove genuine tax planning within the framework of law,” said Surana.

“The most crucial thing is to understand that this judgment reiterates the principle that legitimate tax planning within the four corners of law by set-off of LTCL on sale of shares against the LTCG on sale of immovable property or vice versa is permissible,” pointed out Surana.

As per the experts to understand the context of the question, it is important to note that there has not been any change with respect to the provisions of set-off of capital losses against capital gains in the recent past.

In the end, this benefits individuals to legitimately reduce their tax liability by booking their LTCL and setting it off against the LTCG, and hence the above jurisprudence supports this position.