Bombay High Court Quashes Reassessment Notice, Holding Amount Received Through Arbitration Not Taxable
In a landmark ruling, the Bombay High Court has ruled that amounts received in the settlement of inheritance rights are not subject to income tax.
The bench of Justices K.R. Shriram and Dr Neela Gokhale concluded that neither the receipt of an amount in exchange for inheritance nor the proceeds of a family arrangement can be taxed under the Income Tax Act. The Court reasoned that a family arrangement is an agreement between family members intended to benefit the family by either resolving disputed claims or maintaining family harmony, honour, security, and property by avoiding litigation. As a result, such sums are not liable for taxation.
Established in 1954, M/s. P.N. Writer & Co. is a well-established partnership firm co-founded by Charles D’Souza and P. N. Writer. The firm has undergone several reconstitutions, with the most recent partnership deed being executed in 1979.
Upon Charles D’Souza’s passing in 1997, his will stipulated an additional 5 per cent share in the firm to his daughter (the appellant), increasing her overall stake to 25 per cent.
In 2005, the appellant discovered a 1997 deed declaring her retirement from the partnership, sparking a dispute that led to arbitration proceedings. The Supreme Court intervened, ordering the firm to provide the appellant with interim relief of ₹50,000 per month.
The 2009 arbitration award specified that the appellant would waive all claims in return for ₹28 crore, paid in instalments. An initial amount of ₹5 lakh was received. The appellant maintained that this sum was related to her retirement and therefore not subject to taxation. Initially, the income tax department concurred with this assessment.
In an unexpected turn of events, the income tax department reopened the case in 2014, alleging an unreported income for the assessment year 2010-2011. This decision was prompted by the discovery of details related to the 2009 arbitration award and a 2007 Supreme Court order.
The appellant vehemently contested the tax department’s claims, claiming that the amount in question was not taxable income but rather a settlement related to her retirement from the firm. The tax department, however, dismissed these objections, relying on information obtained from the Assessing Officer of the firm and asserting that the true nature of the amount could not be definitively established.
The appellant contested this order through a writ petition, which was eventually withdrawn in 2015. However, the withdrawal was granted with the explicit understanding that the appellant could raise all objections before the relevant tax authorities.
Following the writ petition’s withdrawal, the tax department reinstated its reassessment proceedings, issuing a notice under Section 142(1) of the Income Tax Act. The notice required the appellant to provide justification for the received amount, either by classifying it as business income or capital gains.
In 2015, the tax department concluded its reassessment proceedings, determining the appellant’s total income at ₹28,18,91,590. This figure included an additional ₹28 crore classified as business income under Section 28(iv) or capital gains.
The department’s justification for this inclusion was that the appellant had not effectively retired from the firm.
Dissatisfied with the assessment order, the appellant pursued an appeal. During the appeal process, the CIT(A) dismissed the applicability of Section 28(iv) but categorised the arbitration award as income from other sources. The Tribunal, upon review, upheld the reassessment, citing the existence of prima facie evidence indicating an escapement of income. Undeterred, the appellant filed an appeal under Section 260A of the IT Act to challenge this decision.
The appellant challenged the reassessment proceedings on the grounds that they were initiated without fulfilling the jurisdictional pre-conditions laid out in Sections 147 and 148 of the Income Tax Act.
Specifically, the appellant argued that the reassessment was unnecessary because the ₹28 crore received represented a settlement for retirement and relinquishment of claims against the family and the partnership firm. As such, the amount was not taxable income.
To support this claim, the appellant provided evidence that upon receiving the ₹28 crore, all outstanding claims had been resolved, and she held no further entitlements. Additionally, the arbitration award, which formed the basis for the reassessment, explicitly stated that the amount was related to retirement and relinquishment of rights under the will.
The appellant further contended that the respondent failed to present a prima facie case to support the belief that income chargeable to tax had escaped assessment. The appellant argued that the information provided by the Assessing Officer of the firm, P.N. Writer & Co., was not recent and did not establish a clear connection between the information and the belief of escaped income. Moreover, the appellant highlighted that the issue of taxability had already been considered in the Assessment Year 2008-2009 and was determined not to be taxable. Initiating reassessment proceedings for the Assessment Year 2010-2011, therefore, constituted a change of opinion, which is prohibited under the law.
The appellant further argued that the onus of proof rests on the tax department to demonstrate that the received amount falls within the purview of taxable income. The appellant asserted that the tax department failed to fulfil this burden of proof. The primary objective of the ₹28 crore payment was to settle the appellant’s relinquishment of rights in the partnership firm, with other issues being mere incidental considerations.
The appellant contended that historically, amounts received by a partner upon retirement were not considered taxable income prior to the introduction of Section 45(4) by the Finance Act of 1987. The appellant maintained that the ₹28 crore received was in exchange for retirement from the firm, as corroborated by various supporting documents. Additionally, the appellant argued that Section 45(4) was not applicable in this case, as it deals with the distribution of capital assets, not a monetary amount.
Even if a portion of the arbitration award was related to inheritance, the appellant contended that in the absence of Estate Duty or a comparable tax, no tax should be imposed. The provisions of Section 56(2)(vii) explicitly exclude amounts received under a bequest from taxation.
The appellant further maintained that the received amount stemmed from a family arrangement, which is not considered taxable income. Drawing upon relevant case law, the appellant asserted that such arrangements, intended to resolve disputes or maintain family harmony, are not subject to taxation.
Initially, the respondent maintained that the amount received/receivable by the appellant should be taxed under Section 28(iv) of the Income Tax Act. However, this argument was rejected by both the CIT(A) and the Tribunal, who recognised that Section 28(iv) does not apply to monetary benefits.
The respondent argued that the taxability of the received amount should be determined by the purpose behind the payment. Citing relevant case law, they argued that the consent terms did not explicitly specify that the payment was made in exchange for relinquishing rights in the partnership. This lack of clarity, they asserted, justified the Tribunal’s conclusion.
The respondent contended that the appellant’s retirement from the firm effectively dissolved the firm, rendering the amount received upon dissolution taxable. In support of this argument, they cited the Supreme Court’s decision in Erach F. D. Mehta v. Minoo F. D. Mehta case.
The respondent maintained that the amount received by the appellant was liable to tax as “Income from other sources” under Section 56(1) of the Act. They reasoned that the receipt constituted a special income and was therefore taxable.
The Bombay High Court delved into the jurisdictional pre-conditions for initiating reassessment proceedings under Section 148 of the Act. It underscored the requirement for the Assessing Officer to hold a genuine belief that the assessee’s income has escaped assessment and that this belief should not stem from a mere change of opinion.
The Court established that the jurisdictional pre-conditions for initiating reassessment proceedings were not met in this case. The reasons provided for reopening the assessment failed to clearly articulate whether the amount received through arbitration constituted taxable income. The belief formed by the Assessing Officer lacked clarity and was inconsistent with the information available at the time.
The Court further remarked that the initiation of reassessment proceedings appeared to be driven by a lack of a genuine belief that income had escaped assessment. Instead, it seemed more like an attempt to launch inquiries or investigations into the facts.
The Court further examined the nature of the amount received through arbitration, concluding that it was primarily related to the settlement of partnership interests and inheritance rights. As such, the Court classified it as capital in nature and not subject to taxation. The Court also criticised the Tribunal’s categorisation of the amount as “special income,” emphasising that such a concept lacks any foundation in the law.
In conclusion, the Court ruled in favour of the appellant, finding that the Assessing Officer had exceeded their jurisdiction by initiating reassessment proceedings without fulfilling the requisite pre-conditions. The Court also determined that the amount received through arbitration was not taxable. The appeal was disposed of without any order as to costs.