Income taxpayers can set off short term capital loss from share sale against long term capital gains: ITAT

In a significant ruling, the Mumbai bench of the Income Tax Appellate Tribunal (ITAT) upheld a taxpayer's right to engage in legitimate tax planning, allowing the set-off of short-term capital losses incurred from the sale of shares against long-term capital gains (LTCGs), according a TOI report. The decision comes as a relief for stock market investors who often face scrutiny during income tax assessments. Tax experts say that the ruling draws a clear distinction between legitimate tax planning and tax evasion.

The case is from financial year 2015-16, where the taxpayer, a resident individual, incurred short-term capital loss of Rs 9.1 crore from selling Mindtree shares. The loss was set off against an LTCG of Rs 16.8 crore from the sale of Avendus Capital shares. The income tax assessing officer, however, disallowed the short-term capital losses claim, reclassified it as long-term capital gains, and added it back to the taxpayer's income. The officer argued that the taxpayer exploited a drop in Mindtree’s share price after the announcement of a bonus issue, strategically selling the shares to generate short-term capital loss that could offset the LTCG, a move the officer described as a "colourable device."

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The taxpayer filed a return declaring an income of Rs 15.87 crore. During assessment, the income tax officer observed that the taxpayer had earned an LTCG of Rs 16.81 crore from selling 1.23 crore shares of Avendus Capital Pvt Ltd. The taxpayer set off Rs 9.14 crore from the sale of Mindtree shares, which the officer contested. He argued that the bonus announcement caused a significant drop in Mindtree’s share price, and the taxpayer’s sale of the shares to book a loss was a tactic to reduce tax liability by offsetting the LTCG, which is exempt.

In response, the taxpayer appealed to the Commissioner of Appeals, who ruled in her favour, leading the tax department to escalate the matter to the ITAT. The tribunal dismissed the department’s appeal, emphasizing that the taxpayer did not employ any unfair means to reduce her tax liability.

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Tax laws allow a short-term capital loss (from shares held for less than 12 months) to be set off against any capital gain, whether short-term or long-term. In contrast, long-term capital losses can only offset long-term gains. The income tax officer’s argument relied on the 1985 Supreme Court ruling in McDowell & Co., which condemned the use of "colourable devices" to evade taxes. The officer claimed the taxpayer timed the sale of Mindtree shares deliberately after the bonus issue announcement to generate short-term capital loss, thereby lowering her tax liability.

However, the ITAT bench, comprising of Vice-President Saktijit Dey and Accountant Member Amarjit Singh, found no evidence to suggest that the transactions were anything but genuine. The tribunal stated that the short-term capital loss incurred by the taxpayer could not be disallowed based solely on accusations of a "colourable device." It concluded that, in the absence of evidence questioning the authenticity of the transactions, the loss resulting from these transactions should be allowed to be set off.

“In our view, the conclusion drawn by the Assessing Officer is wholly irrational and unsustainable. When the transactions relating to purchase and sale of shares are beyond doubt and are not in the nature of sham transaction even there is no such allegation by the Assessing Officer, the short term capital loss derived by the assessee from sale of shares cannot be prevented from being set off against the long term capital gain by alleging adoption of colorable device. There is no requirement under the law that the assessee has to pay more tax. If the assessee arranges her affairs within the legal framework and through legitimate means to reduce its tax liability, the Assessing Officer cannot prevent her from doing so. When there is no evidence on record to doubt the genuineness of the transactions entered into by the assessee, the resultant capital loss derived out of such transaction cannot be disallowed,” the ITAT order stated.

The order further added, “More so, when the Assessing Officer has not expressed any doubt or dispute regarding the nature of loss, being capital. Even, as rightly observed by the learned First Appellate Authority, the Assessing Officer has accepted the computation of short term capital loss made by the assessee. It is further relevant observe, the long term capital gain shown by the assessee on sale of bonus shares of M/s Mindtree Ltd. have been accepted in subsequent assessment year i.e. A.Ys. 2017-18 and 2018-19. That being the factual position emerging on record, we do not find any infirmity in decision of the learned First Appellate Authority. While coming to the aforesaid conclusion, we have drawn support from the decision of Hon’ble Jurisdictional High Court in case of PCIT vs. Cyrus Poonawalla [2018] 100 taxmann.com 227. Accordingly, grounds are dismissed."

The ITAT said there is no requirement under the law for a taxpayer to pay more tax if they arrange their affairs within the legal framework. The tribunal said the taxpayer’s actions were legitimate and conducted within the boundaries of the law, dismissing the Revenue’s appeal. The ITAT also said that the tax authorities later accepted the LTCG from the sale of Mindtree bonus shares in subsequent financial years, further affirming the legitimacy of the taxpayer’s transactions.