Madras High Court Upholds Capital Gains Tax Relief For Company That Shifted Industrial Unit Out Of Chennai

The Madras High Court has upheld a company's claim for capital gains tax relief after it shifted its industrial unit from Chemmenchery to Puzhal, holding that Chemmenchery was part of Chennai's urban agglomeration even before its inclusion within the Chennai Corporation limits in 2011.

The Court also held that payments made to Indian subcontractors would not attract TDS provisions applicable to payments made to non-residents, while rejecting the assessee's claim for road construction expenditure in the absence of supporting evidence.

Section 54GB of the Income Tax Act, 1961, provides a capital gains tax exemption for individuals and Hindu Undivided Families (HUFs) who sell a long-term residential property and reinvest the proceeds into an eligible startup.

A Division Bench comprising Justice Anita Sumanth and Justice Krishnaswamy Govindarajan was hearing an appeal filed by the Income Tax Department against an order of the Income Tax Appellate Tribunal (ITAT), Chennai, in the case of Edac Engineering Limited for Assessment Year 2009-10.

The dispute arose from the assessee's relocation of its industrial unit from Chemmenchery to Puzhal. The assessee had claimed deduction under Section 54G in respect of capital gains arising from the transfer of land in connection with the shifting of the industrial undertaking.

The Assessing Officer rejected the claim on the ground that Chemmenchery was included within the Chennai city corporation limits only with effect from 2011, pursuant to a Tamil Nadu Government Order dated December 26, 2009. The Commissioner of Income Tax (Appeals) upheld the disallowance, but the ITAT allowed the assessee's claim.

On the Section 54G exemption, the High Court agreed with the ITAT and held that Chemmenchery was part of the urban agglomeration of Chennai even before 2010.

The Bench observed that Section 54G was introduced with the objective of decongesting urban areas by providing tax benefits where an industrial undertaking shifts from an urban area to another location.

It noted that the CBDT notification dated April 2, 1996, referred to 'Madras' and that the city limits had expanded over time. The Court also considered the provisions of the Tamil Nadu Urban Land Tax Act, 1966, and the Tamil Nadu Urban Land (Ceiling and Regulation) Act, 1978, which recognised the relevant areas as part of the urban agglomeration.

The Bench observed that the Government Order dated December 26, 2009, merely contemplated the upgradation of certain local bodies, including Chemmenchery, into corporations after the tenure of the existing elected representatives ended in 2011. The deferral was intended to enable completion of their terms and did not alter the existing status of the local bodies.

The Court also referred to its earlier decision in Chemmancherry Estates Co. v. ITO, Ward-VIII(2), which had recognised Chemmenchery as falling within the urban agglomeration for the purposes of the relevant land laws.

Accordingly, the Court held that Chemmenchery qualified as urban land under the Explanation to Section 54G even before 2010. It ruled that the Government Order of December 26, 2009, had no relevance to the assessee's eligibility for the exemption.

On the TDS issue, the Court held that payments made directly to Indian subcontractors would not attract the provisions governing deduction of tax on payments to non-residents.

The assessee had engaged an entity based in Dubai for mass alkali flushing work in boiler units of JSWERL, Toranagallu. However, the work was subcontracted to two Indian entities, Fairline Shipping Services Limited and AMS Enterprises, and payments were made directly to those domestic companies.

The Assessing Officer had invoked Sections 195 and 40(a)(i) of the Income Tax Act on the ground that the payments were made on behalf of the non-resident entity.

Rejecting this approach, the Bench observed that Section 195 deals with deduction of tax at source on payments to non-residents, while Section 40(a)(i) provides for disallowance where tax is not deducted on such payments. Both provisions require the payment to be made to a non-resident and must be interpreted strictly.

"...Both the provisions require payments to be made to the non-residents and would have to be read and interpreted strictly. There is no insinuation in this case that the Indian entities are only a pass through and that the ultimate beneficiary was the non-resident", it said.

The Court noted that there was no allegation or material to suggest that the Indian entities were merely pass-through entities or that the ultimate beneficiary of the payments was the non-resident. The assessee had also produced work orders, correspondence, ledger extracts and invoices to establish that payments were made directly to the Indian entities.

Finding no reason to interfere with the ITAT's factual findings, the Court answered the relevant questions of law in favour of the assessee.

However, the High Court reversed the ITAT's decision, allowing 75% of the road construction expenditure on an estimated basis.

Although the ITAT accepted that temporary roads had been laid and allowed 75% of the expenditure, the High Court held that the assessee's involvement in the overall project could not, by itself, establish the genuineness of the expenditure claimed.

The Bench observed that the burden was on the assessee to substantiate the expenditure through documentary and other supporting material. In the absence of such evidence, the ITAT could not have allowed 75% of the claim merely on an estimated basis.

Accordingly, the Court restored the disallowance made by the Assessing Officer in respect of the road construction expenditure.

The High Court answered the first five substantial questions of law in favour of the assessee and the sixth question in favour of the Revenue.

The tax appeal was disposed of accordingly.

For Appellant: T.Ravikumar, Senior Standing Counsel

For Respondent: J.Saravanan, Advocate