A Delhi bench of the Income Tax Appellate Tribunal (ITAT) has upheld an Income Tax Department demand imposing a 22% tax on capital gains, simply because the entity's total income is otherwise taxed at the same rate under Section 115BAA of the Income Tax Act.
Tax professionals have described the ruling as "bizarre and legally untenable," arguing that it disregards the clear statutory distinction between income from business profits and long-term capital gains (LTCG), which are governed by separate provisions.
The Case: 22% Tax on Capital Gains
The case concerns a private, unlisted company that had opted for the 22% concessional corporate tax rate under Section 115BAA, applicable to domestic companies that do not claim certain deductions or incentives.
For the AY 2021-22, the company had paid 20% tax on LTCG (with indexation benefits) from the sale of capital assets, as per the standard rate under Section 112. However, the Assessing Officer (AO) contended that since the entity was taxed under Section 115BAA, its long-term capital gains should also be taxed at 22%, not 20%.
The Commissioner of Income Tax (Appeals) endorsed the AO's interpretation, and the position was subsequently upheld by a single-member bench of the ITAT in Delhi.
Tribunal's Observations
The Tribunal noted that the assessee had opted for taxation under Section 115BAA and therefore, the "rate of tax applicable in respect of total income of the assessee company is 22%."
Quoting from the order, the ITAT observed:
"Since the assessee has opted for taxation under Section 115BAA of the Act, the rate of tax applicable for the impugned assessment year is 22%. Whereas, according to the assessee, the rate of tax applicable on long-term capital gain should be 20%."
The bench thus sided with the Revenue, asserting that the flat 22% rate applied to all components of income, including capital gains.
Experts Call It a Misreading of the Law
Tax experts have been quick to criticize the interpretation. They argue that Section 115BAA is "subject to" Sections 112 and 112A, which specifically deal with the taxation of long-term capital gains.
"The phrase 'subject to' signifies that Section 115BAA must yield to provisions like Sections 112 and 112A," said a leading tax practitioner. "This hierarchy ensures that while business income is taxed at the concessional rate of 22%, capital gains continue to be governed by their respective rates."
Experts caution that this interpretation, if left unchallenged could open the floodgates for arbitrary tax demands. For instance, tax officers might start claiming 25% tax on LTCG from manufacturing companies established after March 1, 2016 (taxed under Section 115BAB), or similar reclassifications under Section 115BAC, which deals with the new tax regime for individuals.
Automated Error or Policy Confusion?
The case also underscores how automated processing errors by the Income Tax Department's Centralized Processing Centre (CPC) can lead to long-drawn disputes. The initial tax demand was generated through the CPC's automated system, but later found endorsement through successive levels - the AO, CIT(A), and now the ITAT before likely heading to a higher judicial forum.
Industry observers note that the issue may ultimately be settled by the High Court or Supreme Court, but until then, the ruling may embolden some officers to adopt similar positions in ongoing assessments.
Implications for Corporate Taxpayers
If not overturned, the ITAT ruling could have far-reaching implications for companies opting for concessional tax regimes. It could also create inconsistencies between sections that were designed to operate harmoniously within the Act's structure.
"Any contrary construction not only disrupts the internal coherence of Section 115BAA but also risks creating inconsistencies across analogous regimes, such as Sections 115BA, 115BAB and 115BAC," said another tax expert.
For now, tax professionals and corporates alike are hoping that a higher court intervenes to clarify the law and reaffirm the principle that capital gains must be taxed separately from business income, in line with the legislative framework.
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