Sale consideration against property not paid but retained in Escrow Account: Tax implication while computing capital gains u/s 48

Sale consideration against property not paid but retained in Escrow Account: Tax implication while computing capital gains u/s 48

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Sale consideration against property not paid but retained in Escrow Account:

Tax implication while computing capital gains u/s 48

 
 
Often there are transactions in immoveable property wherein the entire consideration is not paid to the seller but the part of the sale consideration is retained for future contingencies or uncertainties. The question arises as to whether the amount retained could be brought to taxation even if it is not received?
The amount retained in an escrow account or otherwise is a matter of tax litigation in various cases.
Here is an interesting case on a similar issue. The citation of the case is as under:
Caborandum Universal Ltd Vs ACIT
TCA No. 1112 of 2010
The issue before the Madras HC was whether part of sale consideration retained in Escrow Account is deemed to have accrued to assessee and should be considered while computing capital gains u/s 48.
Madras HC replied in affirmative and dismissed the appeal filed by the assessee.
Short overview of the case:
1. Assessee had entered into a Business Sale Agreement with SEPR.
2. Parties had agreed that a sum of Rs. 3,25,00,000/- shall be held in the retention account on terms and conditions provided in the Agreement and Retention Account Agreement.
3.Interest accrued on retention sum shall belong to seller and shall be paid to seller as per Retention Account Agreement.
4. Clause 15.1 of the Agreement stated that retention sum shall be paid by purchaser in Retention Account at closing date for purpose of ensuring that sufficient funds would be available to indemnify purchaser against any damages or losses arising from or any of the following:
a) Indemnification for Breach of Warranty;
b) Indemnification for other losses;
c) Unpaid Accounts Receivables and
d) Pursuant to other obligations to pay or
e) reimburse Purchaser as provided in Agreement.
5. Entire amount of Rs. 3.25 Crores was received by assessee without any deduction and was offered for taxation by assessee in subsequent year.
6. Assessee had excluded the amount retained in the Escrow account as retention amount while making computation of capital gains.
7. AO and ITAT had faulted assessee for doing so but CIT(A) had granted relief to assessee.
Aggrieved by the order of the ITAT, assessee filed present appeal before the Hon’ble High Court of Madras.
On Appeal, Masdars High Court held as under:
1. If part of sale consideration retained in Escrow Account is deemed to have accrued to assessee and it has to be considered while computing capital gains u/s 48.
2. CIT(A) had not specifically examined whether the entire amount of Rs. 3.25 Crores was received by the assessee without any deduction and offered for taxation.
3. CIT(A) had solely proceeded on the basis that Escrow account had been opened and amount had been retained as retention money to be utilised by purchaser for indemnification for breach of warranty or any other losses.
4. There were four heads under which retention money could be used to indemnify against losses and none required any payment to be made.
5. CIT(A) concluded that retention sum retained in Escrow account had not accrued to assessee in the year under consideration.
6.  As per Business Sale Agreement, full and final consideration was Rs. 325,000,000/-. Parties had agreed to retain a sum of money in Escrow account, which could not be construed to take away assessee’s case from expression ‘accrued’ u/s 48.
7. Conduct of assessee and purchaser in retaining a sum of money in Escrow account could not take away the amount from purview of full consideration received/accruing in assessee’s favour while computing capital gains u/s 48.
8. Assessee had received the entire amount of Rs. 325,000,000/- without any deduction. Rs. 3.25 Crores was retained in the Escrow account.
9. Assessee’s right was not disputed.
10. Amount was retained to cover four contingencies, which were part of indemnity clause. Assuming certain payoffs were to be made from retention money would not in any manner alter full and total consideration received by assessee.
11. Entire sale consideration had accrued in assessee’s favour during relevant AY.
12. Even assuming that certain payments had been made from the amount retained in the Escrow account, it would not in any manner reduce acquisition cost.

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