The Bombay High Court has held that the income tax authorities cannot unilaterally determine a violation of SEBI regulations to deny a tax benefit when SEBI, as the competent regulatory body, has not alleged any such violation. The Court clarified that when the respondent has invested in the Venture Capital Undertakings (VCU), merely because the VCU was engaged in real estate activity, it cannot be stated that the respondent is engaged in real estate activity as it is an entity separate from the VCUs.
The Court also held that the power of revision under Section 263 of the Income-tax Act, cannot be invoked merely to substitute the view of the PCIT for that of the AO, especially when the AO has conducted a detailed enquiry and has taken a possible view on the matter. For jurisdiction under Section 263 to be validly exercised, the twin conditions, that the assessment order is erroneous and that it is prejudicial to the interest of the revenue, must both be satisfied.
Accordingly, the Court ruled that an assessment order is not prejudicial to the interest of the revenue if the income in question has been duly subjected to tax in the hands of the unitholders under the pass-through status provided by Section 115U of the Income Tax Act. Also, allowing a tax exemption to a Venture Capital Fund (VCF) for investments in the real estate sector is justified, as “real estate” was removed from the negative list of the applicable SEBI (VCF) Regulations, 1996.
The Division Bench comprising Justice B. P. Colabawalla and Justice Firdosh P. Pooniwalla found the PCIT’s reliance on the AIF Regulations to be misplaced, as the respondent was governed by the VCF Regulations, under which real estate was not a prohibited sector. The Bench also noted that SEBI itself had clarified that temporary investments in mutual funds by VCFs are permissible.
The Bench traced the amendments to Section 10(23FB) of the Income Tax Act, noting that for A.Y. 2013-14, the sectoral restrictions on VCUs were removed, and the definition of a VCU was aligned with the SEBI (Venture Capital Funds) Regulations, 1996. Further, since under the VCF Regulations, “real estate” was explicitly removed from the Negative List of prohibited sectors with effect from April 5, 2004, the investment in the real estate sector was permissible for a VCF.
The Bench concurred with the ITAT’s finding that the AO had conducted an extensive and detailed enquiry before allowing the exemption. The AO had raised specific queries regarding the nature of investments, the activities of the VCUs, and the applicability of the negative list, to which the respondent had provided detailed replies.
Briefly, the case concerns Milestone Real Estate Fund (respondent), a Trust created under the Indian Trust Act, 1882, and registered with SEBI as a Venture Capital Fund (VCF) under the SEBI (Venture Capital Funds) Regulations, 1996, whose primary activity is investing in entities engaged in the real estate sector. The dispute arose when the respondent filed a revised return declaring a total income of Rs. 14.29 Crores and claimed an exemption of Rs. 144.60 Crores under Section 10(23FB) of the Income-tax Act, for income earned from its investments in Venture Capital Undertakings (VCUs).
The Assessing Officer (AO) conducted a detailed scrutiny assessment, and issued multiple notices calling for extensive details to justify the exemption claim. This included the SEBI VCF certificate, reports filed with SEBI, details of investments in VCUs, the nature of business of the VCUs, and an explanation of how the respondent was covered by Sections 10(23FB) and 115U. After examining the submissions, the AO passed an assessment order allowing the exemption. The AO noted that as a SEBI-registered VCF, the income from VCUs is exempt in the hands of the Fund and is taxed in the hands of the investors on an accrual basis as per Section 115U of the Act.
Subsequently, the Principal Commissioner of Income-tax (PCIT) issued a show-cause notice under Section 263 of the Act, alleging the assessment order was erroneous and prejudicial to the interest of the Revenue. Later, the PCIT passed an order setting aside the AO’s order on the grounds that (i) the investments in VCUs engaged in the real estate sector were not eligible for exemption under Section 10(23FB); (ii) the respondent’s investment in mutual funds violated SEBI VCF Regulations; and (iii) the respondent’s activities were akin to the sale and purchase of immovable properties, which is not within the ambit of VCF Regulations.
On appeal, the Income Tax Appellate Tribunal (ITAT) quashed the PCIT’s order, finding that the AO had conducted a proper enquiry, the order was not erroneous, and no prejudice was caused to the Revenue as the income was taxed in the hands of the unitholders.
Appearances:
Advocates Malcoln Vaz, Ravi Rattesar, and Kiran Singh, for the Petitioner/ Revenue
Senior Advocate J. D. Mistri, along with Advocate Madhur Agrawal, for the Respondent/ Taxpayer
