Sec. 71(3A) of Income Tax Act limits Set-off Amount, does not eliminate Deduction benefits Entirely: Delhi HC upholds Constitutional Validity of Sub-Section [Read Order]

In a recent ruling, the Delhi High Court dismissed the writ petition challenging the constitutional validity of the amendment of Income tax act interesting the Sub-section 3A to the Section 71 of Income Tax Act, 1961. Together with the constitutionality challenge, the case also dealt with the cap of Rs. 2 lakh on Income from House Property set off.

The bench of Justices Purushaindra Kumar Kaurav and Yashwant Varma observed that “... the alteration in the manner of imposing tax in the present case cannot be said to deprive the taxpayer from a benefit, rather it tantamounts to a realignment of the existing provisions bearing in mind the broader economic and policy considerations, which the Legislature is duly empowered to do.”

A writ petition has been filed challenging the constitutional validity of Section 31 of the Finance Act, 2017, which introduced amendments to the Income Tax Act, 1961. The petitioner, in this case, seeks to annul the insertion of sub-section (3A) to Section 71 of the Income Tax Act, citing it as ultra vires the Constitution of India.

The petitioner, Sanjeev Goyal is a government employee who claims to have constructed his house in April, 2014 by incurring an expenditure of ₹1.35 crore. The said construction was financed through a housing loan, partially raised from the IDBI Bank and the rest from his father, amounting to ₹85,00,000/- and ₹50,00,000/-, respectively. The annual rent for the said house in the Financial Year 2016-17 was computed to be ₹1,20,000/-.

The petitioner, having constructed the house using borrowed capital, availed deductions under Section 24 of the Income Tax Act for the interest payable on such capital. This deduction was applicable to the head "Income from house property." Additionally, the petitioner utilized the provisions of Section 71 to set off this deduction against their salary income. Consequently, the petitioner filed their Income Tax Returns for the fiscal years 2014-15 to 2016-17 after availing these deductions and set-offs.

The Act of 2017 imposed a restriction on the set-off of losses under the head "Income from house property" against any other head of income. This restriction limited the set-off amount to ₹2 lakh for a specific Assessment Year, starting from April 1, 2018, applicable to Assessment Year 2018-19 and subsequent ones.

The primary contention of the petitioner revolved around the restriction imposed by the amendment on the set-off of losses under the head "Income from house property." The amendment specifies that an assessee shall not be entitled to set-off losses exceeding two lakh rupees against income under another head.

The petitioner asserted that the amendment, applied retrospectively from April 1, 2018, imposes an undue tax liability. It was also contended that this curtailment of the right to set off losses exceeding ₹2,00,000 adversely affects his financial standing, leaving him with minimal disposable income.

The petitioner’s counsel has also referred to the excerpts of the Budget Speech by the then Finance Minister, which has been annexed with the present petition, to contend that the legislative intent behind the enactment of the beneficial legislation under consideration was to provide an unhindered deduction and a vested entitlement to set off the actual amount of loss under the head “income from house property” against income from any other head. It was, therefore, asserted that insertion of sub-section (3A) to Section 71 of the Act amounts to a breach of promise, which consequently, attracts the doctrine of promissory estoppel against the respondent.

According to him, since the amendment is retrospective in nature, the same is against the principle of fairness which must be the basis for every legal rule. He asserted that the impugned amendment creates an unreasonable restriction on the existing statutory rights of the taxpayers and thus, deprives them of their rightful claims, which is violative of Articles 14 and 19(1)(g) of the Constitution.

In response, the counsel for the respondent argued that the amendment aims to curb abuse of the previous provision, which allowed unlimited deductions, potentially leading to escalation in property prices and reduced tax revenue.

As per the respondents, the rationale behind the amendment is that prior to the amendment, there was no upper limit (except in the case of self-occupied property) on deductions claimed by taxpayers, which led to the following two undesirable consequences: -

1. Escalation of property prices and reduction in supply of affordable housing to those in need.
2. Decrease in tax revenue as the higher income group reduced its tax liability by claiming loss under the head “Income from house property” by making large interest payments and setting off the loss against income under other heads.

It was submitted by the respondent’s counsel that the insertion of sub-section (3A) to Section 71 of the Act is not a revenue raising measure, rather it is an anti-abuse provision which seeks to minimise revenue loss. He additionally submitted that the said amendment can neither be said to be arbitrary nor unconstitutional and there was no promise from the respondents with respect to the set off of losses for the period in question.

The petitioner's challenge to the constitutional validity of Section 71(3A) of the Act prompted the High Court to discuss the limitations imposed by the Constitution on legislative powers. The court explained that Parliament's competence to legislate is defined by the three lists in the Constitution, with no challenge raised against this competency. Moreover, the court cited Article 265, stating that no tax can be levied or collected without lawful authority.

Regarding fundamental rights, the High Court noted Article 13, which deems state actions unconstitutional if they violate fundamental rights. The petitioner contended that the law in question was discriminatory and unduly burdensome, thereby infringing upon the right to conduct business. However, the court noted that retrospective application of legislation must impair vested rights to impact fundamental rights adversely.

In this case, the bench stated that neither the old nor the amended provisions aimed to create or disturb any vested rights of the petitioner. It was concluded that since the petitioner did not possess any crystallised right, their argument claiming violation of Article 14 of the Constitution was unsubstantiated. The insertion of sub-section (3A) was viewed not as a total elimination of deduction benefits, but rather as a limitation on the amount of set-off. This change, reflecting legislative policy, aimed to ensure equitable treatment among taxpayers claiming deductions under the specified head.

The court emphasised that the amendment did not create a new class or classification; rather, it pertained to an existing category in which the petitioner was included. The alteration in criterion was deemed a reasoned policy decision by the Legislature. The court found no evidence to suggest that the objective behind the amendment was unfounded or flawed. Consequently, the court affirmed the rationality and legitimacy of the legislative amendment.

Thus, the court viewed that the amendment is applicable to all the category of persons without any apparent or real discriminatory classification. In addition, it stated that, as a sequitur, it cannot be said to be against the tenets of equality encapsulated in Article 14 of the Constitution.

Further added that, notably, the petitioner’s challenge regarding Article 14 is only based on the test of reasonable classification and intelligible differentia, and the same has been turned down by us. There is no challenge on the ground of manifest arbitrariness.

The court further emphasised that the amendment did not disturb any vested rights of the petitioner. It noted that the amendment, which came into effect from April 1, 2018, did not promise indefinite benefits under the old taxation regime. Therefore, the doctrine of promissory estoppel was held inapplicable.

The Delhi High Court stated that heavy reliance on the decision of the Supreme Court in the case of CIT v. Vatika Township Pvt. Ltd.  by the petitioner does not come to rescue the case of the petitioner, inasmuch as, the question posited before the Court therein was to determine whether the proviso appended to  Section 113 by Finance Act, 2002 was to be applied prospectively or not. 

In the case at hand, it is palpably observed that the “Notes on Clauses”, appended to Section 31 of the Act of 2017, clearly stipulate that the amendment shall be applicable from AY 2018-19.

Accordingly, the writ petition was devoid of merits and was dismissed.

To Read the full text of the Order CLICK HERE

Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates