Brought-Forward Losses Cannot be Set Off against DTAA-Exempt LTCG: ITAT Bars Adjustment [Read Order]

The Mumbai Bench of Income Tax Appellate Tribunal (ITAT) held that long-term capital gains (LTCG) which are exempt from tax in India under a Double TaxationAvoidance Agreement (DTAA) do not form part of total income under the Income Tax Act, 1961, therefore cannot be adjusted against brought-forward capital losses.

The appellant, iShares Core MSCI Emerging Markets ETF, filed appeals challenging the final assessment orders passed under Section 143(3) read with Section144C(13) of the Income Tax Act, 1961 for the Assessment Years 2022-23 and 2023-24.

During the relevant years, the appellant earned LTCG amounting to ₹718,19,23,425 from the sale of shares acquired prior to 01.04.2017. These gains were claimed as non-taxable in India under Article 13(4) of the India-Mauritius DTAA, as they arose from grandfathered transactions. The appellant also carried forward long-term capital losses (LTCL) from earlier years, which arose from the sale of shares acquired after 01.04.2017.

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In its return of income, the appellant treated the grandfathered LTCG as fully exempt and set off the brought-forward LTCL only against LTCG arising from non-grandfathered transactions. The Assessing Officer (AO), however, adjusted the brought-forward LTCL against the grandfathered LTCG, thereby reducing the treaty-exempt amount. This approach was upheld by the Dispute Resolution Panel, leading to the present appeal.

Pranav Gandhi for the appellant contended that the AO by setting off brought-forward long-term capital losses against treaty-exempt gains, had effectively curtailed the benefit granted under Article 13(4) of the India-Mauritius DTAA read with Section 90(2) of the Income Tax Act, 1961. And pointed out that income which is exempt under the treaty does not form part of total income under the Act and therefore cannot absorb losses.

Vikram Singh Yadav, Accountant Member and Sandeep Singh Karhail, Judicial Member comprising the bench noted that there was no dispute that the LTCG of ₹718,19,23,425 arose from grandfathered transactions and were exempt from tax in India under Article 13(4) of the India-Mauritius DTAA. However, held that exempt income does not enter the computation of total income under the Income Tax Act, 1961 and therefore cannot be adjusted against brought-forward losses.

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Placing reliance on coordinate bench decisions the Tribunal reiterated that treaty-exempt capital gains cannot be used as a vehicle to absorb losses. The Bench further observed that Section 90(2) of the Income Tax Act, 1961 mandates application of treaty provisions where they are more beneficial to the taxpayer, and the treaty cannot be applied in a manner adverse to the assessee.

The Tribunal also relied on the principle laid down by the Bombay High Court that income excluded from total income does not enter the computation mechanism at all. Applying this principle, the Bench held that adjusting losses against treaty-exempt gains would effectively result in taxation of exempt income.

Accordingly, the Tribunal directed the AO to allow exemption of the LTCG of ₹718,19,23,425 arising from grandfathered transactions and to permit set-off of brought-forward LTCL only against LTCG arising from non-grandfathered transactions. Thus, the impugned order on this issue was set aside.

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