ITAT Chennai Rules: Loss on Sale of Shares Is Capital Loss, Cannot Be Claimed as Business Expenditure

Background of the Dispute

The Chennai Bench of the Income Tax Appellate Tribunal (ITAT) in the case of DCIT Vs Jayajothi and Company Private Limited examined the correct tax treatment of a loss of ₹6.81 crore arising from sale of shares for Assessment Year (AY) 2014-15.

The central issue was not whether the loss was genuine—both parties accepted that the loss had actually occurred—but how it should be classified under the Income Tax Act 1961:

  • Could the assessee treat the loss as a business expenditure debited to the Profit & Loss Account?
  • Or should it be treated as a long-term capital loss under the head “Capital Gains” and dealt with in accordance with the relevant provisions of the Act?

The Tribunal’s decision provides important clarity:

  • The loss on sale of shares, being loss on transfer of capital assets, is capital in nature,
  • It cannot be claimed as a deductible business expenditure,
  • But it must be recognized and allowed as long-term capital loss eligible for carry forward, subject to law.

Thus, while the Revenue partially succeeded in having the loss treated as “inadmissible” for business expenditure purposes, the assessee succeeded in preserving the benefit of carry forward as capital loss.

Facts of the Case

Business Profile and Original Return

  • The assessee, Jayajothi and Company Private Limited, is a domestic company engaged in manufacturing and selling cotton yarn.
  • For AY 2014-15, the assessee filed its return of income on 22.09.2014, declaring a loss of Rs.16,95,20,002/-.
  • The case was picked up for scrutiny under CASS.
  • Assessment was completed under Section 143(3) read with Section 92CA(3) on 28.02.2018, after giving effect to a Transfer Pricing Officer (TPO) adjustment.
  • The net assessed loss was determined at Rs.16,79,19,439/-.

In this process, a loss on sale of shares amounting to Rs.6,81,04,103/- had been debited to the Profit & Loss Account and adjusted against business loss, instead of being reflected and carried forward as capital loss.

Revision Proceedings under Section 263

The Principal Commissioner of Income Tax (PCIT) invoked Section 263 on 17.08.2020, holding that:

  • The original assessment order was erroneous and prejudicial to the interests of the Revenue
  • Specifically because the loss on sale of shares of Rs.6,81,04,103/- had been wrongly set off against business loss without adequate inquiry.

Pursuant to this, the assessment was set aside with directions to re-examine the treatment of this loss.

The National Faceless Assessment Centre (NFAC) then issued a show cause notice asking why the said amount should not be added back.

Assessee’s Revised Computation Before AO

In response, on 26.03.2021, the assessee:

  • Accepted that the capital loss on sale of shares had been wrongly treated as expenditure in the Profit & Loss Account,
  • Filed a revised working of income, reducing the claim of business expenditure by Rs.6,81,04,103/-,
  • Contended that this amount represented long-term capital loss and ought to be treated and allowed under the head “Capital Gains” as per law.

However, while giving effect to the Section 263 directions, the Assessing Officer (AO):

  • Disallowed the entire amount of Rs.6,81,04,103/- as an inadmissible expense,
  • Reduced the overall loss to Rs.9,98,15,336/-,
  • But did not grant the benefit of recognizing the amount as long-term capital loss eligible for carry forward.

The AO thus treated the amount only as a disallowed business expense, without corresponding recognition under the capital gains head.

Appeal Before CIT(A)

Assessee’s Contentions