November 3, 2018
November 5, 2018


Section 48(i) of the Income Tax Act of 1961 provides that the expenditure which has been incurred wholly and exclusively in connection with the transfer of a capital asset is not liable to be taxed. Moreover, any amount the payment of which is absolutely necessary to effect the transfer is an expenditure covered by this clause.[1]
For a property to be transferred to a third party it is to be ensured that the same is not burdened with any encumbrance which might have arisen by virtue of a contract with a previous party and henceforth any expenditure incurred in order remove such an encumbrance is eligible for exemptions under the said section. But these exemptions have often been taken undue advantage of. Let us understand this by way of the law of specific relief.
It is a settled position of law that where there is a right to specific performance, some right, in favour of the transferee is created when the agreement to sell is executed and such a right can be surrendered or neutralized by the parties through a conduct leading to no transfer of the property.[2] To clarify it further let us hypothesize that an agreement to sell a property has taken place between two parties and before the sale could be executed the transferor sells it to a third party. Now it is very pertinent to note that if the initial buyer has a right to specific performance he indeed has a right in the property but the same can be surrendered by way of a conduct, say, payment of compensation by the seller to the first buyer. It is this compensation which has been disputed for its liability to be taxed for whether it is the seller or the buyer who shall incur tax liabilities for that part.
The right to specific performance is not available in each and every case and the section 10 of the Specific Relief Act of 1963 is a supporting evidence of this. The interesting part lies here and that is the said section itself which has been substituted by the Specific Relief (Amendment) Act of 2018. It has to be kept in mind that a compensation paid to remove a buyer’s right to specific performance makes him immune from the liability to be taxed for that part but where the buyer does have that right such a compensation would invoke tax liabilities on the part of the seller as the payment of compensation can then in no way be said to remove an encumbrance related to the transfer of shares to the third party. The amending act has certainly brought about a change in the cases where this right to specific performance would be available with the initial buyer. Since our focus is on the circumstances where the property is shares in a private limited company, we would deal with the changes in situation for that part only.
The explanation to the previous section 10 provided that where the movable property is not easily obtainable in the market there shall be a presumption that the breach of the contract may be relieved by way of specific performance. It has been held by the Supreme Court that shares in a private limited company are not easily obtainable in the market.[3] However, the recently inserted section 10 does away with this easily obtainable clause and simply places the reliance on sections 11(2), 14 and 16 for determining as to whether there is a right to specific performance or not. What would happen now is that when the seller transfers his shares in a private limited company to the 2nd buyer in violation of the agreement with the 1st buyer then the right of the latter to specific performance would depend upon certain questions which may be summed up as follows:
  • Whether the compensation to the first buyer in money is an adequate relief?
  • Whether the contract involves performance of a continuous duty which the court cannot supervise?
  • Whether the contract is so dependent on the personal qualifications of the parties that the court cannot enforce specific performance of its material terms?
  • Whether the first buyer violated the essential terms of the contract?
  • Whether the first buyer failed to prove his willingness to perform essential terms of the contract or not?
In short, it has become more troublesome for the seller now to escape his liability to be taxed, the reason being that compensation paid by him to the 1st buyer cannot merely be said to have been done to end his right to specific performance just by virtue of the shares not being easily obtainable in the market.
Apart from this a very drastic change apart that has occurred is that instead of the word “may” the substituting section 10 provides that the specific performance of a contract “shall” be enforced by the courts taking away their discretionary power. Now think of an objective answer to the question that whether this would increase or decrease the probability of the seller being taxed? Well if you have arrived at either of the options I am afraid you are wrong, the reason being that what creates a right in the property is a right to specific performance and not the granting or non-granting of the specific performance itself and hence it is clarified that there is no difference created with respect to the odds of the transferor being taxed by the inclusion of the word “shall”.
Lastly, section 16(c) which is now being relied upon by section 10 has itself undergone changes providing that in place of “who fails to aver and prove” the words inserted shall be “who fails to prove”. The preceding situation made it mandatory for the initial buyer to both aver and prove that he had been ready and willing to perform the essential terms of contract but now the averment of the same shall not be required and a mere proof would suffice.
Reliance of section 10 on section 16 is probably going to serve as a platform for one of the heaviest controversies in the field of taxation. Suppose a case comes up where all the conditions necessary for giving the first buyer a right to specific performance are fulfilled and the ultimate criteria left to be examined is regarding his readiness and willingness. If the same is “proved” there shall be a vesting of the right to specific performance in him. Now the question that needs to be asked is that whether in our case the initial buyer would really want to prove that he was ready and willing to perform the essential terms of the contract?
It won’t be surprising if the answer to the question is a “no”, the reason being that if it is established that the first buyer had a right to specific performance then the same would absolve the seller from the liability to be taxed for the part of the compensation paid to the former as it would qualify as an expenditure incurred in order to transfer the shares to the second buyer under section 48(i) of the Income Tax Act. This would divert the liability to the first buyer as the acceptance of compensation for relinquishment of a right serves as a ground for imposition of tax.[4] Henceforth it won’t be uncommon to come across cases where the initial buyer would himself sought to fail to prove his readiness and willingness and take a subsequent plea that the compensation paid was not to give up his right to specific performance rather it was done for some other non-fulfilments which do not involve a right in the property.
Thus, it can safely be concluded that what stands certain today is the creeping in of uncertainties regarding the right to specific performance in the upcoming matters of taxation where shares in a private limited company are involved not only because of the substitution of section 10, the explanation to which provided for the “easily obtainable” clause that ensured a certainty in the vesting of a right to specific performance in the first buyer but also due to the fact that the right now depends solely on sections 11(2), 14 and 16 which would be contributing no less in further alleviation of the “encumbrances” surrounding the matter.


[1] Commissioner of Income Tax v. Shakuntala Kantilal (1991) 190 (ITR) 56 (Bom.).

[2] Sanjeev Lal v. Commissioner of Income Tax AIR 2014 SC 3589.

[3] M.S. Madhusoodhanan and Ors. v. Kerala Kaumudi Pvt. Ltd. and Ors. (2004) 9 SCC 204.

[4] Commissioner of Income Tax v. Smt. Laxmidevi Ratani and Ors. (2008) 296 ITR 363 (MP).





Kushagra Srivastava is a 2nd year B.A., L.L.B. (Hons.) Student at the National Law Institute University, Bhopal. He can be approached at [email protected]

Leave a Reply

Your email address will not be published. Required fields are marked *