Bombay HC upholds non-taxability of deferred consideration on transfer of shares in the absence of accrual

This Tax Alert which summarizes a recent ruling of the Bombay High Court (HC) in the case of Mrs. Hemal Raju Shete (Taxpayer) on the issue of taxability of capital gains on transfer of the shares of the company where part of the consideration was receivable in the future, subject to occurrence of contingency.

Under the agreement to sell, the Taxpayer and her family members (sellers) transferred shares of the company to the purchaser against payment of consideration, payable upfront. The agreement also contemplated the entitlement of the sellers to additional consideration payable over a period of four years, based on the profitability of the company whose shares were the subject matter of transfer, subject however, to the covenant that the aggregate consideration was not to exceed INR200m. The Tax Authority levied capital gains with respect to the consideration of INR200m, rejecting the Taxpayer’s claim to compute capital gains with respect to the amount actually due and received in the year of transfer.

The HC held that deferred consideration, which is linked to the future performance of the company, is dependent upon uncertain events, which is contingent and has not accrued in the year of execution of the agreement. No part of the deferred consideration is, therefore, chargeable to tax in the year of execution.

Furthermore, the HC also accepted taxability of deferred consideration as capital gain income in the respective year of accrual