Taxability of Forfeited Advance Money for Transfer of Capital Assets Under Section 56(2)(ix)

Here’s a detailed analysis of the taxability of forfeited advance money for transfer of capital assets under Section 56(2)(ix) of the Income Tax Act, 1961:

1. Scope and Applicability of Section 56(2)(ix)

• Introduced in 2014(via Finance (No. 2) Act), this provision taxes any advance or deposit received during negotiations for transferring a capital asset if:
  • The amount is forfeited, and
  • The transfer does not materialize.
• Objective: To prevent tax evasion by treating such forfeited advances as revenue receipts(taxable under “Income from Other Sources”) rather than capital receipts.

2. Key Conditions for Taxability

• Trigger Events:
  • Negotiations for transfer of a capital asset(e.g., land, property, shares).
  • Advance money is received but later forfeited due to failed negotiations.
• Exclusions:
  • Amounts forfeited after transferof the asset (treated as part of sale consideration).
  • Advances for non-capital assets(e.g., inventory).

3. Tax Treatment

• Taxable Amount: Entire forfeited advance is taxed as “Income from Other Sources”in the year of forfeiture.
• No Deductions: Expenses incurred during negotiations (e.g., legal fees) cannotbe deducted.
• Tax Rate: Normal slab rates apply (e.g., 5–30% + cess for individuals/HUFs).

4. Judicial Precedents

• ITAT Mumbai Ruling (Anthony P Lewis Case): Confirmed that forfeited advances are taxable under Section 56(2)(ix) if the asset transfer fails.
• Sterling Investment Corporation Case: Historically, such forfeitures were treated as capital lossesfor the payer, but post-2014, they are revenue receipts for the recipient.

5. Compliance and Reporting

• Disclosure: Report in Schedule OSof ITR-2/ITR-3.
• Documentation: Maintain copies of:
  • Advance agreements.
  • Forfeiture notices.
  • Proof of failed negotiations.

6. Practical Example

Scenario: Mr. X receives ₹10 lakh as an advance for selling land but forfeits it after the buyer backs out.

• Taxable Income: ₹10 lakh under Section 56(2)(ix).
• Tax Liability: Slab rate on ₹10 lakh (e.g., ₹1.12 lakh at 30% + cess).

7. Key Considerations

• For Payers: Forfeited amounts cannotbe claimed as capital losses (only as revenue losses if proven as business expenditure).
• For Recipients: Even partially forfeitedamounts are fully taxable