Investment fund allowed to offset losses despite technical error

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The Income Tax Appellate Tribunal has ruled in favour of an investment fund that was prohibited from offsetting its losses against future profits because of a technical mistake it made when submitting its tax return.

The Nicholas Applegate South East Asia Fund is a Mauritius-based protected cell company (PCC). A PCC is an ordinary company that is statutorily authorized to segregate its assets into cells. A creditor of one cell can only proceed against the assets of that cell – a concept known as “ring-fencing”. PCCs are the most popular entity for use as collective investment vehicles across jurisdictions, especially in Europe. They are particularly useful when a fund manager desires to manage the assets of multiple funds and, at the same time, market the multiple funds as a single opportunity.

Tax_India_-_The_wrapThe Nicholas Applegate South East Asia Fund had four cells, each containing a separate sub-fund. Initially the company filed separate tax returns for each of its sub-funds. Later, however, a single consolidated return was filed by the company.

The sub-funds incurred short-term capital losses with respect to their Indian investments and in order to qualify to offset these losses against future profits, the fund was required under the Indian Tax Act to furnish its tax return by a specific date. The first set of returns was filed before this date, but the consolidated return was filed sometime later.

The assessing officer decided that the cells of the PCC were not liable to be taxed separately. He therefore held that the initial set of returns was invalid and that the consolidated filing, which arrived subsequently, would be regarded as the company’s initial return. Since this consolidated return had been filed after the due date, the fund was not allowed to carry forward its loss.

The fund appealed, but the case was rejected by the first appellate authority. A second appeal was made to the Income Tax Appellate Tribunal.

The tribunal ruled that an initial return is valid as long as it falls within the ambit of Section 292B of the Income Tax Act, where a return which suffers from a defect is not considered invalid if it conforms in substance and effect to the purpose of the act. Therefore, according to the tribunal, the filing of separate returns with respect to each sub-fund was a technical mistake and not an action that would invalidate the tax return.

The consolidated return and the initial return were thus considered valid and the fund was permitted to offset its losses from the year against future profits.

The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai-based law firm. The authors can be contacted at [email protected] Readers should not act on the basis of this information without seeking professional legal advice.