Sale Consideration Deposited In Escrow Account – Event Of Taxability

Acuity Law


Acuity Law
Corporate transactions and their related intricacies have always been a subject of frequent discussions in the corporate world.
India Tax
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Corporate transactions and their related intricacies have always been a subject of frequent discussions in the corporate world. With changing commercials globally, there is an innovation in the commercial terms being agreed between the parties. With growing regulatory concerns and rise in tax claims with no certainty, a need arises to protect the interest of the buyer against any unwarranted claims which may arise on the business/ shares acquired due to past transactions.

To meet future contingencies, it's a common practice for the parties to generally agree depositing a certain portion of the consideration into an Escrow Account, which will be released only if the claims are satisfied or the limitation period for raising the claims has expired. Another very common practice is deferred consideration, wherein the consideration is paid in tranches, which is sometimes based on the happening of certain events and there could be an upward or a downward revision as well to the consideration. Though these arrangements certainly are to protect the interest of the buyer, however, these arrangements may raise certain adverse income-tax consequences for the seller. It would be interesting to discuss the law applicable to these arrangements as well as the judicial interpretations.

Relevant provisions

A transferor is liable to income tax on any gains earned on transfer of business or securities. Section 45 of the Income-tax Act, 1961 (IT Act) is the charging provision to tax capital gains arising from transfer of a capital asset. As per section 45, any profits or gains arising from the transfer of a capital asset shall be chargeable to income-tax, under the head “Capital gains” and shall be deemed to be the income of the previous year in which the transfer took place. Thus, the year in which the transfer takes place is the year in which taxability will arise.

Principle of “Accrual”

Taxation under the head “capital gains” is based on the primary principle of “accrual”, if the income has accrued i.e., when the right to receive the income has vested onto the taxpayer, income-tax implications will arise, irrespective of whether the consideration has been received in full or not. In this regard, the Hon'ble Supreme Court in E.D. Sassoon & Co. Ltd. v. CIT1, had held that “[i]t is clear, therefore, that income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody”.  Thus, till the time the taxpayer has no right to receive the income, no taxability should arise. Considering the same, if the amount is kept in an escrow account and will be released only on satisfaction of certain contingent events, whether this amount can be said to accrue to the taxpayer on the date of transfer? Based on the above reasoning, the amount in an escrow account will accrue only if the taxpayer has a right to receive this amount, and if the right to receive the amount is contingent, then technically income should not be said to have accrued.

Recent Ruling

Taxability of the amount kept in escrow or deferred consideration has always been the subject matter of extended debate, wherein the Indian courts have pronounced rulings on the principles of accrual and on the specific facts and circumstances2. Recently, the Income-tax Appellate Tribunal (Tribunal), Delhi in Modi Rubber Ltd vs DCIT3 dealt with this issue.

In this case, part of the sale consideration was set aside in an escrow account, which will be released after adjusting against any potential claims. The taxpayer in its return of income had offered to tax capital gains by considering the entire sale consideration. However, during the assessment proceeding, taxpayer had made a downward adjustment to the sale consideration on the basis that the amount kept aside in the escrow account will not be received by the taxpayer (as the claims raised by the buyer exceeded the amount in escrow). This claim of the taxpayer was not accepted by the Tax Officer and the Appellate Authority on the grounds that the total amount of sale consideration has accrued, and taxability is not dependent on whether the consideration has been received or not.

The taxpayer in its appeal before the Tribunal contended that since the amount kept aside in the escrow account was to meet contingent liabilities, it never formed part of the full value of consideration for any taxability to arise. The liability to tax on the amount lying in escrow account would arise only in the year of receipt based on happening of events in future. After analyzing conflicting rulings4, the Tribunal ruled in favor of the taxpayer and held that “[i]n accord with the view expressed in Dinesh Vazirani case, the taxability of amount retained in escrow account which is neither received nor likely to be received is contrary to position of law enunciated in s. 45 and s. 48 of the Act. While the amount retained in escrow forms part of agreed consideration, such amount do not necessarily form part of ‘full value of consideration received or accruing' as result of transfer of capital asset as emanating from the facts of the case”.

Open issues


It would be interesting to note that though the Tribunal ruled in favor of the taxpayer, the timing of taxability of the contingent amount has not been evaluated. Technically, consideration which is subject to contingency does not give rise to any right to receive any amount, hence the amount has not accrued and is not taxable. This issue was dealt by the Hon'ble Bombay High Court in CIT vs. Hemal Raju Shete5,wherein the taxpayer had offered to tax only the initial consideration and not the consideration which was contingent. On these facts, the Hon'ble Bombay High Court ruled in favor of the taxpayer and held that “[t]his amount which could be received as deferred consideration is dependent/contingent upon certain uncertain events, therefore, it cannot be said to have accrued to the respondent-assessee”. Thus, the amount is taxable only upon fulfilment of such contingent events and not prior to that.

Under-value transactions:

On account of contingent events, if part consideration is payable upon transfer, which is less than fair market value (FMV), will that lead to applicability of section 50CA of the IT Act on the seller? As per section 50CA, FMV is taken as the full value of consideration for computation of capital gains, if the actual consideration is less than FMV. If the part consideration is less than FMV, which is treated as the entire sale consideration, it may lead to an impact under section 50CA on the seller. The question which arises is the tax impact when the escrow amount is released to the seller. At that point, will the seller be entitled to claim that taxes are required to be paid only on the balance consideration after taking FMV into account and not on the entire escrow amount?

Similarly, can section 56(2)(x) apply to the buyer, as the consideration paid is less than FMV? Technically in transactions with such stipulations, a buyer has paid the entire consideration, be it to the seller or into the escrow account and thus, section 56(2)(x) ideally should not be applicable.

Cost of acquisition – proportionate or not:

If only part consideration has accrued to the seller, then should only a proportionate cost of acquisition be reduced from such consideration? What will happen if no amount is released from the escrow account, will an amendment be allowed to the computation of capital gains in the future? Certainly, if section 50CA is being applied for computing capital gains, then the issue of proportionate cost should not arise at all, as FMV is considered as full value of consideration.

Withholding tax

On account of contingencies, if the entire consideration is not taxable, as it has not accrued, an issue which could arise for the buyer is on what amount the taxes should be withheld. If the taxes are not withheld on the entire amount and the tax department holds against the buyer, then the buyer may be subject to interest and penalty. On the other hand, if taxes are deducted on the entire amount and the seller intends to offer to tax only the initial consideration, then claiming credit of the taxes deducted can be an issue for the seller.


The rulings in the case of Dinesh Vazirani and Modi Rubber certainly are beneficial to the taxpayers, specifically, when similar facts arise for consideration. However, the entire escrow or deferred consideration arrangement, which are payable on contingent events raises various other unresolved issues, which need to be addressed to ensure that unambiguous and transparent tax positions is adopted by the taxpayers.


1. (1954) 26 ITR 0027 (SC)

2. In CIT vs. Hemal Raju Shete (239 Taxman 176), the Hon'ble High Court of Bombay had ruled in favor of the Taxpayer, whereas in Ajay Guliya vs ACIT ([TS-520-HC-2012(DEL)-O]), the Hon'ble High Court of Delhi has ruled against the Taxpayer.

3. I.T.A. No.6866/DEL/2018

4. Carborundum Universal Ltd. Vs. ACIT (130 133(Mad) and Dinesh Vazirani vs. PrCIT in 445 ITR 110 (Bom)

5. (239 Taxman 176)

This Article was published by Taxsutra on 18-04-2024.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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