Section 56(2)(ix): Forfeiture of Advance Money Received – A Critical Analysis

The Dual Conditions for Taxability

Section 56(2)(ix) of the Income Tax Act imposes tax liability on sums received as advance or otherwise during negotiations for transfer of a capital asset, provided two essential conditions are concurrently satisfied: (i) the amount must be received in the course of negotiation for transfer of a capital asset, and (ii) such negotiation must not result in transfer, with the amount being forfeited. The legislature has consciously employed the conjunction 'and', making both conditions mandatory for the provision to apply.

The Karnataka High Court's Interpretation

In PCIT v. Ravi Shankar Shetty (Income Tax Appeal No. 225 of 2021, dated 08.07.2026), the Karnataka High Court delivered a significant ruling elucidating the scope and applicability of this provision.

Facts of the Case

The taxpayer was engaged in the business of identifying, procuring, and facilitating acquisition of lands for real estate projects. He received certain amounts from two concerns for procuring and acquiring lands required for their business projects. The assessee continued to treat these amounts as liabilities in his books of accounts.

Critical Findings by the Court

1. Nature of Receipt – Not a Capital Asset

The Court held that the amounts received were not in the nature of advances paid in the course of negotiations for transfer of any capital asset belonging to the taxpayer. Rather, they pertained to transactions involving stock-in-trade. Consequently, the first essential condition of Section 56(2)(ix) – receipt of advance in the course of transfer of a capital asset – remained unsatisfied.

2. Forfeiture – Mere Efflux of Time Insufficient

The Court further ruled that even if the amount was pending for a long period, its continued treatment as a liability by the taxpayer would not amount to forfeiture. Mere passage of time cannot constitute forfeiture unless there is material to demonstrate that the recipient has become absolutely entitled to retain the advance. The mere fact that eight years had elapsed and no claim for refund was made by the parties was insufficient to establish forfeiture, particularly when the advances continued to be shown as liabilities in the taxpayer's books.

Analysis of "Forfeiture"

Forfeiture requires a positive act or circumstance where the recipient becomes unconditionally entitled to the advance. The following factors are relevant:

• Treatment in books of accounts as liability

• Absence of any agreement or clause providing for forfeiture

• Lack of communication to the payer regarding forfeiture

• Continued acknowledgment of obligation to repay

Conclusion

The judgment clarifies that Section 56(2)(ix) cannot be invoked merely because advances have remained unrefunded for a considerable period. Both conditions – receipt in course of transfer of a capital asset and actual forfeiture – must be strictly established. Taxpayers can protect themselves by maintaining proper books of accounts and ensuring that advances are not automatically treated as income merely due to passage of time.