Taxability of compensation received on delayed possession

1. Facts of the case

1.1 Mr. A, an individual, booked premises in a mall, while under construction.

The premises were not purchased for business purposes.

1.2 As per the agreement between the builder and Mr. A, the possession of the
premises in the mall was to be provided by a particular date.

1.3 The builder did not give possession of the premises in the mall within the
date specified in the agreement. To compensate for the delay, the builder
paid Mr. A Rs 30 lakhs as damages.

1.4 The builder did not withhold taxes at source while making the payment to
Mr. A.

1.5 Currently, the builder has given possession of the premises and Mr. A has
given the premises on rent.

2. Query

Taxability of the compensation paid to Mr. A by the builder on account of

delayed possession under the provisions of the Indian Income-tax Act, 1961
(‘Act’)

3. Our comments

3.1 As per the provisions of the Act, revenue receipts are taxable and capital
receipts are not taxable.

3.2 Accordingly, at the outset, it would be pertinent to determine the nature of

the compensation ie whether revenue or capital receipt.

3.3 Contrary views have been expressed by various judicial precedents on

taxability of compensation and hence is a debatable issue.

3.4 Reliance has been placed on the following case laws:

3.4.1CIT vs M/s Saurashtra Cement Limited 2010-TIOL-49-SC-IT Supreme Court

(Full text of the judgement reproduced in Annexure 1)

Facts of the case

⇒ The Taxpayer, engaged in the manufacture of cement etc, entered into an

agreement with a supplier for purchase of additional cement plant. The
agreement contained a condition that in case of delay in delivery of the plant,
the supplier would be required to pay liquidated damages.

⇒ The supplier defaulted and failed to supply the plant on the scheduled time and,
therefore, as per the terms of contract, the Taxpayer received an amount of
Rs.8,50,000 from the supplier by way of liquidated damages.

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 Taxability of compensation received on delayed possession

⇒ The Taxpayer claimed the above as a capital receipt and did not offer the above
to tax.

⇒ During the course of assessment proceedings, the Assessing Officer negatived

the claim of the Taxpayer that the said amount should be treated as a revenue
receipt and included the said amount in the total income of the Taxpayer.

⇒ Aggrieved, the Taxpayer filed an appeal before the CIT (A), but without any
success. The Taxpayer carried the matter further in appeal to the Tribunal.
Relying on the ratio of the decisions of this Court in Commissioner of Income Tax,
Nagpur Vs. Rai Bahadur Jairam Valji and Others (1959) 35 ITR 148 (SC) and
Kettlewell Bullen and Co. Ltd. Vs. Commissioner of Income-Tax, Calcutta AIR
1965 SC 65, the Tribunal came to the conclusion that the said amount could not
be treated as a revenue receipt.

⇒ According to the Tribunal, the payment of liquidated damages to the Taxpayer

by the supplier was intimately linked with the supply of machinery i.e. a fixed
asset on capital account, which could be said to be connected with the source of
income or profit making apparatus rather than a receipt in course of profit
earning process and, therefore, it could not be treated as part of receipt relating
to a normal business activity of the Taxpayer. The Tribunal also observed that
the said receipt had no connection with loss or profit because the very source of
income viz., the machinery was yet to be installed. Accordingly, the Tribunal
allowed the appeal and deleted the addition made on this account.

⇒ Being dissatisfied with the decision of the Tribunal, the Revenue preferred an
appeal before the High Court, which was answered in favour of the Taxpayer.

⇒ The Revenue then preferred an appeal before the Supreme Court.

Issue before the Supreme Court

⇒ Whether the liquidated damages of Rs 8,50,000 received by the Taxpayer from

the supplier of the plant on account of delay in the supply of plant is a capital or
a revenue receipt?

Observation and Ruling of the Supreme Court

⇒ The question whether a particular receipt is capital or revenue has frequently

engaged the attention of the Courts but it has not been possible to lay down any
single criterion as decisive in the determination of the question. Time and again,
it has been reiterated that answer to the question must ultimately depend on the
facts of a particular case, and the authorities bearing on the question are
valuable only as indicating the matters that have to be taken into account in
reaching a conclusion.

⇒ The Supreme Court discussed the rulings in the cases of Rai Bahadur Jairam Valji
and Kettlewell Bullen and Co. Ltd.

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 Taxability of compensation received on delayed possession

⇒ It is evident that the damages to the Taxpayer was directly and intimately linked
with the procurement of a capital asset i.e. the cement plant, which would
obviously lead to delay in coming into existence of the profit making apparatus,
rather than a receipt in the course of profit earning process.

⇒ Compensation paid for the delay in procurement of capital asset amounted to

sterilization of the capital asset of the Taxpayer as supplier had failed to supply
the plant within time as stipulated in the agreement.

⇒ The afore- stated amount received by the Taxpayer towards compensation for
sterilization of the profit earning source, not in the ordinary course of their
business, in our opinion, was a capital receipt in the hands of the Taxpayer.

⇒ We are, therefore, in agreement with the opinion recorded by the High Court and
hold that the amount of Rs.8,50,000/- received by the Taxpayer from the
suppliers of the plant was in the nature of a capital receipt .

3.4.2Income-tax Officer vs Shri Ram Lal Arora 2007-TIOL-183-ITAT-DEL Delhi

Tribunal (Full text of the judgement reproduced in Annexure 2)

Facts of the case

⇒ The Taxpayer received a payment from the Haryana Urban Development

Authority (HUDA) following the HUDA's failure to give possession of plot despite
payment of its cost by the Taxpayer, which made the Taxpayer to move
consumer forum.

⇒ The Taxpayer treated this amount as a capital receipt and did not offer the same
to tax.

⇒ The Assessing Officer treated the above amount received by the Taxpayer from
HUDA as a revenue receipt.

⇒ Being aggrieved, the Taxpayer preferred an appeal before the CIT(A) decided the
matter in favour of the Taxpayer by treating the above amount as a capital
receipt and not liable to tax.

⇒ The Revenue preferred an appeal before the Tribunal.

Issue before the Tribunal

⇒ Whether the payment received by the Taxpayer from HUDA is a capital receipt or
a revenue receipt?

Observation and Ruling of the Tribunal

⇒ The Tribunal relied on the case of the Delhi Development Authority vs. ITO 53
ITD 19 whereby the interest granted to the assessee for delayed construction of
flat by DDA was held to be compensation and not interest. Consequently, it was
held to be a capital receipt. In this case, interest was granted for delayed

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 Taxability of compensation received on delayed possession

construction whereas in the present case it is granted for delayed possession.

Thus, these is no material difference in the facts of the two cases.

⇒ It may be mentioned that in the said order the Tribunal has held that the
decision in the case reported in 33 ITR 245, 87 ITR 22, 165 ITR 231 (SC) and 81
ITR 440 (SC) are distinguished. We, therefore, respectfully following the order in
the case of Delhi Development Authority (supra) uphold the order passed by the
CIT(A).

4. Conclusion

The following should be noted:

The premises were purchased as a capital asset of Mr. A.

The transaction was not in the ordinary course of business.

The builder has not withheld taxes at source on such payment (in case
appropriate taxes are not withheld by the builder, the builder would not get
a deduction of those expenses).

In view of the above and the various rulings on this subject, it could be
concluded that since the compensation received by Mr. A is in relation to
purchase of capital asset and not in the ordinary course of business, it
should be treated as a capital receipt, not liable to tax.

In Favour Of : Others
SHYAM TELELINK LTD Vs INCOME TAX OFFICER
Date of decision - 30 December 2005
Compensation received for failure to honour contractual obligations is capital receipt...

In Favour Of : Others
THE INCOME-TAX OFFICER Vs GOVINDBHAI MAMAIYA
Date of decision - 22 December 2005
Acquisition of land by the State - Compensation paid - Plea for more compensation -
Compensation awarded along with interest - Such interest income is revenue in nature and the
total income is capital receipt in nature and the same to be taxed as capital gains as per
provisions of sec.45(5)(b)...

In Favour Of : Assessee
PAYAL KAPUR Vs ACIT
Date of decision - 18 November 2005
Compensation received for breach of rights or waiver of rights is capital receipt...

In Favour Of : Others

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Taxability of compensation received on delayed possession

ACIT, NEW DELHI Vs MADAN MOHAN LAL SHRIRAM PVT LTD

Date of decision - 12 December 2004
When no transfer of property took place it is not liable to capital gains tax...

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