2009 (10) TMI 637 - AT - Income Tax

Taxability of receipt - compensation/damages received by way of appropriation of liability - capital receipt or revenue receipt - Whether the amount received from Saumya Construction (P.) Ltd. on account of development rights is business income u/s 28(va) or the same is assessable u/s 41 (1) or a non-taxable capital receipt - assessee has received an amount from Saumya Construction (P.) Ltd. and shown the same as liability in balance-sheet for assessment year 1997-98. The assessee has not shown the same as trading liability and nor claimed any deduction or expense in that assessment year. During the relevant assessment year 2005-06, the liability standing in assessee s books was written off towards the compensation/damages for relinquishment of right to sue in the court of law and the liability was credited as capital receipt in the assessee s capital account - AO has treated it taxable and has added it back in the assessment order, treating it as a revenue receipt - HELD THAT - A liability created for purchase of stock-in-trade on credit is certainly a trading liability. Where A purchases his stock-in-trade from B on credit, the liability of A to B is a trading liability. But if A borrows money from C in order to pay off his liability to B, A s liability to C on such borrowing is not a trading liability. It is thus clear that section 41(1) cannot be invoked if C remits a part or whole of his loan to A. Where the assessee had not claimed nor obtained a deduction in respect of a security deposit treating it as a trading liability, section 41(1) cannot be invoked when such security deposit is refunded to the assessee. In the present case, none of the above probabilities existed and this is a case of amount received from assessee-firm shown as a liability in the shape of cash credit in assessment year 1997-98. The assessee has not claimed the same as deduction or expenses in any of the years till date. The assessee has written off the same as compensation/damages for relinquishment of right to sue in court of law and credited the same in the capital account as capital receipt. In view of the above, we are of the considered view that the provisions of section 41(1) or section 68 of the Act will not apply to the writing off this liability in the capital account and the liability has not been credited in the profit and loss account but the same has been taken as capital basis in the capital account in the books of account of the assessee. We find that, exactly on similar facts, the Hon ble jurisdictional High Court in the case of Baroda Cement Chemicals Ltd. 1985 (12) TMI 55 - GUJARAT HIGH COURT has stated that the compensation received by the assessee was not for consideration for the transfer of capital assets, however, the damages are in capital in nature. The provisions of section 28( va ) provides that any sum whether received or receivable in cash or kind under an agreement for not carrying out any activity in relation to any business or not to share any know-how, patent, copyright, trademark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services, shall be chargeable to income-tax under the head Profits and gains of business or professions . In view of the above facts and discussions, the compensation received in lieu of foregoing a right to sue does not fall under provisions of section 28(va). We further find from the facts of the case that the assessee has not received this amount under an agreement for not carrying out activity in relation to any business or not to share any know-how, patent, copyright, trademark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services, under the head Profit gains of business or profession . This provision is for taxing the receipt by the assessee in the nature of non-compete fee and exclusivity rights and not the receipt as received by the assessee. The receipt received by the assessee has written off the same as compensation/damages for relinquishment of right to sue in court of law and credited the same in the capital account as capital receipt. Accordingly, we are of the considered view that this provision of section 28(va) will not apply to the facts of the present case. Accordingly, this appeal of the assessee is allowed. In the result, assessee s appeal is allowed.

Issues Involved:
1. Whether the amount received from Saumya Construction (P.) Ltd. on account of development rights is business income under section 28(va) of the Act.
2. Whether the amount is assessable under section 41(1) of the Act.
3. Whether the amount is a non-taxable capital receipt.

Issue-wise Detailed Analysis:

1. Business Income under Section 28(va):

The primary issue was whether the amount of Rs. 2.93 crores received by the assessee from Saumya Construction (P.) Ltd. should be treated as business income under section 28(va) of the Income-tax Act, 1961. The assessee argued that the amount was received as compensation for relinquishing the right to sue and not for any business activity. The CIT(A) and the Assessing Officer treated the amount as business income, asserting that it was received for not attempting to acquire development rights through litigation, thus falling under section 28(va).

However, the Tribunal found that the amount was received as compensation for not enforcing a right to sue, which is not considered a business activity under section 28(va). The Tribunal held that section 28(va) is applicable to sums received for not carrying out any business activity or not sharing any know-how, patent, trademark, etc., which was not the case here. The Tribunal concluded that the compensation received for relinquishing the right to sue does not fall under the purview of section 28(va).

2. Assessability under Section 41(1):

The Assessing Officer initially considered the amount under section 41(1), which deals with the remission or cessation of trading liabilities. The CIT(A) and the Tribunal both concluded that section 41(1) was not applicable as the liability was never claimed as a deduction or expense in any earlier year. The Tribunal emphasized that section 41(1) applies to trading liabilities that have been allowed as deductions in previous years, which was not the case here. Therefore, the amount could not be taxed under section 41(1).

3. Non-taxable Capital Receipt:

The assessee contended that the amount was a non-taxable capital receipt, being compensation for relinquishing the right to sue, which is not considered a property under section 6(e) of the Transfer of Property Act. The Tribunal agreed with this view, citing the jurisdictional High Court's decision in Baroda Cement & Chemicals Ltd., which held that compensation received for relinquishing the right to sue is capital in nature and not taxable as income. The Tribunal found that the amount was correctly credited to the capital account and was not subject to tax.

Conclusion:

The Tribunal concluded that the amount of Rs. 2.93 crores received by the assessee from Saumya Construction (P.) Ltd. was not taxable under section 28(va) as business income, nor under section 41(1) as cessation of liability. The amount was a non-taxable capital receipt, being compensation for relinquishing the right to sue. The appeal of the assessee was allowed.

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