2016 (4) TMI 1183 - HC - Income Tax

Payment of liquidated damages - whether the amount was payment of dividend and not allowable/deductible expenditure in the hands of the appellant-company? - Held that - The fact that the payment took the character of liquidated damages, does not obliterate the fact that the liability to pay was on account of dividend. Failure on the part of the assessee to pay dividend was a breach of the contract which entitled the UTI Bank to recover damages. Therefore when the assessee paid the damages the assessee was really discharging its liability to pay dividend under the contract. We are, as such, convinced that the payment was, in fact, a payment of the agreed dividend and therefore, the Tribunal, the Commissioner of Income-tax (Appeals) and the Assessing Officer took a correct view in the matter. - Decided in favour of revenue

Issues Involved:
1. Whether the payment of liquidated damages of ?50,71,328 by the appellant company to UTI Bank Ltd. was a payment of dividend and not an allowable/deductible expenditure under the Income-tax Act, 1961.

Issue-Wise Detailed Analysis:

1. Nature of Payment: Liquidated Damages vs. Dividend
The primary issue revolves around whether the payment of ?50,71,328 by the appellant company to UTI Bank Ltd. should be classified as liquidated damages or dividend. The appellant company argued that the payment was made as liquidated damages due to the early redemption of preference shares and should be deductible as a business expense. However, the Assessing Officer, Commissioner of Income-tax (Appeals), and the Tribunal consistently held that the payment was in lieu of dividend and thus not deductible under the Income-tax Act, 1961.

2. Contractual Agreement and Obligations
The contract between the appellant company and UTI Bank Ltd. stipulated that the preference shares would carry a 12% dividend per annum. In case of failure to declare the dividend, the company agreed to compensate the investor to ensure a post-tax return of 12%. The agreement explicitly mentioned that any failure to pay the dividend would result in liquidated damages to maintain the agreed return rate. This specific stipulation in the contract formed the basis for the authorities to classify the payment as dividend.

3. Legal Interpretation and Precedents
The Tribunal and lower authorities relied on the principle that the payment of dividend is not an allowable expenditure. They reasoned that any payment made in lieu of dividend retains the character of dividend. The Tribunal cited the debit note issued by UTI Bank, which confirmed that the payment was to extinguish the liability related to the preference shares. This interpretation was supported by the legal precedent set in Robinson v. Harman, which states that damages for breach of contract should place the injured party in the same situation as if the contract had been performed.

4. Argument of the Appellant
The appellant argued that since the preference shares were redeemed before the payment, UTI Bank was no longer a shareholder at the time of payment. Therefore, the payment should not be considered a dividend. They also cited Ramaiya on the Companies Act to support their claim that the right to dividend does not continue after redemption unless specifically stipulated. However, the court found that the payment was made based on a specific stipulation in the contract, which required compensation for failure to declare dividends.

5. Court's Conclusion
The court concluded that the payment of ?50,71,328 was indeed a discharge of the liability to pay the agreed dividend under the contract. The characterization of the payment as liquidated damages did not change its nature as a dividend. Therefore, the Tribunal, Commissioner of Income-tax (Appeals), and the Assessing Officer were correct in their view that the payment was not an allowable expenditure under the Income-tax Act, 1961.

Judgment:
The question formulated was answered in the negative and in favor of the Revenue. The appeal was dismissed, upholding the decisions of the lower authorities that the payment was a dividend and not a deductible business expense.

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