2018 (2) TMI 1090 - AT - Income Tax

Allowable busniss expenses u/s 37(1) - payment of damage for breach of contract - compensation/damages paid by TEDPL - Held that - In the absence of any suggestion of bad faith or fraud, the true principle is that the taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document, the liability to tax depends upon the meaning and content of the language used therein, and this must be determined in accordance with the ordinary rules of construction as held in CIT v. Motors General & Stores (P.) Ltd. (1967(5) TMI 3 - SUPREME Court). To recapitulate the ratio laid down in the above decisions, the payment of damage for breach of contract as in the instant case is an allowable expenditure u/s 37 of the Act. We hold so. The compensation of ₹ 20 crore arrived at by the arbitrator is not based on a calculation. During the course of hearing, the assessee files a written submission stating that had TET invested the amount in bank FDR, it would have earned interest @ 9.5%. As against this, the compensation paid @ 10.30% (interest amount is computed on advances of ₹ 49.23 crore on day to day basis till the date of refund in May 2012) was only marginally higher. As the award given by the arbitrator is bereft of calculation, we direct the AO to restrict the compensation/damages to 9.5% on ₹ 49.23 crore in place of 10.30% on day to day basis till the date of refund in May 2012. The assessee would file the details of before the AO. We hold that the compensation/damages paid by TEDPL is an allowable expense u/s 37 of the Act - Decided in favour of assessee.

Summary

Issues Involved:
1. Whether the compensation paid by the assessee to the Trust was excessive and an eyewash.
2. Whether the CIT(A) correctly applied the law pronounced in the case of Jamna Auto Industries vs. CIT.
3. Whether the CIT(A) erred by not questioning the arbitrator’s award given in a customary and irregular manner.

Issue-wise Detailed Analysis:

1. Compensation Paid by Assessee to Trust:
The assessee, TEDPL, engaged in real estate, paid ?20 crore as compensation to TET for the cancellation of a Memorandum of Understanding (MoU) for constructing a college. The AO disallowed this compensation, arguing it was an attempt to divert funds within the Thakur Group to evade taxes. The AO's grounds included the non-business nature of the compensation, its excessive amount, and the suspicion of an eyewash scheme. The CIT(A) overturned this, noting the compensation was justified due to TEDPL's failure to deliver the project owing to legal disputes and the significant profit TEDPL made from the land sale. The CIT(A) found the compensation reasonable, comparing it to bank FD interest rates.

2. Application of Law from Jamna Auto Industries Case:
The CIT(A) applied the principles from the Jamna Auto Industries case, where damages paid due to an arbitrator's decision for breach of contract were considered business expenses. The Tribunal upheld this application, noting that compensation for breach of contract is allowable under Section 37 of the Income Tax Act, as supported by precedents like Hans Machoo & Co., S.A. Builders Pvt. Ltd., and Murari Lal Ahuja & Sons.

3. Arbitrator’s Award and Its Validity:
The AO questioned the arbitrator’s award, claiming it lacked a sound basis and was part of a tax evasion scheme. The Tribunal noted that the arbitrator's award did not provide a detailed calculation for the ?20 crore compensation. However, the Tribunal directed the AO to recalculate the compensation based on a 9.5% interest rate on the ?49.23 crore advance, reflecting a more reasonable compensation rate. The Tribunal held that the compensation should be calculated on a day-to-day basis until the refund date in May 2012.

Conclusion:
The Tribunal concluded that the compensation paid by TEDPL to TET was an allowable business expense under Section 37 of the Act. However, it directed the AO to adjust the compensation calculation to a 9.5% interest rate on the advance amount, ensuring a fair and reasonable assessment. The appeal was partly allowed, with specific instructions for the AO to follow the Tribunal's observations and calculations.