2010 (7) TMI 11 - SC - Income Tax

Liquidated damages revenue receipt versus capital receipt capital employed for the purpose of section 80J delay in delivery of machinery - As per the agreement, in the event of delay caused in delivery of the machinery, the assessee was to be compensated at the rate of 0.5% of the price of the respective portion of the machinery for delay of each month by way of liquidated damages by the supplier, without proof of actual loss. - The supplier defaulted and failed to supply the plant and machinery on the scheduled time and, therefore, as per the terms of contract, the assessee received an amount of Rs.8,50,000/- from the supplier by way of liquidated damages. AO and CIT(A) included Rs. 8,50,000 in the total income as revenue receipt According to the Tribunal, the payment of liquidated damages to the assessee 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 assessee. 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 HC confirmed the view of the ITAT Held that The afore-stated amount received by the assessee 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 assessee. 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 assessee from the suppliers of the plant was in the nature of a capital receipt.

Summary

Issues:
1. Whether the amount received by the assessee as damages was taxable as a revenue receipt?
2. Whether the damages received by the assessee were to be treated as a capital receipt for tax purposes?
3. Whether the addition made to the machinery during the year determined the capital employed for the claim under Section 80J of the Income Tax Act, 1961?

Analysis:
1. The Supreme Court heard an appeal against the High Court's judgment regarding the taxability of damages received by the assessee. The assessee, engaged in cement manufacturing, entered an agreement for a cement plant purchase. The supplier failed to deliver on time, resulting in the assessee receiving damages of Rs. 8,50,000. The Revenue contended the damages were a revenue receipt due to lost profits. However, the Court held that the damages were directly linked to the delayed procurement of a capital asset, making it a capital receipt. The Court referred to the agreement's clause specifying damages without proof of actual loss, emphasizing the link to the capital asset and delay in profit generation.

2. The Court relied on previous decisions to establish a principle distinguishing between capital and revenue receipts. It stated that if compensation for contract cancellation affects the trading structure, it is a capital receipt. In this case, the damages compensated for the delayed procurement of a capital asset, affecting the profit-making apparatus' timely establishment. The damages were deemed to sterilize the capital asset, making it a capital receipt for the assessee. The Court upheld the High Court's decision that the damages were capital in nature, dismissing the appeal.

3. The Court concluded that the damages received by the assessee were not taxable as revenue but were considered a capital receipt due to their direct link to the delayed procurement of a capital asset. The decision highlighted the importance of examining the specific circumstances of each case to determine the nature of receipts for tax purposes. The judgment provided clarity on distinguishing between capital and revenue receipts, emphasizing the impact on the trading structure and income source.