Bhojison Infrastructure Pvt. Ltd vs. ITO (ITAT Ahmedabad)
October, 10th 2018
S. 2(14)/ 28(va): The "right to sue" which arises on breach of a development agreement is a "personal right" and not a "capital asset" which can be transferred. Consequently, the damages received for relinquishment of the "right to sue" is a non-taxable capital receipt (all judgements considered)
The captioned appeal has been f iled at the instance of the assessee against the order of the CIT(A) -1, Ahmedabad (‘CIT(A)’ in short ), dated 26.07.2016 arising in the assessment order dated 11.03.2015 passed by the Assessing Of f icer (AO) under s. 143(3) r.w.s. 147 of the Income Tax Act , 1961 (the Act ) concerning assessment year 2008-09.
2. The grounds of appeal raised by the assessee reads as under :-
“ I. Addition on account of Long term capital gain treating as wrong claim – Rs.1,51,988/-.
“1. The Ld. CIT(A) has erred both in law and on facts in confirming the addition of Rs.1,51,988/- as made by the Ld. A.O. on account of long term capital gain treating as wrong claim. The Ld. CIT (A) has failed to properly consider the written submission filed by the appellant.
II. Addition on account of exempt income claimed treating the same as business income- Rs. 2,47,03,600/-
I. The Ld. CIT (A) has erred in law and on facts in confirming the addition of Rs. 2,47,03,500/- as made by the Ld. A.O while treating the exempt income as income from. business and profession.
2. The Ld. CIT (A) has erred in law and on facts in failing to properly consider appellant company’s detailed written submission and various judicial pronouncements relied upon by the appellant company.
3. That the Ld. CIT (A) has failed to consider the fact that as per the decision of the Hon’ble Jurisdictional Gujarat High Court in the case of Baroda Cement & Chemicals Ltd vs CIT (1986) 53 CTR 260 (Guj) and other judicial pronouncements, “Right to sue” as per the provisions of section 6(e) of the Transfer of Property Act, is not a property and therefore it is not a "Capital Asset" and as a consequence, impugned receipt of Rs. 2,47,03,600/- received as compensation / damages for relinquishment of right to sue in the Courts of law would only be a capital receipt in the hands of the appellant company not subject to tax.”
3. Ground No.1 relates to addi tion of Rs.1,51,988/ – by denying the indexat ion on cost of acquisi tion while computing the long term capital gains.
4. Addressing the issue, the learned AR for the assessee submit ted that the l imited controversy on the issue pertains to denial of indexat ion benef its on the cost of acquisi tion of land under sale giving rise of the long term capital gains. The learned AR pointed out that notwi thstanding the fact that documents in respect of land acquired 7- 8 years back could not be produced, the land was duly ref lected in the balance sheet for last many years. It was thereaf ter contended that the AO has duly accepted the long term capi tal gain on sale of such land parcels. This being so the cost of acquisition of Rs.4,19,533/- requi res to be accepted as sacrosanct . The AO has granted long term capital gain based on the aforesaid amount of cost of acquisit ion but however has denied indexation benef it which is inexpl icable. Per contra, the learned DR relied upon the order of the AO & CIT(A).
5. A simple perusal of the orders of the author it ies below suggest that the cost of acquisit ion of Rs.4,19,533/- has been admitted and the long term capital gain have also been accepted. Therefore, the benef it of statutory indexation cost to of fset the ef fect of inf lat ion cannot be denied. Once, the cost of acquisi tion is determined and the land under sale was found to be a long term capital asset , indexat ion of cost of acquisi tion becomes automatic as per the statutory provisions of the Act . Therefore, we do not f ind any rationale for denial of indexat ion benef its. Therefore, the aforesaid addition of Rs.1,51,988/- arising on account of such denial requi res to be reversed. The AO is di rected to delete the addit ion on this score.
6. In the resul t, Ground No.1 of the assessee’s appeal is allowed.
7. Ground No.2 concerns treatment of capital receipt claim as revenue income by the AO.
8. The learned AR for the assessee in this regard pointed out that the assessee entered into a development agreement dated 30.03.2007 by virtue of which a right in the property/ land was created in favour of the assessee by the owner of the land, Shr i Sureshbhai M. Patel. The learned AR submi tted that despite development agreement entered into by the landlord, it has decided to sale the said land to other parties instead of cont inuing with development proposal of the said land as per the terms and condi tions of the development agreement. Thus, quoted f rom the decision of Hon’ble Gujarat High Court in Baroda Cement & Chemicals Ltd. vs. CIT 158 ITR 636 (Guj) the only recourse available to the assessee company was to f ile a suit in the Courts of law for specif ic performance of preempt ive right to purchase the land as per the development agreement.
Such right to f ile a suit in the Cour ts of law for specif ic performance of preempt ive right to purchase the land as per development agreement is nothing but a ‘r ight to sue’ and as per the provisions of Section 6(e) of the Transfer of the Property Act , ‘right to sue’ is not capable of being t ransferred. The learned AR pointed out that af ter the breach of development agreement , the only right survives for the assessee was r ight to sue the vendor.
The learned AR canvassed that such ‘r ight to sue’ for damages is not an actionable claim and is not transferrable on account of embargo cast upon by Sect ion 6(e) of the Transfer of Property Act. It was further contended that ‘ right to sue’ also does not have any cost of acquisition.
The learned AR professed that there is no property in such ‘r ight to sue’ as discussed in wide ranging decisions rendered by the Cour ts and Tribunals. Such ‘r ight to sue’ does not fall wi thin the sweep of def ini tion of ‘capi tal asset’ under s. 2(14) of the Act . This apart , the ‘r ight to sue’ is a personal right and is not susceptible to ‘transfer’ for i ts taxabil ity. Consequently, the damages received f rom the potential purchaser for such relinquishment of ‘ right to sue’ in the Courts of law for breach of development agreement is clear ly a nontaxable capi tal receipt .
8.1 The learned AR submitted that the issue is no longer res integra and is squarely covered in favour of the assessee by following the decisions including the decision of the Hon’ble Jur isdictional High Court :
8.2 The learned AR accordingly submit ted that the consideration received in l ieu of ‘right to sue’ is a capital receipt which is not taxable at al l since there is no property involved in it for it to be regarded as capital asset u/s. 2(14) of the Act . The learned AR also quipped that assets connected to business can also be regarded as capital asset under s.2(14) of the Act provided such asset is in the nature of property. The ‘r ight to sue’ not being in the nature of property is not chargeable to tax being a capital receipt .
8.3 The learned AR next submi tted that Sect ion 28(va) was inserted to include certain sum receivable in the nature of forgoing r ight in cer tain intangible proper ties as business income. However the present case also does not fall under s. 28(va) of the Act as receipt is not in the nature of activit ies specif ied therein. Elaborat ing further , the learned AR contended that the compensat ion amount received is in respect of relinquishment of assessee’s ‘right to sue’ in a Court of law which r ight cannot be regarded as revenue receipt taxable as business income under s.28(va) of the Act. The provisions of Section 28(va) of the Act are very clear that the compensation received in lieu of ‘ right to sue’ does not fall under these provisions. The learned AR accordingly submi tted that the action of the AO and CIT(A) is opposed to be legal pr inciples delineated in the judicial precedents and thus requi res to be set aside and relief as requested in the grounds of appeal be allowed.
9. The learned DR on the other hand rel ied upon the orders of the AO & CIT(A).
10. We have careful ly considered the rival submissions and perused the orders of the author it ies below as well as the material referred to in terms of Rule 18(6) of the ITAT Rules, 1963 and also the case laws cited. The substant ive question that ar ises for consideration is whether damages received by the assessee for breach of development agreement are capi tal in nature or otherwise chargeable to tax. It is the case of the assessee that the compensation/damages received by the assessee f rom the purchaser on transfer of land under development agreement is capital in nature.
It is the case of the assessee that the only r ight that accrues to the assessee who complains of the breach is right to f ile a sui t for recovery of damages f rom the defaul ting par ty. The breach of cont ract does not give rise to any debt and therefore a right to recover damages is not assignable because i t is not a chose-inact ion. For actionable claim to be assigned, there must be a debt in the sense of an existing obl igation to consider it to be an act ionable claim. I t is the case of assessee that the assessee had a mere ‘ right to sue’ which is neither a capi tal asset wi thin the meaning of Section 2(14) of the Act nor is capable to being t ransfer red and therefore not chargeable under s.45 of the Act.
10.1 The essence of long list of judicial pronouncements cited on behalf of assessee is that Section 6 of the Transfer of Property Act which uses the same expression ‘property of any kind’ in the context of transferabil ity makes an except ion in the case of a mere right to sue. The decisions thereunder make i t abundant ly clear that the ‘r ight to sue’ for damages is not an actionable claim. I t cannot be assigned. Transfer of such a right is opposed to publ ic policy as it tantamounts to gambling in li t igation. Hence, such a ‘r ight to sue’ does not const itute a ‘capital asset ’ which in turn has to be ‘an interest in property of any kind’ .
Despite the def init ion of expression ‘capi tal asset ’ in the widest possible terms in Section 2(14) of the Act , a r ight to a capi tal asset must fall wi th the expression ‘property of any kind’ subject to cer tain exclusions. Notwi thstanding widest impor t assigned to the term ‘proper ty’ which signif ies every possible interest which a person can hold and enjoy, the ‘ right to sue’ is a r ight in personam and such r ight cannot certainly be t ransfer red. In order to att ract the charge of tax on capital gains, the sin qua non is that the receipt must have originated in a ‘t ransfer ’ within the meaning of Section 45 r .w.s. 2(47) of the Act .
In the absence of i ts transferabil ity, the compensat ion/damages received by assessee is not assessable as capital gains.
10.2 The co-ordinate bench of ITAT, Ahmedabad in the case of Deputy CIT(A) vs. Shekhar G. Patel ITA No.1997/Ahd/2010 order dated 19.03.2014 rel ied upon on behalf of the assessee has made reference to host of judicial pronouncements including the decision of the Hon’ble Gujarat High Court in the case of Baroda Cement and Chemicals Ltd. (supra) and concluded the issue in faovur of assessee.
The Co-ordinate bench highlighted the relevant part of the decision of the Hon’ble Gujarat High Cour t which is reproduced hereunder :
"18. The assessee had undoubtedly a right to sue M/s K.C.P. Ltd. for damages for breach of contract . Instead of l i t igat ing in a Court of law, the part ies arrived at a set t lement whereunder compensat ion in the sum of Rs.1,40,000 came to be paid in ful l and f inal sat isfact ion to the assessee. Counsel for the Revenue contends that the compromise/arrangement resul ted in ext inguishment of the assessee’s right to sue for damages wi thin the meaning of s. 2(47) of the Act .
Whi le accept ing this content ion the Tribunal has placed rel iance on the decision of this Court in CIT vs. R.M. Amin (1971) 82 ITR 194 (Guj ). In that case this Court observed that the use of the word ‘ include’ in the def ini t ion of the word ‘ transfer’ in s. 2(47) was intended to enlarge the meaning of ‘ transfer’ beyond i ts natural import so as to include ext inguishment /rel inquishment of rights in the capi tal asset for the purpose of s. 45 of the Act . Since the transfer contemplated by s. 45 is one as a resul t whereof considerat ion has passed to the assessee or has accrued to him, ext inguishment of the right must relate to that ‘capi tal asset ‘ , corporeal or incorporeal .
It is, therefore obvious that a transfer of a capi tal asset in order to at tract l iabi l i ty to tax under the head ‘Capi tal gains’ must be a ‘ transfer’ as a resul t whereof some considerat ion is received by or accrues to the assessee. If the transfer does not yield any considerat ion, the computat ion of prof i ts or gains as provided by s. 48 of the Act would not be possible. If the transfer takes ef fect on ext inguishment of a right in the capi tal asset , there must be receipt of considerat ion for such ext inguishment to at tract l iabi l i ty to tax. Now, in legal parlance, the terms ‘considerat ion’ and ‘compensat ion’ or ‘damages’ have dist inct connotat ions.
The former in the context of ss. 45 and 48 would connote payment of a sum of money to secure transfer of a capi tal asset; the lat ter would suggest payment to make amends for loss or injury occasioned on the breach of contract or tort . Both ss. 45 and 48 postulate the existence of a capi tal asset and the considerat ion received on transfer thereof . But , as discussed earl ier, once there is a breach of contract by one party and the other party does not keep i t al ive but acquiesces in the breach and decides to receive compensat ion therefor, the injured party cannot have any right in the capi tal asset which could be transferred by ext inguishment to the defaul ter for valuable considerat ion.
That is because a right to sue for damages not being an act ionable claim, a capi tal asset , there could be no quest ion of transfer by ext inguishment of the assessee’s rights therein since such a transfer would be hi t by s. 6(e) of the Transfer of Property Act . In any view of the mat ter, i t is di f f icul t to hold that the sum of Rs.1,40,000 received by way of compensat ion by the assessee was considerat ion for the transfer of a capi tal asset ."
10.3 The Hon’ble Gujarat High Cour t in Baroda Cement (supra), in turn, referred to the concept of breach of contract as discussed by the Hon’ble Bombay High Cour t in the case of Iron and Hardware (India) Co. vs. Shamlal & Bros. AIR 1954 Bom 423 as under (p. 645 of 158 ITR):
"10. Chagla, C.J. , had an occasion to consider this aspect of the law in Iron and Hardware (India) Co. vs. Shamlal & Bros. AIR 1954 Bom 423. The learned Chief Just ice observed as under(p. 425) : ‘ I t is wel l set t led that when there is a breach of contract , the only right that accrues to the person who complains of the breach is the right to f i le a sui t for recovering damages.
The breach of contract does not give rise to any debt and, therefore, i t has been held that a right to recover assignable because i t is not a chose- in-act ion. An act ionable claim can be assigned, but in order that there should be an act ionable claim there must be a debt in the sense of an exist ing obl igat ion.
But inasmuch as a breach of contract does not resul t in any exist ing obl igat ion on the part of the person who commi ts the breach, the right to recover damages is not an act ionable claim and cannot be assigned. ‘
Proceeding further, the learned Chief Just ice stated (p. 425) :
‘ In my opinion, i t would not be true to say that a person who commi ts a breach of the contract incurs any pecuniary l iabi l i ty, nor would i t be true to say that the other par ty to the contract who complains of the breach has any amount due to him from the other party.
As already stated, the only right which he has the right to go to a Court of law and recover damages. Now, damages are the compensat ion which a Court of law gives to a party for the injury which he has sustained. But , and this is most important to note, he does not get damages or compensat ion by reason of any exist ing obl igat ion on the part of the person who has commi t ted the breach.
He gets compensat ion as a resul t of the f iat of the Court , Therefore, no pecuniary l iabi l i ty arises t i l l the Court has determined that the party complaining of the breach is ent i t led to damages. Therefore, when damages are as sessed, i t would not be true to say that what the Court is doing i s ascertaining a pecuniary l iabi l i ty which already exists. The Court in the f irst place must decide that the defendant is l iable is l iable and then i t proceeds to assess what that l iabi l i ty is. But t i l l that determinat ion there is no l iabi l i ty at al l upon the defendant . ‘
I t would appear from the above observat ions that on breach of contract the defaul ter does not incur any pecuniary l iabi l i ty nor does the injured party becomes ent i t led to any speci f ic amount , but he only has a right to sue and claim damages which may or may not be decreed in his favour. He wi l l have to prove (i ) that the opposi te party had commi t ted breach of contract and (i i ) that he had suf fered pecuniary los s on account thereof .
11. The above observat ions of Chagla, CJ. , were quoted wi th approval by the Supreme Court in Union of India vs. Raman Iron Foundry AIR 1974 SC 1265. In para 9 of the judgment , the Supreme Court considered the claim for l iquidated damages for breach of contract between the part ies. Point ing out that so far as the law in India is concerned, there is no qual i tat ive di f ference in the nature of the claim, whether i t be for l iquidated damages or unl iquidated damages, the Supreme Court proceeded to state the law as under (p. 1273):
‘ ‘When there is a breach of contract , the party who commi ts the breach does not eo instant i incur any pecuniary obl igat ion, nor does the party complaining of the breach becomes ent i t led to a debt due from the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages. That is not an act ionable claim and this posi t ion is made amply clear by the amendment in s . 6(e) of the Transfer of Property Act , which provides that a mere right to sue for damages cannot be transferred. ‘
Quot ing the statement of law enunciated by Chagla C.J. , which is extracted earl ier, the Supreme Court stated (p. 1273) : ‘This statement in our view represents the correct legal posi t ion and has our ful l concurrence’ .
12. It would seem wel l-set t led from the above discussion that af ter there is a breach of contract for sale of goods, nothing is lef t in the injured party save the right to sue for damages or speci f ic performance which cannot be transferred under s. 6(e) of the Transfer of Property Act since i t is a mere right to sue and not an act ionable claim."
10.4 In view of the above facts and in the light of plethora of case laws relied upon, we are disposed to hold that the receipt towards compensat ion in l ieu of ‘right to sue’ is of capital nature which is not chargeable to tax under s.45 of the Act.
11. At this juncture, i t may be pert inent to observe that the Revenue has inter al ia questioned the basis giving r ise to the cause of act ion for creat ion of ‘right to sue’. We do not see any purport in such aspect. A development agreement was executed which enabled the assessee to uti lize the land for const ruction and for sharing of prof its.
This r ight/advantage accrued to the assessee was sought to be taken away f rom the assessee by way of sale of land. The prospect ive purchaser as well as the defaul ting party (owner ) perceived threat of f iling sui t by developer and consequently paid damages/compensat ion to shun the possible legal battle. The int rinsic point with respect to accrual of ‘r ight to sue’ has to be seen in the light of overr iding circumstances as to how the par ties have perceived the presence of looming legal bat t le f rom their point of view. I t is an admit ted posit ion that the defaul ting party has made the assessee a conf i rming par ty in the sale by vir tue of such development agreement and a compensat ion was paid to avoid li tigat ion. This amply shows the existence of ‘r ight to sue’ in the perception of the default ing par ty.
Thus, the existence of ‘ right to sue’ could not be brushed aside.
12. We shall now advert to the claim of the Revenue that amount received towards relinquishment of such right is purely a revenue receipt. In this regard, we notice that the compensat ion was not received as a result of terminat ion of advantages associated with development r ights but was claimed to be received to relinquish the rights of the assessee to sue against the vendor of the land. The assessee has received the compensat ion amount on sale of property occasioned due to breach of development agreement.
The development agreement was thus f rustrated by sale of land by the owner . The observation of the CIT(A) that assessee had obtained the possession of the proper ty f rom seller is beleaguered one. As pointed out on behalf of the assessee, the possession are typically given to a developer for the purposes of development. Such act is in the nature of license to develop the property whi le the possession of the proper ty continues to remain vested with the vendor.
On a plain reading, we observe that considerat ion received for relinquishment of ‘right to sue’ does not fal l under the provisions of Sect ion 28(va) of the Act .
We further f ind f rom the facts of the case that assessee has not received this amount under an agreement for not car rying out activi ty in relation to any business or not to share in knowhow, patent , copyr ight , t rademark, license etc. as specif ied under s.28(va) of the Act enacted for its taxabi li ty under the head of business income.
Consequently, we are of the considered view that compensat ion received in lieu of ‘r ight to sue’ could not be regarded as revenue receipt. Therefore, we f ind merit in the appeal of the assessee.
13. Consequently, Ground No.2 of the assessee’s appeal is al lowed.
14. In the resul t, appeal of the assessee is allowed.