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November 30, 2020

Receipts from Construction Company being intrinsically connected with construction of plant would be considered as a capital receipt – SC

by CA Shivam Jaiswal in Income Tax

Receipts from the Construction Company being intrinsically connected with construction of plant would be considered as a capital receipt – SC

The Income-tax Act does not define the term ‘Capital receipt’ & “‘Revenue receipt’. Also, it has not laid down the criterion for differentiating the capital and revenue receipt. However, it has exempted certain capital receipts from taxation while certain capital receipts have been taken into ambit of capital receipts chargeable as capital gains. Also, certain revenue receipts have been exempted from taxation under Income-tax Act while certain receipts have been taken as income chargeable to income-tax.

Let us refer to the case of Commissioner of Income Tax vs Bokaro Steel Limited where the main issue under consideration was whether receipts from the Construction Company being intrinsically connected with construction of assessee’s plant, would be considered as a capital receipt or a revenue receipt?

Facts of the Case:

  • The assessee was a company wholly owned by the Government of India.
  • The assessee’s object was to construct and own an integral iron and steel works.
  • During the assessment years under consideration, the work of construction of the company’s factory and installation of the plant was in the process of completion.
  • The company had not started any business during the assessment years in question.
  • During this period the company had given to the contractor’s quarters for the residence of the staff and workers employed by the contractors who were engaged by the assessee for carrying out the work of construction.
  • The assessee charged the contractors for the use of the quarters so given to the contractors for the residence of his workmen who were engaged in the construction activity of the assessee’s plant.
  • The assessee had also entered into supplementary agreements with its contractors under which the assessee had made certain advances to the contractors to enable them to execute the large-scale construction work smoothly.
  • During the year, the assessee received certain amounts from the contractors for housing accommodation for construction workers, hire charges of plant and machinery, interest on advance, and royalty for excavation and use of stone found on the assessee’s land. The Tribunal held that, all of amounts received by the assessee would go to reduction of cost of construction.

Reliance placed by Supreme Court (SC) on an older case law

  • In the case of Addl. Commissioner of Income-tax, New Delhi V. Indian Drugs and Pharmaceuticals ltd, the Delhi High Court considered a case where the work of construction of the factory of the assessee was in progress and production had not commenced.
  • Receipts from sale of tender forms and supply of water and electricity to the contractors engaged in construction as also receipts on account of sale of stones, boulders, grass and trees were held to be receipts not from independent sources but were considered as inextricably linked with the process of setting up of business.
  • These were directly related to the capital structure of business and were held to be capital in nature.
  • SC agreed with this view taken by the Delhi High Court.

Observations of the Supreme Court (SC) in the present case

  • To facilitate the work of the contractor, the assessee permitted the contractor to use the premises of the assessee for housing its staff and workers engaged in the construction activity of the assessee’s plant.
  • This was clearly to facilitate the work of construction.
  • Had this facility not been provided by the assessee, the contractors would have had to make their own arrangements and this would have been reflected in the charges of the contractors for the construction work.
  • Instead, the assessee had provided these facilities.
  • The same was true of the hire charges for plant and machinery which was given by the assessee to the contractor for the assessee’s construction work.
  • The receipts in this connection also compensated the assessee for the wear and tear on the machinery.
  • The advances which the assessee made to the contractor to facilitate the construction activity of putting together a very large project was as much to ensure that the work of the contractors proceeded without any financial hitches as to help the contractors.
  • The arrangements which were made between the assessee-company and the contractors pertaining to these three receipts were arrangements which were intrinsically connected with the construction of its steel plant.
  • The receipts were adjusted against the charges payable to the contractors and reduced the cost of construction.
  • They, therefore, were rightly held as capital receipts and not income of the assessee from any independent source.

In conclusion, the arrangements which were made between the assessee-company and the contractors pertaining to the receipts were arrangements which are intrinsically connected with the construction of its steel plant. The receipts were adjusted against the charges payable to the contractors and reduced the cost of construction. They were, therefore, been rightly held as capital receipts and not income of the assessee from any independent source

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