The right to claim for damages is a capital gain and is therefore not taxable
Fact and issue of the case
The aforesaid appeal has been filed by the assessee against order dated 29/03/2023 passed by PCIT (Central Mumbai-4) in his revisionary jurisdiction u/s.263 for the A.Y.2018-19.
In various grounds of appeal assessee has challenged the order of the ld. PCIT passed u/s.263 on various legal and factual The main issue on merits is with regard to taxability of receipt of damages which was claimed as capital receipt not chargeable to tax, whereas the ld. PCIT has held it to be in the nature of income.
The facts in brief are that the assessee is an individual, who had entered into an MOU with Aadi Properties LLP on 08/07/20 10 with the intention to book commercial space to be developed and constructed in a proposed project by M/s. Aadi Properties LLP on a plot of land for consideration of 10,75,00,000/-. Accordingly, payment of Rs.25,00,000/- by cheque No.017447 drawn on bank of India dated 02/07/2010 was paid by the assessee. This amount of Rs.25,00,000/- was nearly 2.33% of the total consideration payable by the assessee. Later on, the said project did not materialize and was aborted and accordingly, the builder had cancelled the allotment returning the advance of Rs.25,00,000/- vide cheque dated 29/07/2014 which amount was not deposited in the bank by the assessee. The assessee then filed suit on 30/11/2015 before the Hon‟ble Bombay High Court, being suit No.21/2016 for claiming damages, that an agreement sale u/s .4 of Maharashtra Ownership Flats Act (Regulation of the Promotion of Construction, Sale, Management and Transfer) Act (MOFA) was entered for the suit premises and prayed for perpetual injunction restraining the Defendant from selling or dealing with, disposing of, alienating, encumbering, parting with possession or creating third party rights of any nature whatsoever in respect of the suit area or part thereof.
Aadi Property LLP contested the assessee’s suit on the following grounds and expressed its inability to provide the agreed commercial space and refused to meet the claims of the assessee in the suit;
by seeking reference of the dispute in the Suit to Arbitration under the provisions of the Arbitration and Conciliation Act, 1996.
claiming that the MOU was for finance purpose and not for sale of flats.
MOU was cancelled in 2014 by legal notice.
the money was returned on cancellation by cheque.
the plaintiff had failed to perform his obligations and there was No readiness or willingness on the part of the plaintiff to perform the contract.
the said MOU was not capable of specific performance.
the MOU was not stamped or registered and was admissible in evidence.
it was never planned to or possible to develop commercial
that no case made out for specific performance by plaintiff of MOU,
the Plaintiff was estopped from claiming allotment of the suit premises.
claiming that the Suit was not maintainable.
suppression of material facts and circumstances by the Plaintiff.
the suit was not bonafide and was merely an afterthought.
claiming that the Plaintiff has failed to make out the case for the grant of ad-interim reliefs.
Thereafter, a consent decree dated 10/07/2017 was passed by the Hon’ble Bombay High Court on the basis of consent terms filed by the parties. As per the consent decree an amount of Rs.7,65,26,000/- was agreed to be paid by the Aadi Properties LLP by way of damages for its inability to provide the commercial space and the assessee not waiving the „right to sue‟ as per Para 9 and 10 of the consent decree dated 10/07/2017 which reads as under:-
In Course of the discussions and negotiations between the Parties, the Plaintiff released that due to the constant changes in the applicable laws governing planning, FSI and other development accept the Defendant was forced to abort the Old Project and the Defendant have aborted the Old Project and undertaken the development of the project, had made significant progress in the construction of the project which was in stark variance with the Old Project in which the Plaintiff had agreed to invest by way of allotment of 25,000 square feet (Saleable area) of the commercial premises therein and consequently, the contours of the Old Project by completely different from that of the Project as is presently envisaged. The Old Project was comprised of mostly commercial buildings whereas the Project is predominantly residential and very little commercial user. In fact, the location where the commercial premises were to be provided, residential buildings are being put up there. The Defendant, having made significant progress in the construction of the Project and also having created other party rights in the Project, it was realized that the original allotment of office space is not even constructed in the new plan. Since, specific performance of the allotment of 25000 square feet (Saleable area) of the commercial premises is not possible, damages in lieu of the Plaintiff’s right to sue would thus be the only relief/ remedy that the Plaintiff would be eventually entitled in the caption suit. Considering that specific performance of the MOU is not possible, it has been agreed that damages shall be paid by the Defendant to the Plaintiff in lieu of the Plaintiff’s right to sue.”
In accordance with the aforesaid discussions, the parties have agreed to mutually end amicably settle the aforesaid dispute and differences between them. It has been decided between the parties that the plaintiff is entitled to damages of Rs. 7,65,26000 (Rupees Seven crores sixty-five lakhs twenty-six thousand only) in lieu of the plaintiff’s right to sue, in full and final settlement of all the plaintiff’s claims under the captioned suit, the Notice of Motion in Commercial Division No. 179 of 2016 (converted from Notice of Motion of No. 205 of 2016), Notice of Motion in Commercial Division No. 180 of 2016 (converted from Notice of Motion No. 499 of 2016) and the MOU, and the amount of Rs. 25,00,000/- (Rupees Twenty Five Lakh only) paid by the Plaintiff to the Defendant on 08th July, 2010 under the MOU, shall also be refunded without interest by Defendant to the Plaintiff and is included in the aforesaid sum of Rs. 7,65,26,000/- (Rupees Seven Crore Sixty Five Lakh Twenty Six Thousand only) payable by Defendant to the Plaintiff.”
The return of income was filed on 30/10/2018 declaring income of Rs.7,48,63,770/-. In the said return of income assessee claimed that compensation of Rs.7,65,26,000/- received for not suing the M/s. Aadi Properties LLP was a capital receipt not liable to be taxed. The case of the assessee was selected for scrutiny under the E-assessment Scheme 2019 for verifying the claim of exemption. In the course of assessment proceedings, the ld. AO issued notices from time to time inquiring about, whether the receipts of Rs.7,65,26,000/- towards compensation under consent decree was taxable or not? The assessee in response has complied with all the notices and filed its reply alongwith the case laws in support electronically before the ld. AO and the copies of all the replies alongwith details and evidences, which have been placed in the paper book before us also from pages 41-254 of the paper book. The Assessing Officer after considering the details and the judgments furnished by the assessee, completed the assessment u/s. 143(3) vide order dated 24/02/2021 accepting the return of income and confirmed that capital receipt received of Rs.7,65,26,000/- was not taxable.
Post completion of assessment u/s 143(3), on same issue, notice u/s. 148A (b) dated 24/03/2022 was issued requiring the assessee to show-cause as to why notice u/s. 148 should not be issued in his case for A.Y.2018-19 and to explain as to why the receipt of compensation of Rs.7,65,26,000/- should not be treated as income escaping assessment. Again in response to the said notice assessee furnished all the relevant documents and explanations with respect to the information in question, vide letter dated 29/03/2022 explaining that no income had escaped assessment and the damages received were not liable to tax. From the records it appears that after considering the reply of the assessee, order u/s. 148A(d) dated 07/04/2022 was passed wherein it was concluded that the case of the assessee was not a fit case for issue of notice u/s. 148. The copy of notices and the replies have been placed in the paper book from pages 264-279 of the paper book. 8
After the completion of the assessment of Section 143(3) in the aforesaid manner and the issuance of notice u/s. 148A and dropping of such proceedings, the ld. PCIT in his revisionary jurisdiction issued a notice u/s. 263 on 02/03/2023, again on the same issue of taxability of receipt of compensation of Rs.7,65,26,000/-. In the show-cause notice, ld. PCIT held that the ld. AO accepting the claim of the assessee in his order passed u/s. 143(3) dated 24/02/2021 was passed ignoring the decision of the Bombay High Court in the case of CIT vs. Vijay Flexi Containers (Bom) reported in (1990) 186 ITR 693 which makes assessment order passed by the ld. AO erroneous in so far as prejudicial to the interest of the revenue as per clause (d) of Explanation 2 to Section 263. He further observed that in another similar matter with same kind of transaction with the same builder, in the case of Kaushal Agarwal who has also booked commercial space of 25,000 sq.ft on 08/07/2010 and had received similar compensation of Rs.7,65,26,000/-, the ld. AO has made the addition on account of capital gain on such compensation received.
In the reply to the show-cause notice assessee submitted that the case of the assessee is not covered by the judgment of the Hon‟ble Bombay High Court in the case of Vijay Flexi Containers supra, because the said judgment relate to specific performance of the impugned contract but here in this case the specific performance of the contractor was not possible and therefore, there was no possibility to impose the performance of the contract and here assessee had only „right to sue‟. Assessee also relied upon the decision of the Hon‟ble Madras High Court in the case of Venkateswara Aiyer vs. Kallor LLLath Raman Nambudri, AIR 1917 Mad 358, wherein the Hon‟ble Madras High Court has considered the case of CIT vs. Vijay Flexi Containers supra and decided that right to sue in such cases is a capital receipt and not chargeable to tax. Apart from that, assessee had also relied all other judgments which has been referred in the impugned order. The ld. PCIT rejected the replies / explanation of the assessee and held that the Assessing Officer neither during the assessment proceedings u/s. 143(3) nor in the proceedings u/s. 148A(d) has considered the decision of the Hon‟ble Jurisdictional High Court in the case of CIT vs. Vijay Flexi Containers supra and accordingly, he cancelled the assessment order passed by the ld. AO holding it to be erroneous in so far prejudicial to the interest of the Revenue and set aside the assessment order to pass the assessment order afresh in light of his observation about the judgment Hon‟ble Bombay High Court.
On the perusal of the impugned order of ld. PCIT, it seems that the only ground for setting aside the assessment order passed by the ld. AO is failure to consider the judgment of the Hon‟ble Jurisdictional High Court in the case of CIT vs. Vijay Flexi Containers supra and accordingly, in terms of Clause-(d) to Explanation 2 to Section 263 are attracted and therefore, it is deemed to be erroneous and prejudicial to the interest of the Revenue.
We have heard both the parties at length and also perused the relevant finding given in the impugned order as well as various materials referred to before us at the time to hearing. To put the issue succinctly, whether the compensation received by the assessee as per the consent decree dated 10/07/20 17 of the Hon‟ble Bombay High Court which was based on the basis of consent terms filed by the parties, can be brought to tax or it is a capital receipt not chargeable to tax. As noted above in the consent decree of the Hon‟ble Bombay High Court, in para 9, it has been clearly stated that since specific performance of allotment of 25,000 sq.ft (salable area) of the commercial premises is not possible, damages in lieu of the plaintiff‟s right to sue would thus be the only relief/ remedy that the Plaintiff would be eventually entitled in the caption suit. Considering that specific performance of the MOU is not possible, it has been agreed that damages shall be paid by the Defendant to the Plaintiff in lieu of the Plaintiff’s right to sue. Para 10 also clearly states that it has been vested between parties that the plaintiff is entitled to damage of Rs.7,65,46,000/- in view of plaintiff‟s right to sue, full and final settlement of all the plaintiff’s claims under the captioned suit.
As per the Transfer of Property Act, Section 6 which provides property may be transferred. It has been categorically provided a mere right to sue cannot be transferred. The relevant portion of Section 6 of Transfer of Property Act reads as under:- What may be transferred 6. Property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force-
(a) The chance of an heir-apparent succeeding to an estate, the chance of a relation obtaining a legacy on the death of a kinsman, or any other mere possibility of a like nature, cannot be transferred.
(b) A mere right of re-entry for breach of a condition subsequent cannot be transferred to anyone except the owner of the property affected thereby.
(c) An easement cannot be transferred apart from the dominant
(d) An interest in property restricted in its enjoyment to the owner personally cannot be transferred by him.
(d) A right to future maintenance, in whatsoever manner arising, secured or determined, cannot be transferred
(e) A mere right to sue cannot be transferred
(f) A public office cannot be transferred, nor can the salary of a public officer, whether before or after it has become payable.
(g) Stipends allowed to military, naval, air-force and civil pensioners of the government and political pensions cannot be transferred.
(h) No transfer can be made (1) insofar as it is opposed to the nature of the interest affected thereby, or (2) for an unlawful object or consideration within the meaning of section 23 of the Indian Contract Act, 1872 (9 of 1872), or (3) to a person legally disqualified to be transferee.
(i) Nothing in this section shall be deemed to authorise a tenant having an untransferable right of occupancy, the farmer of an estate in respect of which default has been made in paying revenue, or the lessee of an estate, under the management of a Court of Wards, to assign his interest as such tenant, farmer or lessee.
Now whether the damage received by the assessee can be said to be in respect of transfer of capital asset and if there was a breach of contract and the assessee received damages on account of mere „right to sue‟ for the damages, can it be held to be transfer of the property. As noted above, Section 6 of the Transfer of Property Act clearly provides that “a mere right to sue cannot be transferred”, even if it is to be treated as “property” U/s.5 of the Transfer Property Act. Transfer of property means the act by which a person conveys a property to another and to transfer property is to perform such act. The mere right to sue may or may not be property but certainly it cannot be transferred as per law.
Observation of the court
HC held that once there is a breach of contract and defaulting party not only refuse to perform his part of contract but also disposes of the subject-matter, the injured party has nothing left in the contract except right to sue for damages. A right to sue not being an actionable claim cannot be considered as capital asset and hence, there is no question of it resulted in transfer by extinguishment of taxpayer’s right. Also, compensation received does not represent consideration for transfer as for computation under S.45 the taxpayer ought to have incurred cost. If the Revenue fails to show that the taxpayer had incurred a cost as in the present case, it would be impossible to compute the income chargeable to tax under the head ‘capital gains’ and what the Revenue would be charging would be the capital value of the asset and not any profit or gain. Therefore damages cannot be held to be chargeable as capital gains. Basis the above, damages were not liable to capital gains tax levy. ”
once there is a breach of contract and the defaulting party not only refuses to perform his part of the contract but also disposes of the subject-matter, the injured party has nothing left in the contract except the right to sue for damages
a mere right to sue, whether arising out of tortious act or ex-contractual is not transferable. In Mulla’s Transfer of Property Act, Seventh edn., we find the following statement:
“But a debt or actionable claim must be distinguished from a right to sue for damages. After breach of a contract for the sale of goods nothing is left but a right to sue for damages which cannot be transferred. But before breach the benefit of an executory contract for the sale of goods may generally be transferred and the buyer has the right sue for to the goods
Since the transfer contemplated by s. 45 is one as a result whereof consideration has passed to the assessee or has accrued to him, extinguishment of the right must relate to that ‘capital asset’, corporeal or incorporeal. It is, therefore, obvious that a transfer of a capital asset in order to attract liability to tax under the head ‘capital gains must be transfer’ as a result whereof some consideration is received by or accrues to the assessee. If the transfer does not yield any consideration, the computation of profits or gains as provided by s. 48 of the Act would not be possible. If the transfer takes effect on extinguishment of a right in the capital asset, there must be receipt of consideration for such extinguishment to attract liability to tax. Now, in legal parlance, the terms ‘consideration’ and ‘compensation’ or ‘damages’ have distinct connotations. The former in the context of ss. 45 and 48 would connote payment of a sum of money to secure transfer of capital asset; the latter would suggest payment to make amends for loss or injury occasioned on the breach of contract or tort. Both s. 45 and 48 postulate the existence of a capital asset and consideration received thereof
once there is a breach of contract by one party and the other party does not keep it alive but acquiesces in the breach and decides to receive compensation therefore, the injured party cannot have any right in the capital asset which could be transferred by extinguishment to the defaulter for valuable consideration. That is because a right to sue for damages not being an actionable claim, a capital asset, there could be no question of transfer by extinguishment of the assessee’s rights therein since such a transfer would be hit by s. 6(e) of the Transfer of Property Act….”
The asset referred to in s. 45 must be one in the acquisition whereof the assessee had incurred a cost. If the Revenue fails to show that the assessee had incurred a cost as in the present case, it would be impossible to compute the income chargeable to tax under the head ‘capital gains’ and what the Revenue would be charging would be the capital value of the asset and not any profit or gain The Tribunal was not justified in holding that the amount received by the assessee by way of damages for breach of contract of sale was chargeable to tax under the head ‘Capital gains!”
In view of the aforesaid judgments of various High Courts including the two judgments of the Hon‟ble Jurisdictional High Court in favour of the assessee, the impugned order of the ld. PCIT cancelling the assessment order solely relying on the judgment of M/s. Vijay Flexible Containers which is not applicable on the facts of the assessee‟s case cannot be sustained and is hereby set aside and the order of the Assessing Officer accepting the claim is upheld.
In so far as other issues are concerned, i.e., once the ld. AO has examined this issue threadbare relying upon the various judgments of the High Court which was cited before him accepting the claim, then ld. PCIT cannot set aside the assessment order within the scope of u/s. 263 is not adjudicated as we have already held on merits that the judgment of the ld. PCIT is incorrect in law. Accordingly, the appeal of the assessee is allowed.
In the result appeal of the assessee is allowed. Order pronounced on 30th August,2023.
Conclusion
In the result, appeal of the assessee is allowed and ruled in favour of the assessee
Read the full order from here
Virendra-Bhavanji-Gala-Vs-PCIT-ITAT-Mumbai-2
