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The Tax Publishers Avantor Performance Materials India Ltd. v. CIT & Anr. [ITA No. 24 of 2014, dt. 4-1-2016] : 2016 TaxPub(DT) 0818 (HP-HC) Compensation for cancellation of a contract whether capital or revenue receipt - principles determining compensation is of capital or revenue nature Facts The assessee Avantor was in the business of diagnostic, lab solutions , chemical research, had entered into Special Purchase Agreement SPA with a seller (anonymous). The SPA related to the shares of one company Sarabhai Zydus Animal Health Limited (Zydus). Shareholding of Zydus was 50% held by Cadilla health care balance 50% with Ambalal Sarabhai enterprises Ltd. with Mautik Exim Limited, Haryana Containers Ltd. and one Kartikeya Sarabhai (thus sellers were one of the 50% residual stake holders other than Cadilla). The sellers had pledged their holdings with Cadilla and were creditors to Zydus. Consideration of sale was 72.5 crores out of which assessee paid an earnest money for Rs. 24.81 crores. The sale agreement was subject to the right of first refusal by Cadilla. Vide separate agreement it was also agreed that the sellers would convince Cadilla to part with their 50% stake as well for which escrow of 15 crores was separately paid by the assessee. The SPA had compensation/penalty/interest on Earnest money clause as well. Due to Cadilla invoking its rights of first refusal the sellers expressed inability to close the sale. Thus compensation with interest and penalty became payable to assessee. The intent of the assessee in the buy was to grow inorganically in its business. Question arose on the taxability of the compensation as to whether it was capital or revenue in nature. The assessing officer/Commissioner (Appeals) and ITAT all had held the same to be of revenue nature. On appeal by the assessee to the high court. Held by the high court that the compensation was of revenue in nature thus taxable. Applying Kettlewell Bullen and Co. Ltd. v. CIT, Calcutta, AIR 1965 SC 65 the compensation was held to be not in lieu of any capital assets. The assessee knew of the conditionality and impact of its breach and also the fact that it would not be injurious to the assessee as well (thus no loss was sustained by assessee due to the calling off of the SPA). Hence it was of revenue nature taxable under the act. The following were the principles on taxability of compensation for breach of contract (the breach arose because of assessee in the conditional sale agreement due to rights of first refusal by Cadilla) which were held by the court in arriving to the above conclusion after going over a number of decisions. -- Compensation has to be seen in the hands of the recipient not on the basis of the payer as to whether it was paid out of capital or revenue. -- Periodicity or nomenclature is not a criteria to decide whether it is of capital or revenue nature. -- What is received for loss of capital is a capital receipt: what is received as profit in trading transaction is taxable income. -- Payment of compensation for loss of office is always not of capital nature, where compensation is payable under terms of a contract determined is of revenue nature. -- Payment in consideration of the circumstances, made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessees income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt. -- Payment pursuant to a legal right, received from another person in compensation for the traders failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the time when the compensation is so received, the compensation is to be treated for income-tax purposes in the same way as that sum of money would have been treated if it had been received instead of the compensation.

The Tax Publishers

Avantor Performance Materials India Ltd. v. CIT & Anr. [ITA No. 24 of 2014, dt. 4-1-2016] : 2016 TaxPub(DT) 0818 (HP-HC)

Compensation for cancellation of a contract whether capital or revenue receipt - principles determining compensation is of capital or revenue nature

Facts

The assessee Avantor was in the business of diagnostic, lab solutions , chemical research, had entered into Special Purchase Agreement SPA with a seller (anonymous). The SPA related to the shares of one company Sarabhai Zydus Animal Health Limited (Zydus). Shareholding of Zydus was 50% held by Cadilla health care balance 50% with Ambalal Sarabhai enterprises Ltd. with Mautik Exim Limited, Haryana Containers Ltd. and one Kartikeya Sarabhai (thus sellers were one of the 50% residual stake holders other than Cadilla). The sellers had pledged their holdings with Cadilla and were creditors to Zydus. Consideration of sale was 72.5 crores out of which assessee paid an earnest money for Rs. 24.81 crores. The sale agreement was subject to the right of first refusal by Cadilla. Vide separate agreement it was also agreed that the sellers would convince Cadilla to part with their 50% stake as well for which escrow of 15 crores was separately paid by the assessee. The SPA had compensation/penalty/interest on Earnest money clause as well. Due to Cadilla invoking its rights of first refusal the sellers expressed inability to close the sale. Thus compensation with interest and penalty became payable to assessee. The intent of the assessee in the buy was to grow inorganically in its business. Question arose on the taxability of the compensation as to whether it was capital or revenue in nature. The assessing officer/Commissioner (Appeals) and ITAT all had held the same to be of revenue nature. On appeal by the assessee to the high court.

Held by the high court that the compensation was of revenue in nature thus taxable.

Applying Kettlewell Bullen and Co. Ltd. v. CIT, Calcutta, AIR 1965 SC 65 the compensation was held to be not in lieu of any capital assets. The assessee knew of the conditionality and impact of its breach and also the fact that it would not be injurious to the assessee as well (thus no loss was sustained by assessee due to the calling off of the SPA). Hence it was of revenue nature taxable under the act.

The following were the principles on taxability of compensation for breach of contract (the breach arose because of assessee in the conditional sale agreement due to rights of first refusal by Cadilla) which were held by the court in arriving to the above conclusion after going over a number of decisions.

-- Compensation has to be seen in the hands of the recipient not on the basis of the payer as to whether it was paid out of capital or revenue.

-- Periodicity or nomenclature is not a criteria to decide whether it is of capital or revenue nature.

-- What is received for loss of capital is a capital receipt: what is received as profit in trading transaction is taxable income.

-- Payment of compensation for loss of office is always not of capital nature, where compensation is payable under terms of a contract determined is of revenue nature.

-- Payment in consideration of the circumstances, made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessees income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.

-- Payment pursuant to a legal right, received from another person in compensation for the traders failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the time when the compensation is so received, the compensation is to be treated for income-tax purposes in the same way as that sum of money would have been treated if it had been received instead of the compensation.