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Tax Publishers Taxability of liquidated damages/compensation for an yet to commence income earning apparatus - whether capital gains taxable under section 55(2)(a) *Facts:* Assessee was in receipt of Rs. 4.34 crores from one PFG Principal (Mauritius). The said receipt arose from a JV life insurance business that was to be formed jointly with Punjab National bank and Vijaya Bank subject to approvals. Since the approvals did not materialize the shares owned by the assessee were taken over by PFG Principal Mauritius; the taxable capital gains from the shares was offered in assessment year 2011-12 separately which is not the issue in this case. There were legal covenants of the JV (Business cooperation agreement - BCA)which were not upheld by PFG Principal Mauritius they paid Rs. 4.34 to the assessee as compensation/liquidated damages towards non-exercising of the legal rights of the BCA by the assessee. This amount was held to be arising not out of the bundle of rights rather were arising out of a capital asset by the AO and was subject to tax as short term capital gains under section 55(2)(a) and considering the cost of acquisition as NIL the entire amount was taxed as such. On appeal CIT(A) reversed the verdict of the AO holding that the receipt of compensation was only a capital receipt and could not fastened to tax as capital gains nor as income from other sources. On further appeal by the revenue - Held against the revenue that the compensation was a capital receipt and was not taxable neither as capital gains nor as income from other sources. Just because an income was not taxable as capital gains it cannot be taxed as income from other sources. *Applied:* Kettlewell Bullen and Co. Ltd. v. CIT: (1964) 53 ITR 261 (SC) : 1964 TaxPub(DT) 0345 (SC) the Supreme court drew a distinction between the compensation received for injury to trading operations arising from breach of contract or from the exercise of sovereign rights and compensation received as solatium for loss of office. It was held that the compensation received for loss of an asset of enduring value would be regarded as capital in nature. CIT v. H.P. Housing Board (2012) 340 ITR 388 (HP-HC) : 2012 TaxPub(DT) 0666 (HP-HC) CIT v. Ram Nath Exports Ltd. 201 Taxation 42 (Del HC) Shri Rama Multi Tech Ltd. v. ACIT (2005) 92 TTJ 568 (Ahd-Trib) : 2005 TaxPub(DT) 1047 (Ahd-Trib) CIT v. R.D. Ramnath Co. (2007) 164 Taxman 317 (Del HC) : 2007 TaxPub(DT) 1003 (Del-HC) CIT v. HCL Inforsystem Ltd. TS- 725-HC-2015 (Delhi) Vodafone (2012) 341 ITR 1 (SC) : 2012 TaxPub(DT) 0370 (SC) - The compensation was for a bundle of legal rights and they cannot be split or read in a manner convenient to revenue. There was no capital asset in the first place. Computation section fails in the absence of cost of an asset. Motor & General Stores (1967) 66 ITR 692 (SC) : 1967 TaxPub(DT) 0365 (SC) - "In construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions "As preoperative start up expenses before carrying on of the business are not allowable as deduction (refer Delhi High Court Hindustan Times (2013) 211 Taxman 202 (Del-HC) : 2013 TaxPub(DT) 0020 (Del-HC)), subject compensation is also pre-operative income (before commencement of business) which on analogous reasoning should be capital receipt non chargeable to tax; Saurashtra Cement (2010) 325 ITR 422 (SC) : 2010 TaxPub(DT) 2095 (SC), Delhi ITAT Sak Industries (2005) 1 SOT 798 (Del) - computation fails as there is no cost of acquisition. *Ed. Note:* The decision is a one off - revisiting set principles on taxability of compensation/liquidated damages. Decision of Kettlewell Bullen is a landmark verdict on this domain. *Case:* ACIT v. U.K. Paints (India) (P) Ltd. 2023 TaxPub(DT) 3798 (Del-Trib)

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Taxability of liquidated damages/compensation for an yet to commence income earning apparatus - whether capital gains taxable under section 55(2)(a)

Facts:

Assessee was in receipt of Rs. 4.34 crores from one PFG Principal (Mauritius). The said receipt arose from a JV life insurance business that was to be formed jointly with Punjab National bank and Vijaya Bank subject to approvals.

Since the approvals did not materialize the shares owned by the assessee were taken over by PFG Principal Mauritius; the taxable capital gains from the shares was offered in assessment year 2011-12 separately which is not the issue in this case.

There were legal covenants of the JV (Business cooperation agreement - BCA)which were not upheld by PFG Principal Mauritius they paid Rs. 4.34 to the assessee as compensation/liquidated damages towards non-exercising of the legal rights of the BCA by the assessee. This amount was held to be arising not out of the bundle of rights rather were arising out of a capital asset by the AO and was subject to tax as short term capital gains under section 55(2)(a) and considering the cost of acquisition as NIL the entire amount was taxed as such. On appeal CIT(A) reversed the verdict of the AO holding that the receipt of compensation was only a capital receipt and could not fastened to tax as capital gains nor as income from other sources. On further appeal by the revenue -

Held against the revenue that the compensation was a capital receipt and was not taxable neither as capital gains nor as income from other sources. Just because an income was not taxable as capital gains it cannot be taxed as income from other sources.

Applied:

Kettlewell Bullen and Co. Ltd. v. CIT: (1964) 53 ITR 261 (SC) : 1964 TaxPub(DT) 0345 (SC) the Supreme court drew a distinction between the compensation received for injury to trading operations arising from breach of
contract or from the exercise of sovereign rights and compensation received as solatium for loss of office. It was held that the compensation received for loss of an asset of enduring value would be regarded as capital in nature.

CIT v. H.P. Housing Board (2012) 340 ITR 388 (HP-HC) : 2012 TaxPub(DT) 0666 (HP-HC)

CIT v. Ram Nath Exports Ltd. 201 Taxation 42 (Del HC)

Shri Rama Multi Tech Ltd. v. ACIT (2005) 92 TTJ 568 (Ahd-Trib) : 2005 TaxPub(DT) 1047 (Ahd-Trib)

CIT v. R.D. Ramnath Co. (2007) 164 Taxman 317 (Del HC) : 2007 TaxPub(DT) 1003 (Del-HC)

CIT v. HCL Inforsystem Ltd. TS- 725-HC-2015 (Delhi)

Vodafone (2012) 341 ITR 1 (SC) : 2012 TaxPub(DT) 0370 (SC) - The compensation was for a bundle of legal rights and they cannot be split or read in a manner convenient to revenue. There was no capital asset in the first place. Computation section fails in the absence of cost of an asset.

Motor & General Stores (1967) 66 ITR 692 (SC) : 1967 TaxPub(DT) 0365 (SC) - "In construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions

"As preoperative start up expenses before carrying on of the business are not allowable as deduction (refer Delhi High Court Hindustan Times (2013) 211 Taxman 202 (Del-HC) : 2013 TaxPub(DT) 0020 (Del-HC)), subject compensation is also pre-operative income (before commencement of business) which on analogous reasoning should be capital receipt non chargeable to tax;

Saurashtra Cement (2010) 325 ITR 422 (SC) : 2010 TaxPub(DT) 2095 (SC), Delhi ITAT Sak Industries (2005) 1 SOT 798 (Del) - computation fails as there is no cost of acquisition.

Ed. Note: The decision is a one off - revisiting set principles on taxability of compensation/liquidated damages. Decision of Kettlewell Bullen is a landmark verdict on this domain.

Case: ACIT v. U.K. Paints (India) (P) Ltd. 2023 TaxPub(DT) 3798 (Del-Trib)