Income Tax – Liquidated Damages for delay in Supply of plant is Capital receipt: Supreme Court
By TIOL News Service
NEW DELHI, JULY 12, 2010: THE short question for determination is whether the liquidated damages received by the assessee from the supplier of the plant and machinery on account of delay in the supply of plant is a capital or a revenue receipt? Compensation paid for the delay in procurement of capital asset amounted to sterilization of the capital asset of the assessee as supplier had failed to supply the plant within time as stipulated in the agreement. The afore- stated amount received by the assessee towards compensation for sterilization of the profit earning source, not in the ordinary course of their business, was a capital receipt in the hands of the assessee.
The assessee, engaged in the manufacture of cement, entered into an agreement with M/s Walchandnagar Industries Limited, Bombay, ("the supplier") on 1st September, 1967 for purchase of additional cement plant from them for a total consideration of Rs.1,70,00,000/-. As per the terms of contract, the amount of consideration was to be paid by the assesse in four instalments. The agreement contained a condition with regard to the manner in which the machinery was to be delivered and the consequences of delay in delivery.
As per the agreement, in the event of delay caused in delivery of the machinery, the assessee was to be compensated at the rate of 0.5% of the price of the respective portion of the machinery for delay of each month by way of liquidated damages by the supplier, without proof of actual loss. However, the total amount of damages was not to exceed 5% of the total price of the plant and machinery.
The supplier defaulted and failed to supply the plant and machinery on the scheduled time and, therefore, as per the terms of contract, the assessee received an amount of Rs.8,50,000/- from the supplier by way of liquidated damages.
During the course of assessment proceedings for the relevant assessment Year, a question arose whether the said amount received by the assessee as damages was a capital or a revenue receipt. The Assessing Officer negatived the claim of the assessee that the said amount should be treated as a capital receipt. Accordingly, he included the said amount in the total income of the assessee. Aggrieved, the assessee filed an appeal before the Commissioner of Income Tax (Appeals), but without any success. The Tribunal came to the conclusion that the said amount could not be treated as a revenue receipt. According to the Tribunal, the payment of liquidated damages to the assessee by the supplier was intimately linked with the supply of machinery i.e. a fixed asset on capital account, which could be said to be connected with the source of income or profit making apparatus rather than a receipt in course of profit earning process and, therefore, it could not be treated as part of receipt relating to a normal business activity of the assessee. The Tribunal also observed that the said receipt had no connection with loss or profit because the very source of income viz., the machinery was yet to be installed. Accordingly, the Tribunal allowed the appeal and deleted the addition made on this account.
The reference to the High Court on this issue having been answered against the Revenue and in favour of the assessee, the Revenue is before the Supreme Court in this appeal.
The short question for determination is whether the liquidated damages received by the assessee from the supplier of the plant and machinery on account of delay in the supply of plant is a capital or a revenue receipt?
The question whether a particular receipt is capital or revenue has frequently engaged the attention of the Courts but it has not been possible to lay down any single criterion as decisive in the determination of the question. Time and again, it has been reiterated that answer to the question must ultimately depend on the facts of a particular case, and the authorities bearing on the question are valuable only as indicating the matters that have to be taken into account in reaching a conclusion.
In Rai Bahadur Jairam Valji , it was observed thus:
"The question whether a receipt is capital or income has frequently come up for determination before the courts. Various rules have been enunciated as furnishing a key to the solution of the question, but as often observed by the highest authorities, it is not possible to lay down any single test as infallible or any single criterion as decisive in the determination of the question, which must ultimately depend on the facts of the particular case, and the authorities bearing on the question are valuable only as indicating the matters that have to be taken into account in reaching a decision. Vide Van Den Berghs Ltd. v. Clark. That, however, is not to say that the question is one of fact, for, as observed in Davies (H.M. Inspector of Taxes) v. Shell Company of China Ltd., "these questions between capital and income, trading profit or no trading profit, are questions which, though they may depend no doubt to a very great extent on the particular facts of each case, do involve a conclusion of law to be drawn from those facts."
The Supreme Court observed that it was clear from the agreement dated 1st September 1967, that the liquidated damages were to be calculated at 0.5% of the price of the respective machinery and equipment to which the items were delivered late, for each month of delay in delivery completion, without proof of the actual damages the assessee would have suffered on account of the delay. The delay in supply could be of the whole plant or a part thereof but the determination of damages was not based upon the calculation made in respect of loss of profit on account of supply of a particular part of the plant.
It is evident that the damages to the assessee was directly and intimately linked with the procurement of a capital asset i.e. the cement plant, which would obviously lead to delay in coming into existence of the profit making apparatus, rather than a receipt in the course of profit earning process. Compensation paid for the delay in procurement of capital asset amounted to sterilization of the capital asset of the assessee as supplier had failed to supply the plant within time as stipulated in the agreement. The afore- stated amount received by the assessee towards compensation for sterilization of the profit earning source, not in the ordinary course of their business, was a capital receipt in the hands of the assessee.
The Supreme Court therefore held that the amount of Rs.8,50,000/- received by the assessee from the suppliers of the plant was in the nature of a capital receipt.
Revenue Appeal dismissed.
(See 2010-TIOL-49-SC-IT in 'Income Tax')
