Can compensation received in lieu of future profits from abandoned project be taxed as business profits particularly when expenses attributable to project were allowed as revenue expenditure?

Can compensation received in lieu of future profits from abandoned project be taxed as business profits particularly when expenses attributable to project were allowed as revenue expenditure?
-YES, says Delhi HC


NEW DELHI, DEC 22, 2010: THE major issue before the High Court is - Whether compensation received by the assessee in lieu of future profits from the abandoned project is taxable as business profits particularly when the expenses attributable to the abandoned project were allowed as revenue expenses. YES is the High Court's answer. The other issues are - Whether once revenue proves that a particular receipt is income, the burden to prove that such receipt is not income shifts on the assessee and Whether the restrictive covenant having life span of three years and the same can be withdrawn at any time during this period after the approval of the other party, changes the colour of the receipt from revenue to capital.


Facts of the case

M/s. DCM and Kailash Nath & Associates (briefly KNA) entered into a collaboration Agreement dated 17th July, 1986 inter alia with respect to the development of 66.53 acres of land owned by DCM situated at Bara Hindu Rao, New Rohtak Road, Delhi. Under this Agreement, the KNA was to develop and construct multistoried residential flats, flatted factories, shopping complex, schools etc. on the aforesaid land belonging to the DCM. Owing to the magnitude of the project, however, with the mutual consent of DCM and KNA, the appellant-company, M/s. Ansals Properties and Industries Ltd., presently known as M/s. Ansals Properties & Infrastructure Ltd. was inducted for implementation of the project by an Agreement dated 24th November, 1988 entered into between the DCM, KNA and ANSALS. Thereafter some disputes arose between DCM and the assessee along with other participant - KNA and the assessee agreed to neglect the ongoing project subject to compensation - DCM paid the same - AO taxed the compensation as revenue receipt - CIT(A) affirmed the same - ITAT affirmed the order of the CIT(A).


On appeal, the HC held that,

• the Tribunal has rightly opined that the compensation was for the loss of future profits and for the development already undertaken by the assessee, the expenses in relation to such development having already been claimed and allowed as revenue expenditure. Thus, the Tribunal held that what was paid was for the deprivation of the potential income;
• the Tribunal rightly noted that there was not even a mention in the Agreement that the amount paid was towards the restrictive covenant and on the other hand a reading of the Settlement Agreement entered into between the parties clearly shows that the DCM had agreed to pay compensation for the "annulment of the very rights of KNA and ANSALS to carry on business of completing the project under the Principal Agreement and for being deprived of the potential income which could have arisen from carrying on such business, a sum of Rs.6.75 crores to KNA, which is inclusive of refund of Security Deposit of Rs.3.90 crores and a sum of Rs.8.25 crores to ANSALS, which is inclusive of refund of security deposit of 4 crores respectively………"
• undoubtedly, in the preceding clause, i.e. Clause 2, it is mentioned that KNA and ANSALS had agreed that they shall not undertake, without prior written consent of the DCM, similar projects in the vicinity of the said project for a period of 3 years from the date of the signing of the Agreement, but the sum of Rs.8.25 crores, as is clear from a cumulative reading of clauses 2 and 3 of the Agreement, was paid as compensation for the termination of the Agreement to carry on the business of completing the project under the "Principal Agreement" and "for being deprived of the potential income which could have arisen from carrying on such business." The intention of the parties, it is settled law, is conveyed by the terms of the Agreement. In the absence of any ambiguity in the Agreement, the Tribunal was fully justified in construing the intention of the parties;
• the scope and ambit of the restrictive covenant must be examined in the backdrop of the entire fact situation. On examination, it is found that the clause has limited significance, being to save the interest of the DCM, which was to develop the property as an absolute owner. By no stretch of imagination, such a clause was intended to divest the appellant of its income earning apparatus. Had the clause resulted in depriving the appellant of its income earning apparatus, and prohibited it from taking up a similar project anywhere in Delhi, there might have been some strength in the contention of the appellant that it had lost a capital asset and the amount which accrued to it for the loss of the capital asset must be viewed as a capital receipt not assessable to tax. This was not so; the Agreement between the parties was in the normal course of business. In other words, the normal incidence of business. Prohibition to carry on a similar project in the vicinity was on account of the nature of the business and was more by way of affording a safety valve to DCM;
• as regards the restrictive covenant, it cannot be lost sight of that what was prohibited was not to undertake similar project anywhere in or around Delhi, but not to undertake a similar project in the vicinity and that too for the limited duration of 3 years. This was subject to another rider. The restrictive clause was not to undertake a similar project in the vicinity of the existing project for a period of three years, without the written consent of the DCM. To be noted that with the approval of the DCM, it was open to the appellant to undertake a similar project, assuming the site for such a project to be available;
• the counsel for the appellant has sought to draw strength from the decision rendered by the Supreme Court in the case of Best & Co. Pvt. Ltd. where the duration of the restrictive covenant was five years. Yet, it was viewed by the Supreme Court as an independent obligation which came into operation on the termination of the agency and hence not taxable as a revenue receipt. But there is a marked difference in the facts of the said case when placed in juxtaposition to the facts of the instant case;
• in any case, the restriction placed was far from absolute in that it was to remain operative for a limited duration of time and pertained to a limited geographical area within the contours of Delhi. This apart, it was left open to the appellant to approach DCM for its written approval to the appellant carrying on a similar project in the vicinity (assuming such a project was available in the vicinity). Since all disputes were being set at rest, this undertaking appears to have been incorporated in an incidental manner so as to avoid any conflict of interest amongst the erstwhile partners in the project. Viewed from any angle, it is to be seen as a safety valve for the DCM rather than an absolute restriction on the appellant from carrying on its business. Even otherwise, it could hardly be said that given the nature of the restrictive covenant in the Agreement, the appellant was hampered from operating its profit making apparatus in other spheres and even in the very same sphere.