2025 (4) TMI 1616 - AT - Income Tax

Nature of receipt - Compensation in lieu of the right to sue awarded by way of damage suit by order of the Hon ble High Court - revenue of capital receipt - HELD THAT - As relying on Shri Virendra Bhavanji Gala 2023 (9) TMI 746 - ITAT MUMBAI and Vijay Flexi Containers 1989 (9) TMI 16 - BOMBAY HIGH COURT amount of compensation received is capital receipt is upheld and consequently the grounds raised by the Revenue are dismissed.

Summary

The core legal questions considered by the Tribunal in these appeals filed by the Revenue against the orders of the NFAC, Delhi, concern the taxability of compensation amounts received by individual assessees pursuant to a consent decree dated 10/07/2017. The compensation was awarded in a damage suit related to aborted real estate projects and the surrender of the 'right to sue' for specific performance. The principal issues are:

1. Whether the compensation amount received pursuant to the consent decree can be taxed under the head 'capital gain' as income arising from transfer of a capital asset under Section 45 of the Income Tax Act.

2. Whether the compensation represents a transfer of a capital asset or is merely a capital receipt arising from the relinquishment of a 'mere right to sue', which is non-transferable under Section 6(e) of the Transfer of Property Act, 1882.

3. Whether the judgments of the Hon'ble Bombay High Court in CIT v. Vijay Flexible Containers and the Hon'ble Gujarat High Court in Baroda Cement & Chemical Ltd are applicable to the facts of the present case.

4. Whether the appellate orders holding the compensation as non-taxable capital receipt are justified in law and fact.

Issue-wise Detailed Analysis:

Issue 1 & 2: Taxability of Compensation under Capital Gains and Nature of Right Transferred

The relevant legal framework involves Section 45 of the Income Tax Act which taxes income arising from the transfer of a capital asset, and Section 2(14) defining 'capital asset'. Section 2(47) defines 'transfer' to include sale, exchange, relinquishment, or extinguishment of any rights in a capital asset. The Transfer of Property Act, 1882, Section 6, is critical as it enumerates what kinds of property may be transferred and explicitly excludes a 'mere right to sue' from transferability.

The Tribunal examined the facts that the assessees had entered into Memorandum of Understanding (MOU) to purchase commercial space in a project that was later aborted. The assessees paid advance amounts but the project did not materialize. The assessees filed suits for damages and specific performance, but the Hon'ble Bombay High Court passed a consent decree awarding compensation in lieu of the 'right to sue' because specific performance was impossible.

The Tribunal relied on the consent decree's explicit language that the 'specific performance of the allotment was not possible' and the compensation was 'in lieu of the plaintiff's right to sue'. This fact was pivotal because, under Section 6(e) of the Transfer of Property Act, a mere right to sue is not transferable and thus cannot constitute a capital asset for purposes of capital gains tax.

The Tribunal further analyzed the distinction between a 'right to sue' and a substantive right in immovable property. The compensation was not for transfer of any interest in property but for relinquishment of the right to litigate for specific performance. Therefore, the receipt was a capital receipt and not taxable under capital gains provisions.

Competing arguments centered on the Revenue's reliance on the Bombay High Court decision in CIT v. Vijay Flexible Containers, which held that compensation received on relinquishment of a right under an agreement for sale of immovable property was taxable as capital gains. However, the Tribunal distinguished that case on facts: in Vijay Flexible Containers, specific performance was possible and the right to the immovable property was substantive and transferable, unlike the present case where specific performance was impossible and only a right to sue existed.

Issue 3: Applicability of Precedents

The Tribunal considered two key High Court decisions:

(a) CIT v. Abbasbhoy A. Dehgamwalla (Bombay High Court): The Court held that compensation received for breach of contract where specific performance was refused is a non-chargeable capital receipt because the right to sue for damages is not an actionable claim and cannot be assigned or transferred. The compensation is not consideration for transfer of a capital asset.

(b) Baroda Cement & Chemicals Ltd. v. CIT (Gujarat High Court): It was held that once the breach of contract occurs and the subject matter is disposed of by the defaulting party, the injured party is left only with the right to sue for damages, which is not a capital asset. Compensation received is not taxable as capital gains since there is no transfer of capital asset and no cost incurred by the taxpayer to compute gains.

The Tribunal noted that these precedents support the assessee's position that the compensation received is a capital receipt and not taxable under capital gains.

Regarding Vijay Flexible Containers, the Tribunal emphasized that this decision applies where the right to specific performance exists and is transferable, and the claimant relinquishes this right in exchange for damages. Since the present case involved an aborted project where specific performance was impossible, Vijay Flexible Containers was held inapplicable.

Issue 4: Justification of Appellate Orders

The Assessing Officer had reopened assessments under Section 148 and taxed the compensation as capital gains, relying on Vijay Flexible Containers. However, the CIT(A) deleted the addition relying on the Tribunal's earlier decision in the case of one of the affected assessees (Virendra Gala), which held the compensation as non-taxable capital receipt. The Tribunal affirmed this view after detailed examination of facts and law.

The Tribunal found that the Commissioner of Income Tax's revisionary order under Section 263, which set aside the assessment relying on Vijay Flexible Containers, was erroneous and not sustainable on facts. The Tribunal held that the power under Section 263 could not be exercised where the legal position was debatable and the assessment order was not erroneous or prejudicial to the Revenue's interest.

The Tribunal upheld the CIT(A) and ITAT orders, dismissing the Revenue's appeals and confirming that the compensation received pursuant to the consent decree is a capital receipt not chargeable to tax under capital gains.

Significant Holdings:

"The compensation received by the appellant is in lieu of the right to sue. In the facts of this case, the specific performance was not at all possible. Thus, the compensation received is not due to relinquishment of any rights in capital assets. The right to sue is not a transferable right as per the provisions of the Transfer of Property Act. Therefore, the compensation received is not liable to be taxed as per the provisions of Section 45 of the Income Tax Act, as the conditions stipulated therein are not fulfilled."

"Section 6(e) 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' under Section 5 of the Transfer of Property Act, transfer of property means the act by which a person conveys a property to another. The mere right to sue may or may not be property but certainly it cannot be transferred as per law."

"The right to receive compensation is a statutory right acquired on establishment of breach of contract and is a mere right to sue. Such right to sue for damages is not an actionable claim and cannot be assigned. Transfer of such right is opposed to public policy as is gambling in litigation. It is not correct to say that such right constitutes a capital asset within the meaning of the Income Tax Act."

"The agreement for sale of immovable property itself does not create any right, title or interest in the immovable property but creates a right to obtain performance of the agreement by approaching the Court of law for specific performance. It is that limited right which is recognized by law. Once specific performance is refused, the alternative claim for damages is a compensation in lieu of specific performance and cannot be taxed as capital gains."

"The Tribunal was not justified in holding that the order passed by the Assessing Officer was erroneous and prejudicial to the interest of the Revenue and that the Commissioner of Income Tax was justified in exercising jurisdiction under Section 263 of the Income Tax Act. The amount of compensation received by the appellant was not liable to capital gains tax."

"The judgment in CIT v. Vijay Flexible Containers is distinguishable on facts and not applicable where specific performance was not possible and compensation was awarded in lieu of the right to sue."

In conclusion, the Tribunal established the principle that compensation received pursuant to a consent decree in lieu of a mere right to sue, where specific performance of an agreement to sell immovable property is impossible, is a capital receipt and not taxable as capital gains. The 'right to sue' is not a capital asset transferable under the Income Tax Act or the Transfer of Property Act. The competing precedents were carefully analyzed and distinguished, and the Revenue's reliance on Vijay Flexible Containers was rejected as factually inapplicable. The Tribunal upheld the deletion of capital gains tax demand and dismissed the Revenue's appeals accordingly.