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2025 (5) TMI 17 - AT - Income TaxNature of receipt - compensation received for under-performance of the WTGs installed by SEL - revenue or capital receipt not liable to tax - HELD THAT - As perused the decision of case of PCIT vs Xpro India Ltd. 2022 (6) TMI 961 - CALCUTTA HIGH COURT and find it to be squarely applicable to the facts of the present case. In that case the assessee had acquired a machinery from UK which failed to perform at the desired levels and therefore the assessee had claimed compensation from the supplier. The compensation so received for non-compliance with the performance parameter was treated to be capital receipt by the assessee. Though the AO agreed that the compensation receipt was capital in nature but adjusted the same against the cost of the machinery in terms of Explanation (10) to Section 43(1) of the Act. On appeal this Tribunal held that the compensation received from the UK supplier on account of under performance of the machinery was in the nature of capital receipt outside the purview of taxation. We also note that identical issue was also involved in the case of Ramkrishna Forgings Limited 2020 (3) TMI 1486 - ITAT KOLKATA wherein the compensation given by the suppliers for technical loss caused due to under-performance of the machines installed was held by the coordinate bench to be on capital account. Having to fact that the Revenue itself has acceded to the assessee s identical claim in the subsequent AY 2009-10 we hold that the compensation received from SEL for failure to meet the performance parameters is in capital field outside the purview of taxation. The AO is accordingly directed to exclude the same while computing the assessable income. Appeal of the assessee is allowed.
Issues Presented and Considered
The core legal questions considered by the Tribunal were:
Issue-wise Detailed Analysis 1. Nature of Compensation: Revenue Receipt or Capital Receipt? Legal Framework and Precedents: The Tribunal was guided primarily by the Supreme Court ruling in CIT vs. Saurashtra Cement Ltd., which held that compensation linked to procurement delays of capital assets, resulting in sterilization of the profit-earning apparatus, is a capital receipt. Additionally, decisions such as CIT vs. Rai Bahadur Jairam Valji (1959) 35 ITR 148 (SC), PCIT vs. Xpro India Ltd., and ACIT vs. Ramkrishna Forgings Ltd. were considered to differentiate between compensation for loss of profit (revenue) and compensation for impairment or sterilization of capital assets (capital). Court's Interpretation and Reasoning: The Tribunal noted that unlike the Saurashtra Cement case, where compensation was for delay in delivery of machinery (before use), in the present case the WTGs were installed and used, but failed to perform at guaranteed levels. The compensation was paid due to underperformance, not delay, and was quantified after the machines were operational. The Tribunal held that this compensation was directly connected to the business activity and was intended to offset losses arising from the WTGs' failure to meet performance guarantees. However, the Calcutta High Court found the Tribunal's distinction from Saurashtra Cement Ltd. to be incorrect, emphasizing that the ratio of the Supreme Court decision should be applied rather than the factual distinctions. The Court remanded the matter for reconsideration in light of the Supreme Court's legal principles. On reconsideration, the Tribunal carefully analyzed the nature of the compensation clause in the purchase contract, which guaranteed minimum generation levels for two years and provided for compensation at the MSEB power purchase rate for shortfalls. The Tribunal observed that the compensation was not a reimbursement or discount on the cost of the machinery but was paid due to the WTGs' failure to perform, which impaired the profit-earning capacity of the asset. Key Evidence and Findings: The purchase contract's generation guarantee clause, the invocation of the performance guarantee, arbitration proceedings, and payment of Rs. 19.28 crores compensation including encashment of bank guarantees were pivotal. The Tribunal also noted that the Revenue had accepted similar compensation as capital receipt in the subsequent assessment year without objection. Application of Law to Facts: Applying the principle from Saurashtra Cement Ltd., the Tribunal concluded that the compensation was for sterilization or impairment of the profit-earning capital asset (WTGs) and thus a capital receipt. The compensation was not linked to revenue loss in the ordinary course but to the failure of capital assets to perform as guaranteed. Treatment of Competing Arguments: The Revenue argued the compensation was revenue in nature, representing loss of revenue due to non-generation of power and the opportunity cost of purchasing power from MSEB. The Tribunal rejected this, finding the compensation was not for loss of profit but for non-fulfillment of performance parameters of capital assets. The assessee's reliance on Saurashtra Cement Ltd. and other precedents was upheld. Conclusion: The compensation received from SEL on account of failure to meet performance guarantees of WTGs is a capital receipt and not taxable as revenue income. 2. Whether Compensation Should Reduce the Cost of Machinery under Explanation (10) to Section 43(1) of the Act? Legal Framework and Precedents: Explanation (10) to Section 43(1) provides that if the cost of an asset is met directly or indirectly by the government or any other person, the actual cost shall be reduced accordingly. The Tribunal also considered the ruling in PCIT vs. Xpro India Ltd. and Ramkrishna Forgings Ltd. where compensation received for underperformance was not treated as reducing the cost of the asset. Court's Interpretation and Reasoning: The Tribunal found that the compensation from SEL was paid solely to compensate for the WTGs' failure to meet performance parameters and was not intended to subsidize or reimburse the cost of the machinery. There was no evidence that the cost of the machines was met directly or indirectly by SEL or any other party as required by Explanation (10). Key Evidence and Findings: Purchase contracts and settlement agreements showed no provision or indication that compensation was a discount or reimbursement of the purchase price. The compensation was linked to performance shortfall and was paid after the assets were in use. Application of Law to Facts: Since the compensation did not meet the conditions of Explanation (10), the Tribunal held that it should not reduce the cost of the machinery in the assessee's books. Treatment of Competing Arguments: The CIT(A) had directed reduction of the machinery cost by the compensation amount, but the Tribunal found this to be legally incorrect and reversed that order. Conclusion: The compensation received should not be reduced from the cost of machinery under Explanation (10) to Section 43(1). 3. Applicability of Judicial Precedents and Interpretation of Saurashtra Cement Ltd. Legal Framework and Precedents: The Supreme Court in Saurashtra Cement Ltd. laid down that compensation linked to delay in procurement of capital assets, which sterilizes the profit-earning apparatus, is capital receipt. The Court also emphasized the absence of a singular test to determine capital versus revenue receipts, requiring examination of facts in each case. Other precedents like Rai Bahadur Jairam Valji, PCIT vs. Xpro India Ltd., and Ramkrishna Forgings Ltd. were also considered. Court's Interpretation and Reasoning: The Tribunal initially distinguished Saurashtra Cement Ltd. on factual grounds but was directed by the Calcutta High Court to apply the legal ratio rather than focus on factual differences. On reconsideration, the Tribunal aligned its findings with the Supreme Court's legal principles, concluding that compensation for non-performance of capital assets impairs the profit-earning source and is capital in nature. Key Evidence and Findings: The Tribunal relied on the purchase contract terms, arbitration records, settlement deeds, and consistent judicial decisions to support its conclusion. Application of Law to Facts: The Tribunal applied the principles from Saurashtra Cement Ltd. and related cases to the facts, emphasizing the nature and purpose of the compensation rather than the mode of computation. Treatment of Competing Arguments: The Revenue's reliance on the AO's order treating compensation as revenue was rejected in light of the legal precedents and factual matrix. Conclusion: The legal principles established by the Supreme Court and other courts support treating the compensation as capital receipt. Significant Holdings "The compensation was given on Revenue account i.e. to reduce the running loss of the assessee and that too in the course of the business. Thus the impugned compensation has direct nexus with the business of the assessee" - earlier view of the Tribunal, which was set aside by the High Court. "The manner in which the Tribunal distinguished the decision in Saurashtra Cement Ltd. is incorrect. What is required to be considered by the Tribunal is the ratio laid down by the Hon'ble Supreme Court in the said decision and then test the case of the assessee as to whether the compensation received should be treated as a revenue receipt or a capital receipt." - Calcutta High Court. "Compensation paid for the delay in procurement of capital asset amounted to sterilization of the capital asset of the assessee... amount received by the assessee towards compensation for sterilization of the profit-earning source... was a capital receipt in the hands of the assessee." - Supreme Court in Saurashtra Cement Ltd. "The compensation was not computed with reference to the cost of the said machines. The compensation paid was neither in form of discount nor against the price nor it was in the nature of subsidy nor it was in the nature of the reimbursement." - Tribunal in Xpro India Ltd. "The compensation received from SEL for failure to meet the performance parameters is in capital field outside the purview of taxation." - Final holding of the Tribunal in the present case. Core Principles Established
Final Determinations on Each Issue
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