CA Mukesh Kohli & CA Pranav Kohli
Whether right to receive Compensation/damages for release of right to sue on account of breach of contract for sale of Land is chargeable to tax in the hands of recipient as Capital gains?
Introduction
The question that is posed above and required to be answered is whether the right to receive compensation/damages for release of right to sue on account of breach of contract for sale of capital assets is chargeable to tax in the hands of recipient as Capital gains?
Before answering the question, let us understand the meaning of the following terms under Income Tax Act, 1961 and other Laws-
- Capital Gain
- Capital Asset
- Transfer under Income Tax Act,1961
- Transfer under Transfer of Property Act, 1882
- Income under Income Tax Act,1961
Capital Gain
As per Section 45 of the Income Tax Act, 1961, capital gain means any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F , 54G and 54H, be chargeable to income-tax under the head “Capital gains”, and shall be deemed to be the income of the previous year in which the transfer took place.
Section 45 of the Income Tax Act,1961 is the charging section which prescribes that the profit or loss from the transfer of capital asset effected in previous year shall be chargeable to income tax under the head capital gain and it deems the capital gain to be the income of previous year in which the transfer takes place.
Capital Assets
Capital Asset means under section 2(14) of the Income Tax Act, 1961.
a. property of any kind held by an assessee, whether or not connected with his business or profession.
Transfer under Income Tax Act, 1961
As per Section 2(47) of the Income Tax Act, 1961 “Transfer”, in relation to a capital asset, includes, —
a) the sale, exchange or relinquishment of the asset; or
b) the extinguishment of any rights therein; or
c) the compulsory acquisition thereof under any law; or
d) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment; [or] the maturity or redemption of a zero-coupon bond; or]
e) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882); or
f) any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.
Transfer under Transfer of Property Act, 1882
Property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force—
(a) …
(b) …
(c) …
(d) …
(dd) …
(e) A mere right to sue cannot be transferred.
(f) …
(g) …
(h) …
(i) …
Income
The meaning of income can be classified on the basis of item specifically define as income under section 2(24). Anything which can be defined as income is taxable unless it is specifically exempted from tax. On the other hand, a receipt which cannot be termed as income cannot be taxed.
Compensation
Income includes the compensation due to or received by the following:
(a) Any person, who is wholly or substantially managing the affairs of an Indian company, for the termination of his management or for the modification of the terms and conditions relating thereto.
(b) Any person, who is managing the affairs of any other company in India, for the termination of his office or modification of the terms and conditions relating thereto.
(c) Any person, who is holding an agency in India for any part of the activities relating to the business of any other person, for the termination of the agency or the modification of the terms and conditions relating thereto.
(d) Any person for vesting of the management of any property or business in the government or in any corporation owned or controlled by the government.
(e) Any person for termination or modification of the terms and conditions of any contract relating to his business.
(f) In connection with the termination of his employment or the modification of the terms and conditions relating thereto.
Outline
Following amendments have been made in Finance Act, 2018 to tax compensation:
A. Amendment in Section 2(24)
Clause (xviib) was inserted by Finance Act, 2018 which state that “any compensation or other payment referred to in clause (xi) of sub-section (2) of Section 56.”
B. Amendment in Section 56
Section 56(2)(xi) was inserted by Finance Act, 2018 which state that “any compensation or other payment, due to or received by any person, by whatever name called, in connection with the termination of his employment or the modification of the terms and conditions relating thereto.”
C. Amendment in Section 28
Similarly clause (e) of Section 28(ii) was inserted by Finance Act, 2018 which state that “any compensation or other payment due to or received by any person by whatever name called, at or in connection with the termination or the modification of the terms and conditions, of any contract relating to his business.”
Conclusion
The Definition of Capital Assets in section 2(14) includes “property of any kind”. Similarly, section 6(e) of the Transfer of Property Act, 1882 uses the same expression “property of any kind” but excludes “mere right to sue” from its coverage. Hence the right to receive compensation/damage for release of right to sue on account of breach of contract is not chargeable to tax as the right to sue is not Capital Assets. It is evident that the right to sue for compensation is not an actionable claim and it cannot be assigned. The right to sue for damages for breach of contract no doubt is capable of maturing into a right to receive damage for breach of contract but that happens only where damages claimed for breach of contract are either admitted or decreed and not before. Hence mere right to sue does not contribute a Capital Asset.
“Further, all receipt are not taxable under the Income-tax Act. Section 2(24) defines income, it is no doubt that this is an inclusive definition, however, a capital receipt is not income u/s. 2(24) unless it is chargeable to tax as capital gain u/s. 45. It is for that reason that u/s. 2(24)(vi) the legislature has expressly stated that income shall include capital gain chargeable u/s, 45. Under section 2(24)(vi), the legislature has not included all capital gains as income. It is only capital gain chargeable u/s. 45 which has been treated as income u/s. 2(24). Further u/s. 2(24)(vi) the legislature has not stopped with the words any capital gains. On contrary, it is obviously stated that only capital gain which are taxable u/s. 45 could be treated as income. In other words, capital gain not chargeable to tax u/s 45 fall outside the definition of income in section 2(24). Therefore, the word chargeable u/s 45 are very important. So, whenever an amount which is otherwise a capital receipt is to be charged u/s. 2(24) and when specifically, so provides for not charging to capital gain for any reason u/s. 45, the same cannot be brought to tax as income by applying the general connation u/s 2(24).”
In the case of ITO vs Ganeshsagar Infrastructure Private Limited (2022) 135 taxmann.com 313 (Ahmadabad Tribunal), it was held that right to receive compensation/damages for release of right to sue on account of breach of contract for sale of land is not a capital asset and thus not chargeable to tax as capital gains.
Earlier in the case of Bhojison Infrastructure Pvt. Ltd. vs ITO (2018) 99 taxmann.com 26(Ahmadabad Tribunal), it was held hat right to sue in personam which cannot be transferred and thus amount received as compensation in lieu of said right is not chargeable to tax u/s 45.
Author Remarks
Even various amendments have been made in Section 2(24), Section 28 and Section 56 to tax compensation but none of these amendments made above give right to receive Compensation/damages for release of right to sue on account of breach of contract for sale of Land chargeable to tax in the hands of recipient under the head Capital gains.
Author Bio
Very informative article