As we all know, nowadays builders and developers are frequently used to default in performing their obligation and the issue arises as to “what is the nature and character of the amount received by the assessee as liquidated damages from the developer on breach of contract by not allotting and handing over the developed plot/flat to the assessee as agreed upon in the Agreement”.

As per usual practice, assessee enters into an agreement with the developer for purchase of developed land/flat and pays the advance money / retention money to be adjusted against the consideration of plot/flat. It was also agreed upon that in case of failure on the part of developer due to non-performance of his part of contract, he will return the advances / retention money along with liquidated damages. Most of the time, damages are not recited in the agreement and matters goes to the arbitration who awards the damages. Hence, the issue arises as to whether the said amount is a receipt chargeable to tax as capital gains or as business receipt.

a) If the assessee caries on the business in the real estate then such receipt would constitute business receipt in his hands, chargeable to tax under the head “Profit & Gain of Business”. However if the amount has been paid by the assessee as an investment then the same would constitute a capital receipt.

b) Capital gains is chargeable to tax u/s. 45 of the Income-tax Act which lays down that any profit or gain arising from the transfer of a capital asset shall 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.

Dissection of this section requires that

i) there should be a capital asset

ii) there should be a transfer of capital asset and

iii) as a result of transfer there should be profit or gain which is chargeable to tax

c) The term “capital asset” has been defined in section 2(14) of the Income-tax Act which lays down that capital asset means property of any kind held by an assessee, whether or not connected with his business or profession.

d) The term “property” has not been defined either under the Income-tax Act or under the Transfer of Property Act (TPA in short). However the term “transfer of property” has been defined in Section 5 of TPA as –

“Transfer of property means an act by which a living person conveys property in present or in future to one or more other living persons and to transfer property is to perform such act.”

e) Sec. 6 of TPA prescribes as to what may be transferred. It lays down that 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. However, section 6 also carves out certain exceptions as to what may not be transferred; one of the exceptions carved out is in sub-clause {e} which lays down that “a mere right to sue cannot be transferred”.

f) “Property” is a bundle of rights, which an owner can lawfully exercise to the exclusion of all others. He is entitled to use and enjoy it as he pleases provided he does not infringe any law of the State.

g) In any case, the definition of capital asset requires existence of property of any description and such property must be held by an assessee.

Whether right to obtain conveyance of immovable property is a property ?

h) A contract for sale of land is capable of specific performance; it is also assignable and therefore, a right to obtain conveyance of im movable property is a property within the meaning of 2(14} of the Act as held by the
Bombay High Court in CIT v. Tata Services Ltd., {1980) 122 ITR 595 (Bom).

In this case, assessee transferred and assigned its right, title and interest under the agreement to purchase 5,000 sq. yd. of a residential plot and received the consideration over and above the earnest money paid by it to the vendor. The Hon’ble Court held that the amount received by the assessee over and above the earnest money could not be claimed to have been received by way of compensation or damages for breach of the agreement of sale. The amount was received by the assessee as consideration for assigning its right under the agreement to the third party and therefore, the said right clearly fell within the definition of “capital asset” under Section 2(14) of the Act. The said judgment has been followed by the Bombay High Court in

CIT v. Sterling Investment Corporation, {1980) 123 ITR 441 (Bom.)

CIT v. Vijay Flexible Containers, {1990) 186 ITR 693, 697 (Bom.)

i) However Hon’ble Delhi High Court in the case of CIT v. R. Dalmia, (1987) 163 ITR 517 have held that the right acquired by the assessee under an agreement to sell is not a proprietary right and the same is not a capital asset, relying upon its own judgment in the case of CIT v. J. Dalmia, (1984} 149 ITR 215 (Del.), Special Leave Petition dismissed by the Supreme Court in (1991) 181 ITR (St.) 122 (SC).

In the case of J. Dalmia, the assessee entered into an agreement with the contractors (who were the owners) for the construction of a building and sale thereof to him for a consideration of ₹ 4,95,000/-, out of which earnest money of ₹ 20,000/- was paid to the contractors. Contractors defaulted in performing their part of the contract and the arbitrator awarded ₹ 1,02,500/- as damages. The issue arose as to whether the said amount received by the assessee as damages is a “property of any kind” and thus a “capital asset” under Section 2(14) of the Act. Hon’ble Delhi High Court distinguished the judgment of Bombay High Court in the case of Tata Services Ltd. and held that Section 54 of the TPA lays down that a contract for sale of an immovable property does not by itself create any interest in or charge on such property. In Siddharthbhai v. State of Gujarat (AIR 1963 SC 540) it was held that the word “Property” in Article 19(l)(f) must doubtless be extended to all those recognised types of interest which have the insignia or characteristic of proprietary rights. There was a breach of contract and the assessee received the damages in satisfaction thereof. He had a mere right to sue for damages. Assuming the same to be “property” this could not be transferred under section 6{e) of TPA, which says that “a mere right to sue cannot be transferred”. Transfer under section 2(47) includes “sale, exchange or relinquishment of the asset or the extinguishment of any rights therein”. The damages received by the assessee cannot be said to be on account of relinquishment of any of his asset or on account of extinguishment of his right of specific performance under the contract for sale.

Hon’ble Court further held, “under section 5 of TPA, transfer of “property” means an act by which a person conveys property to another and “to transfer property” is to perform such act. A mere right to sue may or may not be property but it certainly cannot be transferred. There cannot be any dispute with the proposition that in order that a receipt or accrual of income may attract the charge of tax on capital gains the sine qua non is that the receipt or accrual must have originated in a “transfer” within the meaning of section 45 read with section 2(47) of the Act. Since there could not be any transfer in the instant case, it has to be held that the amount of ₹ 1,02,500/­ received by the assessee as damages was not assessable as capital gains.”

j) A right to sue for damages for breach of a contract does not constitute a “capital asset” as held by Bombay High Court in

CIT v. Abbas Bhoy A. Dehgamwalla, (1992) 195 ITR 28, 35

Bharat Forge Co. Ltd. v. CIT, {1994} 205 ITR 339, 350.

k) In the first cited case, the Bombay High Court held that it is a trite law that income can be held to accrue, when the assessee acquires a right to receive the income. Despite the definition of the expression “capital asset” in the widest expression in section 2(14), a right to a capital asset must fall within the expression “property of any kind” and must not fall within the exceptions. Section 6 of TPA which uses the same expression “property of any kind” in the context of transferability makes an exception in the case of a mere right to sue. It is abundantly clear that the right to sue for damages is not an actionable claim. It cannot be assigned. Transfer of such a right is as much opposed to public policy as is gambling in litigation . Therefore, it will not be quite correct to say that such a right constituted a “capital asset” which in turn has to be an interest in “property of any kind”. The right to sue for damages for breach of contract no doubt is capable of maturing into a right to receive damages for breach of contract. But that happens only Where the damages claimed for breach of contract are either admitted or decreed and not before. Accordingly, Hon’ble Court held that mere right to sue does not constitute a “capital asset”. This judgment has been relied upon by the Bombay High Court in the case of Bharat Forge Co. Ltd.

l) For invoking the provisions of Section 45, the second ingredient is that there should be “transfer” of “capital asset”. The term “transfer” in relation to a “capital asset” has been defined in section 2(47) as – “Transfer’ includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein”.

m) In Patel Brass Ltd. v. CIT (2006) 286 ITR 598 (Guj.), Hon’ble Gujarat High Court observed that the scheme of Income-tax Act, 1961 envisages a conjoint reading of provisions of sections 45, 2(47) and 2(14) thereof. For capital gains or capital loss, the essential requirements are that there should be a “transfer” of a “capital asset” effected in the previous year. Transfer has been defined in relation to a capital asset, to include various contingencies stipulated by sub-clauses of section 2(47) of the Act. Sub-clause (ii) of Section 2(47) of the Act states that “transfer” includes the extinguishment of any rights therein. That requires assigning meaning to the term “therein”. In other words, for the purpose of transfer of a capital asset, it would suffice if there is extinguishment of any rights in a capital asset. However, even for the purpose of extinguishment of any right, existence of a capital asset is a must.

In this case, assessee had entered into a contract for purchase of machinery. The contract was in subsistence till the point of time the assessee cancelled the cont ract. Therefore, till that point of time, the assessee did not have any right which could be termed to be the property so as to fall within the definition of “capital asset” as defined in section 2(14) of the Act. The right that the assessee had till that point of time, was to make payment of balance amount and take delivery of machinery i.e. assessee was to perform its part of contract and to seek performance of the contract from its supplier. This could not be termed to be a “capital asset”, howsoever wide the definition of “property” may be cast. Hon’ble Court has relied upon the judgment of Bombay High Court in the case of Bharat Forge Co. Ltd. vs. CIT, (1994) 205 ITR 339 (Bom).

n) In CIT v. Saurashtra Cement Ltd. {2010) 11 sec. 84 (SC), Supplier defaulted and failed to supply plant and machinery on scheduled time and, therefore, as per terms of contract, assessee received liquidated damages. Issue arose : Whether, receipt relating to liquidated damages could be treated as revenue receipt or capital receipt?

Hon’ble Supreme Court held that damages to assessee was directly and intimately linked with procurement of a capital asset i.e. cement plant – Compensation paid for delay in procurement of capital asset amounted to sterilisation of capital asset of assessee as supplier had failed to supply plant within time as stipulated in agreement – Amount received by assessee towards compensation for sterilisation of profit earning of source, not in ordinary course of their business, thus it was capital receipt in hands of assessee.

o) In Dhruv N. Shah v. DCIT, (2004) 88 ITD 118 (Mum.), the assessee entered into agreement for purchasing a flat from MBPL and for which the assessee paid part of purchase consideration. For obtaining no objection certificate under section 269UC relevant form were filed but before the approval two trespassers forcibly obtained possession of said flat on basis of an earlier agreement with TPPL. After filing suit the assessee received purchased price and also certain amount termed as liquidated damages from MBPL for mental agony and tension. The Commissioner brought into the tax liquidated damages to capital gains after invoking section 263 holding the same as revenue receipt.

ITAT Mumbai held that on the facts of the case, the MBPL had no right, title or interest in the subject property and, therefore, there was neither capital assets under section 2(14) nor there was “transfer” within the meaning of section 2(47). Therefore, what was received by the assessee on or above the purchase consideration (termed as liquidated damages) was for mental tension and agony therefore, same was not chargeable to capital gains tax.

p) In CIT v. Barium Chemicals Ltd., 168 ITR 164 (AP), assessee entered into contract by which English company was required to erect barium chemical plant for assessee – during trial it was found that plant and machinery did not confirm agreed specification and design . The issue arose: Whether the amount received by assessee from English company for non-fulfilment of contract (deficiencies of production units) is capital receipt or income?

Andhra Pradesh High Court held that the amount received amounts to capital receipt. As there was no transfer of any capital asset as envisaged under Section 45, the receipt cannot be termed as capital gains. Amount paid by assessee should be deemed as capital expenditure whereas damages received by assessee as capital receipt.

q) In CIT v. Hiralal ManilaI Mody {131 ITR 421) (Guj), assessee entered into an agreement with one Modi Kalidas Hargovandas and Another for the purchase of an immovable property. The agreement was entered into in 1956, and under the terms of the agreement, the sellers had to execute the deed of conveyance within a period of three years. The vendors failed to execute the deed of conveyance as stipulated. Issue arose : Whether Tribunal justified in holding that impugned amount having been received by assessee by way of damages on account of breach of agreement committed by sellers not to be treated as assessee’s income?

Gujarat High Court held that the said amount represented damages which vendors had agreed to pay to assessee. The said amount was by way of damages for loss of good bargain which assessee had to forgo as vendors were not prepared to execute conveyance deed.

r) In Swami Motor Transport (P) Ltd. and Anr. v. Sri Sankaraswamigal Mutt and Anr., AIR 1963 SC 864 (SC), Hon’ble Supreme Court have observed that it is settled law that a contract to purchase a property does not create an interest in immovable property.

s) Section 54 of Transfer of Property Act lays down that

“Contract for Sale – A contract for the sale of immovable property is a contract that a sale of such property shall take place on terms settled between the parties.

It does not, of itself, create any interest in or charge on such property.”

t) Section 73 of the Contract Act says that when a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation or any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.

In view of above discussion, it appears that compensation/ damages are given due to breach of contract and not on account of any transfer of any capital asset so as to attract the provisions of section 45 of the Act. Hence, it may be treated as capital receipt, not chargeable to tax.


Life is a difficult game. You can win it only by retaining your birthright to be a person.

— Dr. A. P. J. Abdul Kalam

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