2015 (1) TMI 199 - HC - Income Tax

Appeal outcome: Notice validity and interest levy against appellant, compensation as capital receipt deducted from asset value.

The Elegant Chemicals Enterprises Private Limited Versus The Assistant Commissioner of Income Tax

The appeal was partly allowed with the following outcomes: the validity of the notice under Section 148 and the levy of interest under Section 234B were ... Compensation received form P&G for sterilization of the assets – Revenue receipt or capital receipt - Termination of contract between assessee and P&G – Held that:- The distinction between the capital receipt on the one hand, and the revenue receipt on the other hand, is not that easy to maintain - obviously because, the implication of the classification of the amounts received by the assessee into either of the categories would entail in serious consequences, acute attention is paid both by the assessee and the AO higher the amount and greater the compensation – in Commissioner Of Income-Tax Versus Barium Chemicals Limited [1987 (2) TMI 18 - ANDHRA PRADESH High Court] it has been held that in order to decide whether or not a payment is a revenue receipt, its true nature and substance must be looked into – assessee has been manufacturing the product as and when orders are placed in ordinary course of business - The one, as regards which the payment was made, is not as a contract or order of that nature - M/s. P&G wanted the appellant to produce a product as regards which it i.e., appellant does not have the arrangement or machinery - an equipment with altogether different specifications was to be acquired only, to meet the needs of M/s. P&G. Barring that, there was no other necessity for the appellant to install that machinery - Obviously for that reason, the agency agreed to provide funds for installation - the machinery was installed and hardly before the test run was completed, M/s. P&G resiled from the contract. The new machinery installed by the appellant was exclusively for the purpose of manufacturing a specialized product and the contract in that behalf was terminated even before the production has commenced - the amount received by the appellant from M/s. P&G being ₹ 87,33,056/- certainly deserves to be treated as capital receipt - the amount cannot be kept outside the purview of the taxation - The machinery installed for manufacturing the new product has already become part of assets - the written down value of the assets has been fixed - once the appellant has the advantage of receiving a sum towards installation of machinery alone, the same deserves to be deducted from the WDV, to the extent it has been added to the value of block assets - It would have its own impact upon the amount of depreciation to be allowed on the block assets – Decided partly in favour of assessee. Issues Involved:1. Validity of notice under Section 148 of the Income Tax Act, 1961 for reopening an assessment.2. Legality of interest levy under Section 234B of the Income Tax Act.3. Classification of compensation received as capital or revenue receipt.4. Consideration of alternative plea for adjustment in the gross block of assets.Detailed Analysis:Issue 1: Validity of Notice under Section 148The appellant did not press this issue, acknowledging that it should be answered against them in light of the Supreme Court judgment in Assistant Commissioner of Income Tax v. Rajesh Jhaveri Stock Brokers P. Ltd. [2007] 291 ITR 500 (SC).Issue 2: Levy of Interest under Section 234BSimilarly, the appellant did not press this issue, and it was not considered further.Issue 3: Classification of Compensation as Capital or Revenue ReceiptThe primary contention was whether the compensation amount received from M/s. P&G for the termination of the contract should be treated as a capital receipt or a revenue receipt. The appellant argued that the amount was not received in the ordinary course of business but was meant for the installation of new machinery specifically for producing Vicks 1000. They cited the judgment in Commissioner of Income Tax v. Barium Chemicals Ltd 168 ITR 164, asserting that the compensation was for the sterilization of assets, thus qualifying as a capital receipt.The respondent countered by stating that the order from M/s. P&G was in the ordinary course of business and that the compensation was for business loss, thus a revenue receipt. They referenced the Supreme Court case Commissioner of Income Tax, Nagpur v. Rai Bahadur Jairam Valji 35 ITR 148.The court reviewed the distinction between capital and revenue receipts, emphasizing that the nature and substance of the payment must be examined. Payments received in the ordinary course of business for loss of stock-in-trade are revenue receipts, while compensation for the sterilization of profit-earning sources is a capital receipt. The court found that the machinery was installed specifically for M/s. P&G and not for any other business necessity. Therefore, the compensation received was for the sterilization of a capital asset, making it a capital receipt.Issue 4: Alternative Plea for Adjustment in the Gross Block of AssetsThis issue was considered as a facet of the third issue. The court noted that while the compensation amount should be treated as a capital receipt, it should not be excluded from taxation. The amount received should be deducted from the written down value (WDV) of the assets, impacting the depreciation allowed on the block assets.Conclusion:The appeal was partly allowed:- Questions 1 and 2 were answered against the appellant.- Question 3 was answered in favor of the appellant, classifying the compensation as a capital receipt.- Question 4 was addressed by stating that the compensation amount should be deducted from the WDV of the assets.The miscellaneous petitions filed in this appeal were also disposed of, and there was no order as to costs.