Cooperative housing society's mesne profits from commercial premises ruled as non-taxable capital receipts

The ITAT Mumbai held that mesne profits received by a cooperative housing society from commercial premises constitute capital receipts and are not chargeable to tax. The tribunal noted divergent HC opinions on this issue and applied the principle that when two conflicting HC views exist, the one favorable to the assessee should be followed. The tribunal relied on judgments from Kerala HC and Calcutta HC treating mesne profits as capital receipts. The assessee's appeals were allowed, establishing that such receipts are not taxable as revenue income.

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The core legal question considered by the Tribunal was whether the Mesne Profits received by the assessee from the unauthorized occupation of its property constituted a capital receipt or a revenue receipt chargeable to tax under the Income Tax Act, 1961. Specifically, the issues were:

1. Whether the Mesne Profits of Rs. 2,00,00,000/- for A.Y. 2012-13 and Rs. 39,23,278/- for A.Y. 2014-15, awarded by the Small Causes Court and received by the assessee, are to be treated as capital receipts or revenue receipts.

2. Whether the interest component on the Mesne Profits is taxable as revenue income.

3. The applicability and interpretation of judicial precedents, including conflicting High Court decisions, on the nature of Mesne Profits in the context of income tax.

Issue-wise Detailed Analysis

1. Nature of Mesne Profits: Capital Receipt or Revenue ReceiptRs.

Relevant Legal Framework and Precedents: The Income Tax Act does not define "Mesne Profits". However, Section 2(12) of the Code of Civil Procedure, 1908 defines Mesne Profits as profits received or that could have been received by a person in wrongful possession of property, excluding profits due to improvements made by such person. The legal principle is that Mesne Profits represent damages or compensation payable for wrongful occupation of immovable property.

Several judicial precedents were considered. The Special Bench of the Tribunal in Narang Overseas P. Ltd. held that Mesne Profits, including interest, are capital receipts not chargeable to tax. The Hon'ble Bombay High Court in CIT vs. Goodwill Creators P. Ltd. affirmed this view. Similarly, the Kerala High Court in CIT vs. M/s Annamma Alexander and the Calcutta High Court in CIT vs. Smt. Leela Ghosh held that Mesne Profits are damages for deprivation of property and thus capital in nature.

Conversely, the Madras High Court in CIT vs. P. Mariappa Gounder held that Mesne Profits awarded for wrongful possession are taxable as income, a view followed by the Delhi High Court in Skyland Builders (P.) Ltd. The Delhi High Court relied on the Madras High Court decision and held Mesne Profits as revenue receipts under Section 23(1) of the Act.

Court's Interpretation and Reasoning: The Tribunal analyzed the nature of Mesne Profits as compensation for deprivation of use and occupation of capital assets, not as arrears of rent or income from property. The Tribunal emphasized that Mesne Profits are damages awarded for wrongful occupation, which is essentially a capital loss or deprivation suffered by the owner.

The Tribunal noted the divergent views of High Courts but preferred the reasoning in the Kerala and Calcutta High Court decisions, which considered the character of Mesne Profits as capital receipts. The Tribunal distinguished the Delhi High Court decision by highlighting that the Supreme Court in the P. Mariappa Gounder case had not dealt with the issue of capital versus revenue nature but only the year of taxability.

The Tribunal also relied on the principle that where there are conflicting High Court decisions, the view favorable to the assessee should be followed.

Key Evidence and Findings: The factual matrix showed that the Society was deprived of possession of its property by the Bank beyond the lease period and after loan repayment, leading to legal proceedings culminating in a decree awarding Mesne Profits at a rate much higher than the lease rent. The Mesne Profits were awarded as damages for wrongful occupation, not as arrears of rent.

The Tribunal observed that the Mesne Profits were not rental income but compensation for deprivation of capital asset use, supported by the decree and the legal history.

Application of Law to Facts: Applying the legal principles and precedents, the Tribunal concluded that the Mesne Profits received by the Society were capital receipts. The damages compensated the Society for loss of use of its capital asset (property), and thus the amount was not taxable as income under the Act.

Treatment of Competing Arguments: The Revenue relied on the Delhi High Court decision and the Madras High Court precedent to argue that Mesne Profits are taxable revenue receipts. The assessee relied on the Special Bench of the Tribunal, Bombay High Court, Kerala High Court, and Calcutta High Court decisions to support the capital receipt nature.

The Tribunal critically examined these decisions, noting that the Madras High Court decision did not consider important Supreme Court and Privy Council rulings and that the Delhi High Court's reliance on Madras High Court was limited to the issue of year of taxability, not nature of receipt. Thus, the Tribunal declined to follow the Revenue's line of argument.

2. Taxability of Interest on Mesne Profits

The Tribunal noted that the interest component on Mesne Profits, being part of the damages for wrongful possession, is also capital in nature. This view was supported by the Kerala High Court in Annamma Alexander and other decisions which held that interest received on Mesne Profits cannot be treated as revenue receipts.

3. Quantum of Mesne Profits and Interim Disbursement

The Tribunal noted the procedural history where the total Mesne Profits awarded were Rs. 3.32 crores, later reduced to Rs. 2.40 crores on appeal. The Society received an interim disbursement of Rs. 2 crores during the relevant assessment year. The CIT(A) reduced the addition accordingly, which the Tribunal accepted.

Significant Holdings

"The term 'mesne profits' relates to the damages or compensation recoverable from a person who has been in wrongful possession of immovable property. The Mesne profits are nothing but a compensation that a person in the unlawful possession of others property has to pay for such wrongful occupation to the owner of the property."

"The nature of deprivation suffered by the assessee is crucial for the purpose of determination of nature of receipt of mesne profits. Where the compensation is paid for deprivation of capital asset, or source of income, it would be a capital receipt in the hands of recipient of the compensation."

"In view of the aforesaid decisions and the way has been deferred by the two High Court the Reliance placed by the department in case of 'P. Mariappa Gounder' is not followed and accordingly, respectively following the judgment of Jurisdictional High Court in the case of Good Will Creators P. Ltd. this issue is decided in the favor of the Assessee."

"It is a well settled law that, if there are two divergent views of different High Courts, then one favour to the assessee should be followed. Accordingly, we hold that Mesne profit is treated as capital receipt not chargeable to tax."

The Tribunal ultimately held that the Mesne Profits and interest received by the Society for wrongful occupation of its property were capital receipts and not taxable as income under the Income Tax Act for the assessment years 2012-13 and 2014-15. The appeals filed by the assessee were allowed accordingly.

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