The Hon’ble Delhi Income Tax Appellate Tribunal (“ITAT”) held that compensation received pursuant to an arbitral settlement for relinquishment of the right to sue constitutes a capital receipt. The Tribunal observed that the right to sue, even if regarded as property, is inherently non-transferable and therefore does not qualify as a capital asset under the Income-tax Act. Consequently, such capital receipt, being incapable of transfer, is not chargeable to tax under the head “Capital Gains”.
The said decision was given in the case of Milan Saini vs DCIT, Circle-2, Gurgaon (Delhi ITAT)1, for the Assessment Year (AY) 2014-15.
Facts of the case
- Mr. Milan Saini (“Assessee”) along with Mr. Deepak Marda had proposed Cinepolis Group for development and operations of cinema multiplex theatres in India, post which, Cineplex Group established Cinepolis India Private Limited (“CIPL”).
- Cinepolis Group agreed to provide a fixed salary, along with equity in CIPL to the Assessee and Mr. Deepak Marda. These terms were documented via emails sent in October 2007 and the agreement dated November 06, 2007 (“the agreement”).
- The agreed remuneration/equity was continuously delayed by the Cinepolis Group. In the year 2012, Cinepolis group finally admitted that they will not be able to uphold the agreement. The Assessee along with Mr. Deepak Marda filed various civil and criminal proceedings against Cinepolis group on account of violation of the agreement.
- Cinepolis Group reached a settlement with the Assessee & Mr. Deepak Marda via an agreement dated November 12, 2013 (“the settlement agreement”) to pay INR 33.55 crores towards settlement of all disputes and the Assessee agreed to unconditionally and irrevocably relinquish all rights to any equity shares of CIPL along with withdrawal of all suits filed against Cinepolis Group.
- The Assessee received the agreed compensation in FY 2013-14. He assumed it as capital asset being relinquishment of rights & the interest in equity shares of CIPL, and disclosed it as Long Term Capital Gains (“LTCG”) in the Return of Income (“the return”).
- The Assessee received notice u/s 142(1) of the Income Tax Act, 1961 (“the Act”), contending that the compensation received was taxable u/s 28(iv) of the Act as profits and gains of business and profession (“PGBP”), alleging the same to be in lieu of professional services.
- The Assessee responded to the notice contending that the compensation is not liable to tax as its cost of acquisition cannot be determined. The Assessing Officer (“AO”) passed an order dated December 12, 2016 rejecting Assessee’s contention.
- The Assessee preferred appeal before Commissioner of Income Tax (“CIT(A)”) and submitted additional grounds of appeal that the compensation received is a capital receipt and thus not liable to tax. The CIT(A) dismissed the same via order dated January 22, 2018.
- The aggrieved Assessee preferred the appeal before Income Tax Appellate Tribunal (“ITAT”).
Assessee’s Contention
- The Assessee contended that the dominant purpose of the settlement agreement was to end all legal disputes, wherein the compensation given was decided basis mutual negotiations and not based on value of shares.
- Though the Assessee had offered to tax the compensation receipt as LTCG, he submitted that the cost of acquisition in this case is not determinable and hence the gains should not be taxable.
- Referring to multiple judgements (references given in footnotes), the Assessee claimed that ‘income’ connotes a periodical monetary return2 with expected regularity from definite sources. Though the definition of income is inclusive, it does not lose its natural connotation3. It is claimed that the compensation, being a capital receipt, is not income under section 2(24) of the Act unless it is taxed as capital gains under section 45 of the Act4.
- The Assessee further claimed that the right to sue for damages is not an actionable claim, incapable of being transferred5, thus it cannot quality as ‘consideration in lieu of a transfer’. Hence, reaffirming the claim that the compensation received is a capital receipt which is not taxable under capital gains6.
- The Assessee submitted that the compensation received was towards loss of source of income. As per section 28(ii)(e) of the Act, compensation received with respect to termination/change of terms of a contract related to business is taxable as business income with effect from AY 2019-20. However, the present case is related to FY 2013-14, which is prior to the aforesaid provision, thus supporting the claim that the same is a capital receipt not liable to tax7.
- The Assessee also contended that the rights in equity shares of CIPL could be considered as ‘capital asset’ and relinquishing that right could be considered as ‘transfer’ in terms of section 2(47) of the Act. Therefore, if at all the compensation received is taxable, it should be taxable as LTCG8. Mr. Deepak Marda who also received similar compensation from Cinepolis for relinquishing his rights to sue had claimed it as LTCG in Income Tax Return of AY 2014-15 which was accepted by the Revenue.
AO’s Contention
- The AO claimed that the compensation provided by Cinepolis Group is a benefit or perquisite arising from business, or exercise of profession, covered u/s 28(iv) of the Act. Thus, the same is taxable as business income under the head PGBP.
CIT(A)’s Contention
- CIT(A) contended that the compensation is taxable as salary, or, alternatively, PGBP (upholding the stance of AO), or, at last, STCG. However, CIT(A) held that it shall not be taxed as LTCG in any case.
Issues raised before the ITAT
- Whether compensation received by Assessee for relinquishing his right to sue is taxable?
- Whether compensation received by Assessee for relinquishing his right to sue is taxable?
- The Hon’ble ITAT observed that the compensation received by the Assessee was against relinquishment of right to sue and for settlement of disputes, pursuant to the settlement agreement.
- Further, the ITAT relied on the Supreme Court judgement CIT vs. J. Dalmia9 wherein it was held that the compensation received for relinquishing right to sue is a capital receipt and therefore not assessable as capital gains under the Act. It was also noted that the relinquishing of right to sue cannot be transferred.10
- As per section 45 [read with section 2(47)] of the Act, the receipt or accrual of income will attract capital gains tax only if it has occurred against ‘transfer’ of capital asset.
- Therefore, the ITAT set aside the order of CIT(A) and upheld that compensation received for relinquishing right to sue is not chargeable to tax under the Act.
The Hon’ble ITAT held that the compensation received for relinquishing right to sue cannot be transferred and hence out of purview of capital gains tax. It further concluded, that the same cannot be taxed as salary or business income as the same is a capital receipt and doesn’t fall under the definition of “income” as defined in the Act.
[1] [ITA No. 2335/Del/2018]
[2] CIT vs. Shaw Wallace and Company (SC)
[3] Emil Webber vs. CIT: 200 ITR 483
[4] Cadell Weaving Mills Company Ltd vs. CIT: 249 ITR 266 (Bombay HC),
CIT vs. D.P. Sandu Bros. Chembur (P.) Ltd.: 273 ITR 1 (SC)
[5] Baroda Cement & Chemicals Ltd. vs. CIT: [1986] 158 ITR 636 (Guj);
Lead Counsel of Qualified Settlement Fund (QSF): [2016] 381 ITR 1
[6] CIT vs. Abbasbhoy A. Dehgamwalla: [1992] 195 ITR 28 (Bombay)
[7] Kettlewell Bullen and Co. Ltd. v. CIT: (1964) 53 ITR 261 (SC)
[8] Hari Brothers Pvt. Ltd. vs. ITO: [1964] 52 ITR 399 (P&H),
Navin Jindal vs. ACIT: [2010] 320 ITR 708 (SC),
Chittharanjan A. Dasannacharya vs. CIT: [2020] 429 ITR 570 (Kar),
Simka Hotels & Resorts vs. DCIT: (2013) 213 Taxman 482,
CIT v. Vijay Flexible Containers: [1990] 186 ITR 693 (Bom),
Akash Poddar vs. ACIT: [2024] 165 taxmann.com 271
[9] CIT vs. J. Dalmia: 189 ITR 122 (SC)
[10] Hari Dass Sood v. Narinder Singh Oberai [R.F.A. (Ori.) No. 3 of 1977, Sidhrajbhai Sabbai v. State of Gujarat AIR 1963 SC 540
