EVOS DESIGN LIVING PRIVATE LIMITED,CHENNAI vs. DCIT, CHENNAI

According to the assessee, the total income for the year, predominantly consisted of taxable Long Term Capital Gain that had arisen on account of the Joint Development Agreement entered with M/s.SAS Hotels & Enterprises Pvt. Ltd. on a land parcel admeasuring 2.69 acres located at TS No.105, Adambakkam Village, Alandur Town, Chennai – 600 016. It was stated that the land was originally owned by M/s.VAK Engineering Pvt. Ltd. and was given on lease to M/s.Evolv Clothing Company Pvt. Ltd., a company engaged in the business of manufacture and supply of garments. As a tenant, it erected a factory building over the said land and operating its manufacturing activities in it.

By the scheme of Demerger approved by the Hon’ble High Court of Madras vide its Order dated 24.07.2017, the land devolved on the assessee together with the tenant (M/s.Evolv Clothing Co. Pvt. Ltd.) from M/s.VAK Engineering Pvt.Ltd. The land was held as Fixed Assets in the books of the company. Since the land was not held as ‘Stock-in-Trade’ but only as a fixed asset in the books of the assessee, the resultant gain was offered to tax by the assessee under ‘Long-term Capital Gains’.

The computation of LTCG adopted by the assessee arriving at a total income of Rs.69,09,53,500/- which constituted LTCG of Rs.67,12,83,589/- is tabulated below:

The assessee declared that the compensation was paid towards M/s.Evolv Clothing Co. Pvt. Ltd., towards the loss incurred on account of relinquishment of the factory building to pay for the Joint Development being a sum of Rs.3,18,53,014/- and an additional compensation towards relocation charges of Rs.1,19,09,233/-. These payments were made through banking channels and the same were accounted in the books of M/s.Evolv Clothing Co. Pvt. Ltd. and the WDV in the Fixed Asset Schedule of that company was modified accordingly.

The AO had reopened the assessment for A.Y.2017-18 and accordingly the Notice u/s.148 of the Act was issued on 30.03.2021. The reason for reopening the assessment, as extracted from the assessment order dated 30.03.2022 is that since the property development is in the nature of the business of the assessee, the profit on sale of the aforementioned land is to be treated as ‘Profits and Gains from Business’ (PGBP) instead of ‘Long-term Capital Gains’ (LTCG) and was proposed to be taxed accordingly. Consequent to the receipt of reasoning, the same were objected to by the assessee.

The ld.AR for the assessee stated that, without offering any rebuttal to the objections of the assessee, the FAO, NFAC, Delhi proceeded to make an assessment u/s.147 r.w.s 144B dt. 30.03.2022. In the said order, the long Term capital gain shown by the assessee was Rs.67,67,07,524/- substituted with a value of Rs.74,21,96,126/-. This was categorized as ‘Business Profit’ and brought to tax. Even the cost of land and other costs, which were supported by corresponding payments & documentation, were not allowed while determining the business profit.

Aggrieved by the said order, the assessee had approached the Hon’ble High Court of Madras invoking the Writ Jurisdiction and the Court disposing WP

It is under such circumstances that the present Order being contested by the assessee before this Tribunal was passed on 28.06.2023 u/s.147 r.w.s 260 of the Act. The principal bone of contention is whether the impugned transaction is in the nature of Capital Gains or business profit.

The AO appreciated that the assessee did not get involved in the property development in any manner and on considering the submissions made by the assessee, the AO concluded that the incomes that accrued on account of JDA with the Developer as LTCG and not the business profit. The qualification to such effect was drawn by the AO in Para 3.6 of the assessment order dated 28.06.2023 which concluded that considering the facts and submission of the assessee as well as other documents on record, the contention that the incomes accruing to the assessee as its share in the revenue on account of sale of the apartment flats which were developed in the land owned by the assessee through a JDA with a Developer is capital gain and not business income to be in order.

However, the AO proceeded to disallow the indexed cost that relates to the compensation paid to M/s.Evolv Clothing Company Ltd. totalling Rs.5,12,46,431/-. According to the AO, the payments made as compensation for relocation of M/s.Evolv Clothing Company Pvt. Ltd. does not find a mention in the JDA and thus the AO was not satisfied that the amount paid by VAK Engineering Ltd. to Evolv Clothing Co. Pvt. Ltd. was for compensation to relocate the factory. Therefore, the compensation paid was not allowed as cost of improvement and added to the total income under the head ‘LTCG’. Accordingly, the income returned u/s.148 of the Act of Rs.69,09,53,500/- increased to Rs.74,21,99,931/-.

Dissatisfied with the Order, the assessee preferred an appeal before the ld.CIT(A). The ld.CIT(A) was appraised that any compensation paid to vacate

The assessee submitted that the payments made to vacate the tenant is to be allowed as cost. However, the ld.CIT(A) upheld the position taken by the AO on a finding that such expenses qualify for deduction only in case of existence of an encumbrance by passing an order dated 30.06.2026. According to the ld.CIT(A), since the impugned payment was not mandated by any binding legal obligation or that such expenditure constituted unavoidable expenditure for transfer, the same were not to be allowed.

The assessee stated that the fact that the recipients had also treated the income in their hands was found insignificant to the ld.CIT(A) and therefore the reasoning adopted by the AO was, according to the ld.CIT(A), logical and sustainable. Thus, the grounds of appeal of the appellant were dismissed.

Aggrieved by the aforesaid dismissal, the assessee is in appeal before us by raising the specific grounds are reproduced below:

The Ld.AR for the assessee assailing the action of the ld.CIT(A), advanced arguments and supported the case of the assessee with various case laws and furnished various documents containing workings / computations etc.

The ld.AR further stated that there was a compulsion to make such payment was additionally proven by the fact that the developer M/s.SAS Hotels & Enterprises Ltd. had also paid a sum of Rs.3 crores as compensation directly to the tenant in the month of April 2016. Though the fact that there was an obligation to pay compensation was proven, the same were discarded by the AO & ld.CIT(A) and the addition according to the ld.AR was sustained in an arbitrary manner without any reason.

On the procedural infirmity involved in the conclusion of assessment, the ld.AR submitted that the original reasons for reopening have been abrogated and do not facilitate additions to total income on issues outside the scope of reopening. In such an event, when the reasons for reopening stood defeated, the AO is not empowered to proceed any further.

In this regard, the ld.AR relied upon the decision rendered by the Coordinate Bench of the Chennai Tribunal in the case of Income-tax Officer vs. Ambattur Constructions (P.) Ltd. [2025] 173 taxmann.com 432 (Chennai - Trib.) [25.03.2025] to plead that this legal ground stands in favour of the assessee. In view of the above arguments and submissions, the ld.AR prayed for setting aside the order of the ld.CIT(A) by allowing the appeal of the assessee.

We have heard the rival submissions, perused the material available on record, examined the orders of the lower authorities and considered the judicial precedents relied upon by both parties. The principal issue arising for our consideration is whether the indexed cost of compensation paid to M/s. Evolv Clothing Company Pvt. Ltd. towards relinquishment of its factory building and relocation of its manufacturing facility is allowable while computing the long- term capital gains arising from the transfer of the impugned property.

It is an undisputed fact that M/s.Evolv Clothing Company Pvt. Ltd. was occupying the property as a tenant and had erected a factory building thereon for carrying on its manufacturing activities. The assessee was required to ensure that the property was made available to the developer under the JDA, free from the occupation and claims of the existing tenant, so as to facilitate the proposed development. In these circumstances, the compensation paid towards relinquishment of the factory building and relocation of the tenant's manufacturing facility cannot be viewed as an expenditure devoid of commercial justification. On the contrary, such payments were intrinsically connected with the proposed development and the realisation of the value of the property through the JDA.

We further find that the assessee has furnished material to substantiate the genuineness of the tenancy, the actual payment of compensation through banking channels and the corresponding accounting treatment in the books of the recipient company. It is also brought on record that the developer, M/s.SAS Hotels & Enterprises Pvt. Ltd., had independently paid compensation of Rs.3 crore directly to the tenant in April 2016. This circumstance lends further support to the assessee's contention that the relinquishment of the tenant's occupation and the relocation of its manufacturing facility formed part of the commercial arrangements connected with the proposed development. Neither the AO nor the ld.CIT(A) has brought any cogent material on record to establish that the payments made by the assessee were fictitious, non-genuine or lacking in

We are unable to subscribe to the reasoning of the ld.CIT(A) that expenditure incurred towards vacating the tenant is allowable only where the property is subject to an encumbrance arising from a binding legal obligation. The subsisting tenancy and the tenant's continued occupation of the property necessarily affected the assessee's ability to deliver vacant possession and diminished the property's effective marketability and development potential. The absence of a separately identified or formally recorded encumbrance does not eliminate the commercial and legal consequences of the subsisting tenancy. The payment made to secure the relinquishment of the tenant's occupation and facilitate the proposed transfer must, therefore, be examined in the context of its direct nexus with the transfer of the capital asset.

In this regard, the principles laid down by the Hon'ble Madras High Court in CIT v. A. Venkataraman (1982) 137 ITR 846, relied upon by the assessee, support consideration of the expenditure in determining the taxable capital gains. Having regard to the facts of the present case, we find that the compensation paid towards relinquishment of the factory building and the relocation of the tenant's manufacturing facility was incurred for facilitating the proposed development and realisation of the property's value. The expenditure had a direct and proximate connection with the transaction and cannot be disallowed merely because the corresponding payment was not expressly incorporated into the terms of the JDA. Accordingly, the indexed cost attributable to the aforesaid compensation, aggregating to Rs.5,12,46,431/-, is allowable in computing the long-term capital gains u/s.48 of the Act, subject to the computation and supporting particulars already available on record. The disallowance made by the AO and sustained by the ld.CIT(A) is, therefore, unsustainable on merits.

We also find merit in the assessee's alternative contention concerning the validity of the reassessment proceedings. The assessment was reopened on the specific premise that, since the assessee was engaged in property development, the gains arising from the impugned transaction were assessable as business income rather than as long-term capital gains. However, upon considering the assessee's explanation and the material available on record, the AO accepted that the income arising from the JDA was chargeable under the head 'Capital Gains' and not under the head 'Profits and Gains of Business or Profession'. Having thus found the very basis on which the reassessment was initiated to be unsustainable, the AO proceeded to make a separate addition by disallowing the indexed cost of compensation paid to the tenant.

In this connection, we take note of the decision of the Coordinate Bench of the Chennai Tribunal in Income-tax Officer v. Ambattur Constructions (P.) Ltd. [2025] 173 taxmann.com 432 (Chennai-Tribunal), dated 25.03.2025, wherein the principles laid down by the Hon'ble Bombay High Court in CIT v. Jet Airways (I) Ltd. [2010] 195 Taxman 117/[2011] 331 ITR 236 (Bom.) were considered. The relevant extract of the order is given below:

The principle emerging from the said decisions is that, where the AO accepts the assessee's contention that the income which formed the basis for reopening has not escaped assessment, the power to assess any other income u/s.147 of the Act cannot be exercised independently of the statutory conditions governing reassessment. Explanation 3 to section 147 cannot be construed so as to override or render nugatory the substantive conditions prescribed under the section. In such circumstances, an independent assessment of another item of income would require the reassessment proceedings to be validly initiated in accordance with law.

Applying the aforesaid principle to the facts before us, we find that the AO did not sustain the original basis for reopening the assessment but proceeded to make the impugned addition on a distinct issue concerning the deductibility of the compensation expenditure. The addition, therefore, cannot be sustained merely by reference to the reassessment proceedings originally initiated on the aforesaid ground. Respectfully following the ratio laid down in the above judicial precedents, we find merit in the assessee's jurisdictional objection.

In view of the foregoing discussion, we hold that the assessee is entitled to relief on both the merits of the claim and the jurisdictional ground raised against the impugned addition. The compensation paid towards relinquishment of the tenant's occupation and relocation of its manufacturing facility was supported by the material on record, incurred for commercial reasons directly connected with the proposed development, and allowable in computing the long-term capital gains u/s.48 of the Act. Further, the impugned addition is not sustainable in the reassessment proceedings for the reasons discussed above. We, accordingly, set aside the order of the ld.CIT(A) to the extent challenged before us and direct the AO to delete the addition of Rs.5,12,46,431/- by allowing the grounds raised by the assessee.

In the result, the appeal of the assessee is allowed and the stay application is dismissed.