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IN THE HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS THE 20TH DAY OF SEPTEMBER, 2024 PRESENT THE HON'BLE MR. JUSTICE S.G.PANDIT AND THE HON’BLE MR. JUSTICE C.M. POONACHA I.T.A. No.876 OF 2017
BETWEEN
1 . THE PR. COMMISSIONER OF INCOME TAX CENTRAL, C.R. BUILDING, QUEENS ROAD, BANGALORE-560000
2 . JOINT COMMISSIONER OF INCOME-TAX (OSD) CENTRAL RANGE, BANGALORE. ...APPELLANTS (BY SRI SANMATHI E.I., ADVOCATE)
AND
M/S CANARA HOUSING DEVELOPMENT COMPANY 10/1, LAKSHMINARAYANA COMPLEX, PALACE ROAD, BANGALORE-560 052 …RESPONDENT (BY SRI M.V. SESHACHALA, SENIOR ADVOCATE FOR SRI G.S. NAGHARISH, ADVOCATE)
THE ITA / INCOME TAX APPEAL IS FILED UNDER SEC.260-A OF INCOME TAX ACT 1961 PRAYING TO FORMULATE THE SUBSTANTIAL QUESTIONS OF LAW AS FRAMED ABOVE AND ALLOW THE APPEAL BY DECIDING THE SUBSTANTIAL QUESTIONS OF LAW IN FAVOR OF THE APPELLANTS AND SET ASIDE THE ORDER DATED 12.05.2017 PASSED
2 BY THE INCOME-TAX APPELLATE TRIBUNAL 'B' BENCH, BANGALORE IN ITA NO. 193/BANG/2014 FOR ASSESSMENT YEAR 2005-2006 AND ETC.
THIS APPEAL HAVING BEEN RESERVED FOR JUDGMENT ON 02.09.2024, COMING ON FOR PRONOUNCEMENT THIS DAY, POONACHA J, DELIVERED THE FOLLOWING:
CORAM: HON'BLE MR JUSTICE S.G.PANDIT and HON'BLE MR JUSTICE C.M. POONACHA
CAV JUDGMENT
(PER: HON'BLE MR JUSTICE C.M. POONACHA)
The present appeal is filed by the Revenue under Section 260A of the Income Tax Act, 19611 challenging the order dated 12.5.2017 passed in ITA No.193/Bang/2014 by the Income Tax Appellate Tribunal, ‘B’ Bench, Bengaluru2, for the Assessment Year3 2005-2006.
The relevant facts leading to the present appeal are that the respondent/assessee – firm is engaged in the business of Real Estate and land development. For AY 2005-06, the respondent filed its return of income on 10.1.2006 declaring loss of income of `61,11,28,165/-. During the course of assessment, it was observed that the assessee had claimed `64,74,05,370/- as
1 Hereinafter referred to as the ‘IT Act’ 2 Hereinafter referred to as the ‘Tribunal’ 3 Hereinafter referred to as ‘AY’
3 compensation paid in its profit and loss account. In response to the queries raised by the Assessing Officer4, the assessee placed on record that it had entered into an agreement with M/s. Manipal Infocom Pvt. Ltd.,5 for sale of its rights in respect of four properties in Bengaluru for `22.00 crores and since it did not hand over the properties as per the agreement within the stipulated time, the purchaser claimed compensation and the dispute between the parties was referred to arbitration. That the compensation was paid pursuant to the Arbitrator’s award.
The AO, vide assessment order dated 28.12.2007 assessed the total income of the assessee at `3,62,77,205/- after disallowing the compensation amounting to `64,74,05,370/-. Being aggrieved, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals)6. The Commissioner, affirmed the order of the AO. The assessee filed ITA No.406/Bang/2010 before the Tribunal and vide order dated 10.11.2010 the Tribunal remanded the matter back to the AO to decide the matter afresh. Consequent to the remand, vide order dated 30.12.2011, the compensation as sought for by the
4 Hereinafter referred to as ‘AO’ 5 Hereinafter referred to as ‘MIPL’ 6 Hereinafter referred to as the ‘Commissioner’
4 assessee was disallowed by the AO. Being aggrieved, the assessee filed an appeal before the Commissioner and vide order dated 28.11.2013 the said appeal was dismissed. Being aggrieved, the assessee preferred ITA No.193/Bang/2014 before the Tribunal. The Tribunal, by order dated 12.5.2017 allowed the appeal of the assessee. Being aggrieved, the present appeal is filed by the Revenue.
This Court, vide order dated 18.10.2019 admitted the above appeal and framed the following substantial questions of law: i. “Whether the respondent/assessee can claim compensation paid as expenditure U/Sec.37(1) of the Income tax Act, 1961, when the respondent has not incurred the said expenditure for the purpose of business?
ii. Whether the ITAT is legally justified in allowing the claim of the respondent/assessee under Section – 37(1) of the Income tax Act, 1961, when the respondent/assessee has not acquired the said property as fixed asset nor it has started yielding revenue?”
Sri E.I.Sanmathi, learned counsel for the Revenue assailing the order of the Tribunal contends that the assessee is not the owner of any of the properties, which were the subject matter of the agreement with the purchaser and the agreement entered into with the purchaser was not entered into by the
5 assessee. That the chronology indicates that the transaction is a sham transaction and damages cannot be claimed under Section 37(1) of the IT Act, as the same is not a business expenditure. It is further alleged that the liability has not been crystallized in AY 2005-06 since the arbitral award was passed on 30.8.2005. Hence, it is contended that the order of the Tribunal is erroneous and is liable to be set aside. He contends that the substantial questions of law are required to be answered in favour of the Revenue and against the assessee.
Per contra, learned Senior Counsel Sri M.V.Seshachala along with learned counsel Sri G.S.Nagharish, for the assessee would contend that the agreement was entered into by the partner of the assessee - firm and having regard to Section 14 of the Partnership Act, 19327, the transaction has been shown in the books of accounts of the assessee and hence, the assessee is entitled to claim the said deduction. It is further contended that the amounts have been crystallized and amortized as noticed by the Tribunal and contends that the same is liable to be granted under Section 37(1) of the IT Act. It is further contended that the
7 Hereinafter referred to as the ‘Act of 1932’
6 order of the Tribunal is just and proper and the substantial questions of law are required to be answered in favour of the assessee and against the Revenue. Hence, he seeks for dismissal of the above appeal.
The submissions of both the learned counsel have been considered and the material on record has been perused.
It is forthcoming that pursuant to the order dated 10.11.2010 passed by the Tribunal, wherein the matter was remanded to the file of the AO, the assessee was called upon to submit the Joint Development Agreement8, in response to which the assessee vide its letter 23.11.2011 has placed its submissions.
The factual matrix is that one Sri P.Dayanand Pai entered into an agreement with MIPL on 2.4.2002 in his individual capacity, wherein he has agreed to transfer his part of the interest in the built-up area of 4 properties, which were proposed to be developed by various builders under the JDA. The said 4 properties were situated at J.P.Nagar, Airport Road, Brook Field Road and Bannergatta Road property (IBC Knowledge Park) in
8 Hereinafter referred to as the ‘JDA’
7 Bangalore. That the total sale consideration under the said agreement was `22.00 crores, which was paid by MIPL vide cheque dated 30.3.2002. That another agreement was entered into by Sri Dayanand Pai with MIPL on 10.3.2004 undertaking to deliver built-up area within a certain time frame. It was further agreed that in the event of default, the said Sri Dayanand Pai shall make good all the losses and consequential damages.
It is further forthcoming that the said Sri Dayanand Pai admittedly did not hand over the built up area as agreed and hence, arbitration proceedings were initiated to resolve the disputes between the parties. That the Arbitrator was appointed on 27.6.2005, pursuant to which the claim petition was filed before the Arbitrator on 11.7.2005. Thereafter, the parties filed a compromise petition before the Arbitrator on 5.8.2005, based on which the Arbitrator passed an award on 30.8.2005. In the said compromise, based on which the arbitration award was passed, it was agreed that the assessee shall refund a sum of `22.00 crores and make a further payment of `64.00 crores as compensation. Hence, the assessee claimed a sum of `64,74,05,370/- as compensation paid in its return of income.
8 11. The AO, vide its order dated 30.12.2011 has disallowed the claim of the assessee seeking deduction of the said amount of `64.74 crores. The AO considered the submission of the assessee with regard to each of the properties and did not allow the assessee’s claim for expenditure primarily due to the following reasons: i. That the assessee was not the original owner or had any ownership over the properties as on the date of the agreement dated 2.4.2002; ii. That the arbitration proceedings have been initiated with predetermined purpose of getting stamp of arbitration to a mutually agreed transaction and the said act is a colourable device to claim the expenditure by the assessee; iii. The expenditure on account of the compensation paid is not an expenditure for the purpose of business of the assessee, because it is connected with the properties which were never found to be part of the assessee’s business transactions and the assessee was never the owner of the subject properties;
9 iv. That the said expenditure could not be allowed during AY 2005-06;
The assessee preferred an appeal before the Commissioner. The Commissioner, vide order dated 28.11.2013 dismissed the appeal by recording the following findings: “12. It is clear from the above that none of the properties for which the appellant claims to have received the advance from ‘Manipal Infocom Pvt Ltd of ` 22 crores (in connection with which the compensation is claimed to have been paid) belonged to the appellant or formed the part of the appellant’s assets. In fact, the appellant has categorically stated before me and as apparent from the above submissions that these properties belonged to other group concerns of Sri P Dayanand Pai, Managing Partner, like M/s Pai Electronic Systems Pvt Ltd, M/s Surya Builders and Developers, M/s Global Associates and M/s Bangalore Housing Development and Investments.
For any payment of this nature to be claimed as expenditure, it is important that the said property should have either been acquired by the appellant as a fixed asset or/and it should have started yielding revenue. This payment, in effect, is towards buying back the rights in the property for which the appellant had received the advance. This payment can be claimed as expenditure only in the year in which the appellant actually acquires the assets.
It is clear that until March 2013, neither the said properties have become the asset of the appellant, nor have they yielded any revenue. It is interesting to note that this recognition of revenue for A.Y. 2013-14 is made for the first time after this issue has been questioned in appeal at length. It is also to be noted that `22 crore advance has become worth `86 crore without any addition to the appellant’s assets or income. In my view, therefore, from the facts of the case, the payment of ` 64 crore is not an expenditure allowable for A.Y. 2005-06 or
10 even for A.Y. 2006-07. Any claim in this respect will have to be examined in the year when the assets are declared or shown by the appellant, as the asset of the firm or any income is recognized there from. This is the nature of the appellant’s business and expenditure can be recognized only in this manner. It is also on record that the appellant firm has no rights in the said properties, as admittedly, the assets belong to other group concerns belonging to Sri P Dayanand Pai, Managing Partner of appellant firm.
As the land (s) in question have not become an asset of the appellant firm in the year in question or even upto 2013 (as admitted by the appellant), this payment can only be treated as an addition to the cost of the land and can be allowed as an expenditure in the year the said asset or source of revenue comes into existence. Since, the appellant is in the business of acquiring and developing land and real estate business, this payment cannot be allowed as an expenditure in the year in which it is being claimed.
Under such circumstances, the claim of expenditure of Rs. 64 crore, by the name ‘compensation’ in A.Y. 2005-06 defies any accounting principles in the nature of the appellant’s business. The same is not allowable and the disallowance made in this regard is upheld.”
(emphasis supplied)
Being aggrieved, the assessee preferred an appeal before the Tribunal and the Tribunal, by its order dated 12.5.2017 while allowing the appeal of the assessee has, held that the order dated 30.12.2011, passed by the AO was not in terms of the order of remand dated 10.11.2010, passed by the Tribunal. Further, on merits, the Tribunal allowed the appeal of the assessee on the following grounds:
11 i. That the properties to be developed and transferred by the assessee to the other party were identified in the agreement dated 2.4.2002; ii. The properties identified by the assessee for development through other developers under the JDA, registration of ownership of the properties is not a prerequisite condition for acquiring the right, title and interest in the constructed area of the properties developed under the JDA; iii. The validity and enforcement of the agreement dated 2.4.2002 as well as the revised agreement dated 10.3.2004 cannot be questioned on the basis that the assessee was not the registered owner of the properties, when it is clear to the parties to the agreement that the said properties would be developed in future under the JDA and will receive the constructed area as per the agreement; iv. The receipt of `22.00 crores from the MIPL was recorded in the books of accounts of the assessee partnership firm; v. That this is not an isolated transaction carried out by Dayanand Pai, but it is a regular practice of the
12 assessee to purchase and sell the properties through the said Dayanand Pai; vi. That for the AY 2004-05 and 2008-09 the AO has accepted the income from the transaction of the purchase and sale of properties through Dayanand Pai and therefore, the practice of the assessee firm of doing transactions through Dayanand Pai is well recognized and accepted by the AO; vii. It is a clear case of mutual understanding and consent between the partners of the assessee – firm as well as the parties to the transaction that Dayanand Pai acted on behalf of the assessee – firm and not in his personal individual capacity. viii. Section 14 of the Act of 1932 deals with the property belonging to the partnership firm, if rights and interest in the property originally brought into the stock of the firm; ix. The books of accounts of the assessee used to disclose various properties owned by the assessee though these properties are not registered in the name of the
13 assessee – firm. The AO has not questioned all those transactions; x. Therefore, acquiring the right, title and interest over a property without registering to its name, is the normal and regular business activity of the assessee;
With regard to crystallization of liability, the Tribunal has held that the events occurring after balance sheet might confirm the statement of affairs on the balance sheet date and therefore, permits adjustment to assets and liabilities at the balance sheet if events occurring after the balance sheet date confirm the conditions existing on the balance sheet date. It was held that the true nature of the transaction is required to be seen regardless of entries in the books of accounts as taxability of income and loss is based on the provisions of the IT Act. Further, the Tribunal held that the actual payment has not been disputed and when the assessee has realized in definite terms that it would not be possible to honour the commitment under the agreement, then the liability is a certain liability, though quantum of the same could have been determined subsequently. Hence, it was held that the liability to pay compensation is crystallized when the
14 assessee accepted its failure to perform its part under the agreement within the stipulated time period and thus, determination of compensation after the balance sheet has to be taken into account.
The Tribunal has recorded a finding that the order passed by the Commissioner after remand i.e., after the order of the Tribunal dated 10.11.2010 is contrary to the provisions of the Tribunal. It is relevant to note that the Tribunal in its order dated 10.11.2010 held that some more factual findings are necessary with regard to the contention put forth by the assessee that Sri Dayanand Pai had entered into the agreement on behalf of the firm and that the AO should have examined the other parties to the agreement and also examined the JDA. It is forthcoming that after remand, the assessee was called upon to submit the JDA and that the assessee vide its letter dated 23.11.2011 has submitted its detailed response with regard to each of the properties as well as produced the relevant documents. The assessee has not raised a ground that the AO has not followed the remand order. The AO has in detail considered the contentions put forth by the assessee. In any event, the Tribunal proceeded to consider the merits of the
15 case and allowed the appeal of the assessee. Hence, in the present appeal also the merits have been considered without going into the order of the Tribunal that the AO did not comply the scope of the remand proceedings.
Before considering the contentions of the parties, it is relevant to notice Section 37(1) of the IT Act, which states as follows: “37 (1)Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Explanation 1.—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.”
(emphasis supplied)
It is the specific case of the Revenue that the agreement not having been entered into by the assessee, the question of the assessee claiming an expenditure as contemplated under section 37(1) of the IT Act would not arise since the same is not “incurred” by the assessee. In this context, it is relevant to
16 note that admittedly, the assessee was not the owner nor had any right of ownership over the properties, which were the subject matter of the agreements dated 2.4.2002 and 10.3.2004 with MIPL. It is further undisputed that the said agreements were entered into by Sri P.Dayanand Pai in his individual capacity with MIPL. The AO and the Commissioner had concurrently held that the expenditure on the compensation can be claimed only by the entity which owns the property and not somebody else and hence, disallowed the expenditure. The Tribunal, while setting aside the said findings has held that the properties which were the subject matter of the agreement dated 2.4.2002 were identified and there was no doubt or ambiguity of the properties to be developed and the properties which are identified by the assessee for development through other developers under the JDAs, the registration of ownership of the properties is not a pre-requisite condition for acquiring any interest, right or title in the constructed area of the properties being developed.
It is further held by the Tribunal that the sum of `22.00 crores which is received from MIPL as advance was recorded in the books of accounts of the assessee and that the
17 present transaction is not an isolated transaction, but is a regular practice of the assessee to purchase and sell properties through Sri Dayanand Pai, which has been accepted for the AY 2004-05 and 2008-09 and hence, the practice of the assessee doing transactions through Sri Dayanand Pai is well recognized and accepted by the AO. Hence, the Tribunal has held that Sri Dayanand Pai acted on behalf of the assessee and not in his personal, individual capacity.
In support of the said finding the Tribunal placed reliance on Section 14 of the Partnership Act, which states as follows: “14. The property of the firm.— Subject to contract between the partners, the property of the firm includes all property and rights and interests in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or for the firm, or for the purposes and in the course of business of the firm, and includes also the goodwill of the business. Unless the contrary intention appears, property and rights and interests in property acquired with money belonging to the firm are deemed to have been acquired for the firm.”
(emphasis supplied)
It is clear from a perusal of Section 14 of the Act of 1932 that subject to contract between the partners, the property
18 of the firm includes all properties originally brought into the stock of the firm, or acquired for the firm in the course of business.
In the present case, there is no mention in the agreements dated 2.4.2002 or 10.3.2004 that the said Sri Dayanand Pai was acting as a partner of the firm or that the properties which were the subject matter of the agreements were the properties of the firm.
In this context, it is relevant to note that under the agreement dated 2.4.2002 (a copy of which has been placed on record by the learned counsel for the Revenue) the said Sri Dayanand Pai was stated to ”being in control of vast valuable Real Estate in Bengaluru and has entered into arrangements jointly to develop some of the properties with various reputed builders”. Hence, the said Dayanand Pai offered to MIPL the portions of built up area out of his entitlement in four properties, which were being developed by various builders. Admittedly, the assessee was not the owner of the properties that were offered to be conveyed to MIPL nor was entitled to any area in the four properties mentioned in the agreement that were being developed by the respective builders. That in consideration of the properties that were offered
19 to MIPL, the total consideration agreed was `22.00 corres which were paid vide the said agreements. It is further forthcoming that the arrangement agreed between the parties under the agreement dated 2.4.2002 was further modified vide the agreement dated 10.3.2004.
The AO while considering the material placed by the assessee with regard to the four properties has recorded a factual finding that as on the date of the agreement dated 2.4.2002, neither the assessee nor the said Sri Dayanand Pai was the owner or had any interest in respect of the said 4 properties.
It is the claim of the assessee that a claim petition was filed claiming refund of the amount paid under the agreement dated 2.4.2002 and a compensation together with interest was claimed and a total claim of `95.00 crores was made against the assessee. It is the further case of the assessee that the Managing Partner – Dayanand Pai representing the assessee had not yet filed the statement of defence and in the meantime, the parties settled the dispute and a compromise petition was signed between the parties, which was accepted by the Arbitrator and an award was passed in the said compromise. In the said context, the AO
20 after appreciating the material on record has noticed that the date of appointment of the Arbitrator was 27.6.2005, the date of filing of claim petition was 11.7.2005, the compromise petition was filed on 5.8.2005 and the arbitral award based on the compromise was passed on 30.8.2005. Hence, the AO held that it appears that the assessee along with MIPL have approached the Hon’ble Arbitrator with predetermined purpose of getting stamp of arbitration to their mutually agreed transaction and it is a colourable device to claim the expenditure by the assessee.
The Commissioner has also recorded a finding that the assessee has stated that the properties which were the subject matter of the agreement dated 2.4.2002 belonged to the other group concerns of the Managing Partner Sri Dayanand Pai. Hence, the Commissioner has held that payment of `64.00 crores is not an expenditure allowable for AYs 2005-06 or 2006-07.
Having regard to the aforementioned, it is clear that the properties/rights which were the subject matter of the agreement dated 2.4.2002 did not belong to the firm during the said period i.e., AY 2005-06. Further, the assessee admittedly did not contract with MIPL to provide the built up area in the four
21 properties mentioned in the agreement dated 2.4.2002 nor were any of the four properties mentioned in the said agreement belonged to the assessee nor that the assessee had any manner of right, title or interest in the said properties. The contention of the assessee that the properties belonged to the assessee by virtue of Section 14 of the Act of 1932 is ex facie untenable and liable to be rejected having regard to the fact that there is no material placed on record to demonstrate that the said properties were brought into or were part of the stock of the firm. Hence, the properties cannot by any stretch of imagination be held to be the properties of the assessee firm.
The reasoning of the Tribunal that the advance of `22.00 crores having been shown in the books of accounts of the assessee and earlier transactions made by Sri Dayanand Pai having been shown as transactions made by the assessee, will also not aid the case of the assessee since the context of the said transaction has not been looked into. In view of the admitted position that the assessee was not the owner of the properties as also that the assessee did not have any manner of right, title or interest in the said properties, which were the subject matter of
22 the agreements dated 2.4.2002 or 10.3.2004, the question of permitting the assessee to claim a deduction under Section 37(1) of the IT Act does not arise. Further, the reasoning of the Tribunal that the properties which were the subject matter of the agreement dated 2.4.2002 are identified and there was no doubt or ambiguity of the properties to be developed and identified by the assessee for development through other developers and that registration was not a prerequisite condition for acquiring interest, right or title in the constructed area of the properties being developed, is erroneous having regard to the admitted position that the assessee was not a signatory to the agreement dated 2.4.2002 or that the assessee had any manner of right, title or interest in the properties which were the subject matter of the said agreement.
Learned Senior Counsel for the respondent relied on the judgment of the Hon’ble Supreme Court in the case of Commissioner of Income-tax, Bombay City-III, Bombay v. M/s. Shantilal Pvt.Ltd., Bombay9 to contend that when damages are paid by way of compensation for breach of a
9 AIR 1983 SC 952
23 contract, the same will not tantamount to speculative transaction. Having regard to the fact that the assessee was not owning the property or not having any manner of right, title or interest in respect of the property, which was the subject matter of the agreement dated 2.4.2002 or 10.3.2004, it cannot claim the same as a business transaction. Hence, the said judgment will not aid the case of the assessee.
It is further relevant to note that the deduction has been claimed for AY 2005-06 whereas, the date of appointment of the Arbitrator was 27.6.2005 and the compromise petition was filed on 5.8.2005 and the arbitral award was passed on 30.8.2005. Hence, the question of claiming deduction for AY 2005-06 does not arise.
It is the vehement contention on behalf of the assessee that crystallization having been done and the liability having been provided for, the assessee was entitled to claim expenditure during AY 2005-06. The said contention is untenable and liable to be rejected since there is no factual basis for the same, inasmuch as there is no material placed before the
24 authorities to indicate that the liability was crystallized or provided for during AY 2005-06. 31. The Tribunal erred in allowing the appeal of the assessee and setting aside the well considered, concurrent findings of fact recorded by the AO and the Commissioner. The reasoning adopted by the Tribunal is clearly erroneous and contrary to law as noticed above. 32. In view of the aforementioned, the substantial questions of law are answered in favour of the Revenue and against the assessee.
In the result, the above appeal is allowed and the order dated 12.5.2017 passed in ITA No.193/Bang/2014 passed by the Income Tax Appellate Tribunal, ‘B’ Bench, Bengaluru, is set aside.
Sd/-
(S.G.PANDIT) JUDGE
Sd/- (C.M. POONACHA) JUDGE nd/-