Damages paid for violation of agreement to sell allowed as incurred in connection with the transfer of property for computing long term capital gains-High Court
The question framed by the Hon’ble High Court was as to whether the ITAT, was correct in holding that the amount paid by the assessee for non-fulfillment of first agreement to sell was not incurred in connection with the transfer of property and, therefore, could not be deducted from the sale consideration for computing long term capital gains?
ABCAUS Case Law Citation:
ABCAUS 2298 (2018) (04) HC
The appellant assessee was an individual and had entered into an agreement to sell the immovable property with an individual (“agreed buyer”) for Rs. 15,00,000/-. Under the said agreement, the assessee had received Rs. 7,50,000/- as advance and part payment. However, later the assessee sold the property to another person (the purchaser) and had declared long term capital gains of Rs. 5,42,000/- from sale of immovable property. The property was sold by a tripartite agreement to sell amongst the various parties.
The purchaser paid Rs. 45,00,000/- to the tenant to vacate the property and transfer possession, and Rs. 55,00,000/- to the assessee for transfer of title and ownership rights in the property. Rs. 55,00,000/- received by the assessee was treated as the sale consideration. The assessee paid Rs. 25,00,000/- to the agreed buyer for foregoing his right and claim under the agreement to sell. The advance of Rs. 7.50 lacs received was refunded by the purchaser to the agreed buyer directly and reduced from payment of Rs. 55,00,000/- to be paid to the assessee.
The assessee had treated the payment of said Rs. 25,00,000/- as expenditure incurred wholly and exclusively in connection with transfer under Section 48(i) of the Act. In the alternative, it was submitted that the expenditure was incurred for improvement of the asset and was deductible under Section 48 (ii) of the Act.
The Assessing Officer (AO) held that Rs. 25,00,000/- paid as liquidated damages could not be allowed as a deduction for computation of capital gains as this payment was not incurred wholly and exclusively in connection with the transfer of the property to the purchaser. According to him the amount paid was not towards cost of improvement or to remove an encumbrance. Even otherwise, as a principle, the amount spent to get rid of any liability or encumbrance cannot be regarded as cost of improvement of a capital asset or expenditure incurred to perfect one‟s title. The agreed buyer had not paid the full consideration and was not the first purchaser within the meaning of Section 53-A of the Transfer of Property Act.
The Assessing Officer nevertheless invoked and applied Section 51 and reduced the indexed cost of acquisition by the amount of advance of Rs. 7,50,000/-
The Commissioner of Income Tax (Appeals) held that the agreement to sell was an enforceable contract in law and under the Specific Relief Act, even if the name and license number of the stamp vendor were not indicated. He accepted the contention of the assessee that payment of Rs. 25,00,000/- was in connection with the transfer of property and, therefore, should be reduced from the full value of the consideration while computing capital gains. However, he held that in case of failure to execute the sale deed, the agreement had stipulated lump-sum payment of liquidated damages of Rs. 25,00,000/- only which was not in addition to repayment of advance of Rs.7,50.000/. Thus, he upheld the reduction of cost of acquisition by the AO.
The Tribunal held that Payment of Rs. 25,00,000/- was personal liability of the assessee and not attached to the capital asset sold and, therefore, it could not be held that the expenditure incurred was wholly and exclusively in connection with the transfer of property. However, it held that Rs. 7,50,000/- could not be deducted from the cost of acquisition and to this extent appeal of the assessee was allowed.
The High Court observed that the Hon’ble Supreme Court had interpreted the provisions of Specific Relief Act, 1963 and observed that it was not the legislative intent that mere proof that a sum of money was specified as liquidated damages and penalty for breach would be enough to prove that the contract for transfer of immovable property cannot be specifically enforced and could be adequately compensated by specified damages or penalty.
The Hon’ble High Court observed that provisions of section 48 states that expenditure incurred wholly or exclusively in connection with such transfer are to be reduced. The expression “expenditure” used in Section 48 should be given the same meaning as used in Section 37 of the Act, except that expenditure may be also capital in nature.
The Hon’ble High Court opined that the expenditure would primarily connote and has the meaning of spending or paying out. In a given case, it may also cover the amount of loss, which has gone out of the assessee’s pocket. Settlement of a claim and payment made can amount to expenditure. Again the words “wholly and exclusively” used in Section 48 are also to be found in Section 37 of the Act and relate to the nature and character of the expenditure, which in the case of Section 48 must have connection i.e. proximate and perceptible nexus and link with the transfer resulting in income by way of capital gain. The word “wholly” refers to the quantum of expenditure and word “exclusively” refers to the motive, objective and purpose of the expenditure. These two words give jurisdiction to the taxing authority to decide whether the expenditure was incurred in connection with the transfer. The expression “wholly and exclusively” however, does not mean and indicate that there must exist a necessity or compulsion to incur an expense before an expenditure is to be allowed.
The Hon’ble High Court observed that Word “connection” in Section 48(i) reflects that there should be a causal connect and the expenditure incurred to be allowed as a deduction must be united or in the state of being united with the transfer resulting in income by way of capital gains on which tax has to be paid. The expenditure, therefore, should have direct concern and should not be remote or have indirect result or connect with the transfer. Practical and pragmatic view in the circumstances should be taken to tax the real income i.e. the gain.
The Hon’ble High Court observed that the assessee had always stated that the purchaser was aware of the agreement to sell with the agreed buyer and had directly paid Rs. 7,50,000/- by way of cheque to him. The assessee and the agreed buyer had jointly located the purchaser, who had agreed to pay total consideration of Rs. 1 crore, which included Rs. 45,00,000/- to be paid to the tenant and Rs. 55,00,000/- to be paid to the assessee. Rs. 25,00,000/- was paid by the assessee to the agreed buyer vide cheque, which was after the agreement to sell with the purchaser. The agreed buyer was a signatory as a witness to some of the documents executed in favour of the purchaser at the time of transfer.
Looking at the totality of the circumstances and findings recorded by the Tribunal, the Hon’ble High Court held that there was a close nexus and connect between the payment of Rs. 25,00,000/- and the transfer of the property to the purchaser resulting in income by way of capital gains. There was proximate link and the expenditure incurred was in furtherance and to effectuate the transfer/sale of the property and was not remote and unconnected. Expenditure of Rs. 25,00,000/-, therefore, had to be treated as expense incurred wholly and exclusively in connection with the transfer of immovable property and, hence, allowable as a deduction under clause (i) of Section 48 of the Act.
However, it was clarified that Rs.7,50,000/- which was paid and subsequently refunded, cannot be allowed as a double deduction. In other words, refund of Rs. 7,50,000/- would mean that the earlier payment made by the agreed buyer was squared off. The assessee had in fact incurred expenditure of Rs. 25,00,000/- which was paid to forego and give up his right under the agreement to sell.
However the Hon’ble High Court made it clear that aforesaid ratio and findings should not be interpreted to mean that wherever an assessee has paid an amount under an earlier agreement-to-sell in terms of the settlement or even a court decree, the said amount would be treated as expenditure wholly or exclusively in connection with the transfer, the subject matter of capital gains. The nature and character of the agreement, timing of the earlier agreement and payment claimed as expenditure and the date of transfer resulting in capital gains, are relevant aspects, which should be taken into consideration. For example, an agreement-to-sell rescinded or cancelled and payment made long before the date on which immovable property was transferred resulting in capital gains, may not be expenditure incurred wholly and exclusively in connection with such transfer. The words used in clause (i) do not permit and allow expenditure incurred wholly and exclusively on the immovable property as an expenditure to be deducted while computing capital gains. Link and connection with the transfer of a capital asset and the expenditure must be inextricable and should be established.
Accordingly, Rs. 25,00,000/- paid by the assessee was ordered to be deducted under clause (i) to Section 48 of the Act while computing capital gains.
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