Income-tax---

----Income---Meaning of income---Agreement of sale of old rubber trees-- Effect---Agreement creates rights and liabilities in accordance with it-- Breach of agreement and agreement terminated by decree of Court-- Forfeiture of earnest money---Amount forfeited was assessable---Indian Income Tax Act, 1961, S.2(24).

The definition of income in section 2(24) of the Income Tax Act, 1961, is of an inclusive character. The purpose is not to limit the meaning of the term but to widen its net and even if a receipt does not fall within the ambit of any of the clauses, it might still be income if it partakes of the nature of income.

An agreement of sale as such can only be understood to create rights and liabilities in accordance with the terms and conditions thereof, subject to the provisions relating to the law of contract. Although the agreement of sale has a potentiality to have connection with the subject-matter, the moment such an agreement comes to an end it cannot be said that the agreement had any connection with the subject-matter thereof.

The assessee entered into three agreements of sale of old rubber trees. As the purchasers did not pay the first instalment on the due date, the assessee-company terminated all the three agreements and forfeited the moneys already paid. In the proceedings before the Subordinate Judge, all the three agreements came to be cancelled and the decrees were not challenged. The amounts forfeited were brought to tax by the Assessing Officer and this was upheld by the Tribunal. On a reference:

Held, that the amounts after forfeiture could not be said to have been retained by the assessee in respect of the transaction. The immediate nexus was the forfeiture as a result of the cancellation of the agreement by the Court. The Tribunal was right in law in holding that the earnest money deposit of Rs.75,000 received by the assessee in respect of the agreements for sale of old and uneconomic rubber trees was income assessable to income-tax.

CIT v. G.R. Karthikeyan (1993) 201 ITR 866 (SC); CIT v. Travancore Rubber and Tea Co. Ltd. (1991) 190 ITR 508 (Ker.) and CIT v. Raja Bahadur Kamakhaya Narayan Singh (1948) 16 ITR 325 (PC) ref.

P.K.R. Menon, Senior Advocate and N.R.K. Nair for the Commissioner.

Markos Vellappally for the Assessee.

JUDGMENT

V. V. KAMAT, J. ---Both the Revenue as well as the assessee have come before us for answers to the following questions:

Question suggested by the assessee in Revision Application No.290/Coch) of 1991:

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the earnest money deposit of Rs.75,000 received by the assessee in respect of the agreements for sale of old and uneconomic rubber trees is revenue income assessable to income-tax when forfeited consequent to termination of the said agreements for breach thereof by the purchasers?"

Questions suggested by the Department in Revision Application No.291/(Coch) of 1991:

(1)Whether, on the facts and in the circumstances of the case, the Tribunal is right in law and fact in holding that the receipt by way of forfeiture of advance amount arising to the assessee,--

(a)is a benefit arising to the assessee in the course of its plantation business?

(b)is not or cannot be subject to tax?

(2)Whether, on the facts and in the circumstances of the case and in view of the fact that the trees were transferred, i.e. cut and removed, ultimately by agreement, dated July 22, 1979, the Tribunal is,--

(i)factually correct in holding that it is an undisputed fact that the trees had not been cut and removed or at least there is no evidence?

(ii)legally and factually right in rejecting the contention of the Revenue after having rightly accepted the contention of the Revenue that the receipt would be exigible to income-tax for capital gains?

(3)Whether, on the facts and in the circumstances of the case if the answer to question No.2 is in favour of the revenue should not the Tribunal have in view of the provisions contained in section 51 of the Income-tax Act and read with the decision of the Supreme Court in 131 ITR 451 given appropriate direction to the assessing authority?

These questions are in pursuance of the earlier directions of this Court in CIT v. Travancore Rubber and Tea Co. Ltd. (1991) 190 ITR 508. In fact, the most appropriate step would be to spread over the synopsis of the above earlier judgment of this Court and this is also to provide the factual matrix for this judgment borrowed therefrom.

The assessee is a public limited plantation company. The original assessment for the year in question was made on August 20, 1980. Under section 144-B of the Income-tax Act, the Inspecting Assistant Commissioner initiated the proceedings in pursuance of which the Income-tax Officer in the draft assessment order, proposed to treat a sum of Rs.3,95,229 as income of the assessee. This amount concerns the earnest money and the advance received by the assessee towards sale of old rubber trees, after forfeiture of the agreements. At the initial stage, since the Inspecting Assistant Commissioner, acting under section 144-B of the Act, took the view that it was not a Revenue Receipt, ordered the same not to be included on the basis that it is the income of the assessee.

Thereafter, under section 263 of the Act, the Commissioner of Income-tax, by order, dated August 2, 1982, ,took a contrary view that the said sum represented receipt of an income nature in the hands of the assessee. Thus, the said sum of Rs.3,95,229 was treated as a Revenue Receipt attracting assessment to tax. This was appealed against before the Income-tax Appellate Tribunal. It was held in the appeal that there was no justification for treating the above amount as income of the assessee for the year in question. It was held that the said amount would not be income of the assessee for the assessment year (1977-78) in question.

In such a situation the Revenue took up the matter before this Court as stated above.

In the process of reasoning, the factual aspect is paraphrased further. The assessee entered into three agreements (1) with one Shri P.M. Joseph, dated July 10, 1975, (2) with one Shri George Joseph, dated July 19, 1975; and (3) with one Shri N. Viswam, dated August 8, 1975. By all these three agreements approximately, (1) 9,804 trees standing on 163.8 acres of land were agreed to be sold for a total consideration of Rs.16,87,500. Towards these agreements, the purchasers paid certain amounts. Similarly, the particulars with regard to the agreements entered into with Shri George Joseph as well as Shri N. Viswam which are really not material for the purpose of this judgment. It would be sufficient if the amounts of earnest money and advance referable to the three agreements are laid out hereafter in this judgment to show that the total amount of Rs.4,31,300 became the subject-matter of the consideration as to whether it would be income for assessment with regard to the year in question. The tabulation is as follows:--

It would be at once seen and the same has been emphasised in the earlier judgment of this Court (CIT v. Travancore Rubber and Tea Co. Ltd. (1991) 190 ITR 508) that as far as the total amount of earnest money is concerned it is Rs.75,000 and the balance relates to the amount of advance received by the assessee under the said agreement.

The purchases did not conform to the terms of the contract and so the amounts received from the above three purchasers came to be forfeited.

It is necessary to state that since the three vendees committed acts resulting in the forfeiture of the agreement, in the Sub-Court, Kottayam, three suits came to be filed separately, being O.S. Nos. 69 of 1976, 70 of 1976 and 72 of 1976 for cancellation of all the three agreements. The situation of finality in regard to these proceedings would be seen from the final order in regard thereto of the learned Subordinate Judge, Kottayam, cancelling all the three agreements and as a result thereof ordering forfeiture of these amounts of deposit and advances, the said orders not having been challenged.

This Court considered the position of law in detail, to observe that the moment an earnest money or deposit is received certain legal incidents are attached to it. It is a security received for due performance of the contract, and whether the contract is effectuated or not, the amount could and will ordinarily be retained by the seller. Thereafter, if the purchaser commits breach of the agreement, earnest money can be forfeited. At the other end, when the transaction goes through the earnest money received is given credit to, towards the consideration fixed in the agreement. It is observed that the earnest money or deposit is not a refundable amount, unless the vendor backs out. In the process it is observed that to find out as to whether the receipt of these amounts is a trading of Revenue- Receipt or a capital receipt, it will have to be taken into consideration the immediate nexus with the business carried on by the assessee-company, as to whether it is a part of the bargain in the course of carrying on a business. The Court has in the process observed that the whole situation depends on the nature of the transaction entered into between the parties for the sale of the trees and the subsequent sale of the trees by the seller. The Court found that it was more necessary and vital to determine the character of the amount in question as vital aspect which are germane for the consideration of the question. In the process of this reasoning as this Court thought that the matter called for the interpretation of the agreements entered into by the company with the various purchasers, to understand the legal import flowing therefrom and also the difference between the two counts of amounts received by the assessee company from the purchasers earnest money or deposit and advance. As this Court found that the question was then oversimplified by the Tribunal, consequently dealing with the same in a very elementary and summary fashion remitted the matter as it found that a perfunctory and arbitrary treatment is given to the factual matrix. This Court also emphasised reference to the observations in Kanga and Palkhivala's. The law and practice of Income-tax Eighth Edition, volume 1, pages 179 and 197 with a direction that the same is useful about some aspects of the matter that may fall for consideration.

With such a background, when the proceedings were taken up again by the Income-tax Appellate Tribunal, Cochin Bench, the salient features of the agreements were examined and it is observed that as tie purchasers did not pay the first instalment on the due date, the assessee-company terminated all the three agreements and forfeited the moneys already paid. It is also mentioned that the proceedings before the Subordinate Judge, Kottayam, all the three agreements came to be cancelled as a situation of finality, the said decrees not having been challenged.

After examination of the agreements, the Tribunal considered the issue as to whether the amounts of earnest money deposit and advances forfeited by the assessee would constitute the income of the assessee exigible or not.

It is observed that if the sale had materialised it would certainly have been a gain exigible to capital gains tax. However, the sale did not materialise and the result was of invocation of the forfeiture clause.

Particularly in paragraph 6 of the order of the Tribunal (Annexure "C"), the factual conclusion is reached that the amounts received by the assessee under the agreement form part of the purchase price of the assets to be sold. The Tribunal proceeded further, rather to consider the situation as regards earnest money and deposit on the one hand as against the amounts of advance with an approach of dichotomy between the two probably or rather inevitably misleading itself by observing that the High Court had succinctly drawn a distinction between earnest money deposit and advance money, specially referring to the portion of the discussion available from the general law in regard thereto. The Tribunal has reached a conclusion as a consequence thereof that earnest money deposit is different from advance money, further to spell out the differentiation by observing that advance money has a different shade of character because the earnest money deposit is in the nature of a guarantee that the contract will be fulfilled, being in the nature of a binding factor of the contract and would only become part of the purchase price when the transaction is gone through. It is observed that earnest money would be unlike an advance because it would form part of the purchase price only when the transaction is put through and not before.

Proceeding on the basis of this misdirection to find out that there is dichotomy for treatment, all the earnest money deposit, on the one hand, and the advance, on the other hand, the Tribunal recorded that on forfeiture the purchasers are disentitled to the refund of the earnest money and as a result thereof it would become the income of the assessee. It is observed that the income is assessable under other sources as it cannot assume the character of agricultural income but an income arising from the breach of contract.

Consequently, the Tribunal has yet reached an incongruous conclusion. It held that the forfeiture of the advance amount of Rs:3,56,300 does not give, rise to any taxable income for the year 1977-78. It also observed that for all earnest money deposit would, however, give rise to taxable income in the hands of the assessee thus upholding the order of the Commissioner of Income-tax under section 263 of the Income-tax Act. We have explained the factual matrix as spelt out as a result of the examination of agreements. The staring feature in the context would be that the agreements are cancelled as a result of the final decrees of the Subordinate Judge, Kottayam, and by reason of this factual situation, the amounts received by the assessee snapped all connections with any possibility of finalisation of the transactions covered thereby. The factual matrix shows that all the three agreements by way of the final situation of cancellation could not be considered in relation to any other thing other than the situation of forfeiture.

It would be more than elementary to state that an agreement of sale is only a contract between the parties and does not create any kind of interest or legal right with regard to the property which is the subject-matter of the agreement. It is only in the nature of an agreement to perform a contract and as such cannot be understood to create any semblance of a connection with the subject-matter covered by it. In other words, the agreement of sale as such can only be understood to create rights and liabilities is accordance with the terms and conditions thereof subject to the provisions relating to the law of contract. Even this Court in its earlier judgment by referring to various decisions has laid emphasis that apart from the provisions relating to the law of contract agreement are essentially governed with reference to the terms and conditions thereof. Therefore, it is emphasised that the relevant provisions relating to the law of contract are prefixed carving out the exception "subject to the contract to the contrary" at every stage. It is needless to state that although the agreement of sale has a potentiality to have the connection with the subject-matter, the moment such an agreement comes to an end and in this situation it has come to an end by a final order of forfeiture, the factual situation would lead to the conclusion that at no point of time an agreement of sale could be said to have had any connection with the subject-matter thereof much less any time after the finality of forfeiture thereof.

The final situation of forfeiture not only puts an end to the agreement of sale for all purposes but as a result thereof changes the entire character of the amounts covered thereby. Forfeiture also reduces the ostensible difference between classification of the amounts under the agreement such as earnest money deposit, on the one hand, and. advances, on the other. Once it is held that forfeiture puts an end to the agreement in question as a necessary sequitur it follows that it puts an end to the character as is understood by the parties and to the amounts covered thereby. In the light of this situation it is difficult to appreciate unnecessary confusion to treat the amounts covered by earnest money deposit as different from "advance". To treat them differently is a fallacy based on ignoring the legal consequences of forfeiture of the agreements.

The Tribunal has yet again fallen as a victim of logical fallacy although really it was not called upon to proceed in the direction. The Tribunal has reached the conclusion that as result of the forfeiture the amounts will have to be viewed as a benefit arising in the course of the planting business of the assessee. In the judgment, the Tribunal really ought not to have considered this question as to whether the amount can be linked as income from agriculture or not and could be viewed as such only as a benefit arising in the course of plantation. Really we need not dwell upon this because that is not the question required to be considered by any stretch of imagination with reference to the questions before us or even before the earlier Court.

We have observed above that it is the finality of the situation relating to the forfeiture of the agreements that changes the character of the amounts, additionally because even under the original agreement the amounts that are described differently could not be said to have any connection with the subject-matter thereof. We have already held that once the agreements are cancelled by the decrees of the Court forfeiture is a logical consequence thereof. Losing all differentiation to nomenclature under the agreements in question, as a result of forfeiture the amounts will be credited to the assessee.

Section 10(3) of the Income-tax Act is more than clear in the context that the total income would include any receipts which are of a casual and non-recurring nature, any kind of receipt as understood under section 10(3) of the Act would assume the character of income which would fall under the appropriate needs of income liable to tax. In section 2(24) of the Income-tax Act an inclusive definition of income is available as the term "income", it is held and observed by the Supreme Court in CIT v. G.R. Karthikeyan (1993) 'O1 ITR 866 with the fact that the definition is of inclusive character, the purpose is not to limit the meaning of the term but to widen its net and even if a receipt did not fall within the ambit of any of the clauses, it might still be income if it partook the nature of the income. In the process of elaboration, after referring to the decided cases in the context it is observed further that the idea behind providing an inclusive definition in section 2(24) is not to limit it but to widen its net and, therefore, the Court has repeatedly held that the term income is of the widest amplitude and has to be given its natural and grammatical meaning. In the process of reasoning it is observed that the receipt is also income, may be it is casual in nature but it is income nevertheless.

An attempt to understand the meaning in question as a result of forfeiture of the agreements and a logical conclusion as a result thereof, of snapping all connections with the subject-matter thereof, undoubtedly the amounts in question would have all the character of receipts in the context of the situation.

Learned counsel for the assessee tried his best to take out the situation and in the process he vehemently relied on the provisions of section 51 of the Income-tax Act for the purpose of deduction. Reading the provisions of the said section it is at once clear that on the basis of the accepted factual matrix and consequences thereof the provisions would be far away to govern the situation. It is more than clear that the amounts that are with the assessee, after forfeiture could not be said to have been retained by the assessee in respect of the transaction. On other count also, on a bare reading of the section it would be clear that the application thereof is contemplated or can be thought of at a stage prior to the execution of the agreement in question, at a stage of negotiation deal with receipt of advance or other money and retention thereof. It must be made clear that when on a bare reading of the section, application thereof cannot be thought of it would be unnecessary and would be termed as casual, to proceed to consider and adventure to make observations in regard to the submission in the context.

Therefore, when we have held that forfeiture and even otherwise the agreement of sale would not touch the subject-matter of the agreements, it is more than clear as a result thereof that the amounts would not go any way near formation of capital as is sought to be urged.

This is in view of the situation and it has been made clear by the earlier judgment of this Court (See (1991) 190 ITR 508 which is the source of the present proceedings that there has to be some nexus. Nexus means immediate cause and not cause of causes. We have already held that immediate nexus with regard to the character of these amounts being income is the forfeiture as a result of the cancellation of the agreements by the Court. The importance of immediate nexus is also emphasised by the Privy Council in CIT v. Raja Bahadur Kamakhaya Narayan Singh (1948) 16 ITR 325. It is observed that it is the derivation that is important and in the context that it demands an enquiry into the genealogy of the product and such enquiry is expected to stop as soon as the effective source is discovered. The factual position leads us to the source of forfeiture as the immediate and effective source which is otherwise known as nexus. For all the above reasons, we answer the question of the assessee in the affirmative, in favour of the Revenue and against the assessee.

We answer the questions of the Department as follows. Question No.l in the negative, in favour of the Revenue and against the assessee. Questions Nos.2 and 3 not necessary to answer in the light of answer to question No. 1.

A copy of the judgment under the seal of this Court . and the signature of the Registrar shall be sent to the Income-tax Appellate Tribunal, Cochin Bench, for passing consequential orders.

M.B.A./1288/FCReference answered.