Income-tax---

----Income or capital ---Assessee carrying on agency business ---Assessee entering into agreement to sell land---Earnest money forfeited by assessee-- Amount of earnest money was referable to fixed capital---Amount was not a revenue receipt.

When a receipt is referable to fixed capital, it is not taxable. It is taxable as a revenue item when it is referable to circulating capital or stock- in-trade.

The assessee-company which carried on agency business entered into an agreement to sell its land and superstructure for a sum of Rs.4,20,000. The purchaser was to pay the vendor a sum of Rs.60,000 as earnest money towards the sale price, which was to be paid in two instalments (i) on the execution of the agreement, i.e., on October 11, 1971, Rs.20,000 and (ii) Rs.40,000 on or before December 1, 1971. In the event of default in paying the further sum of Its.4b,000 on or before December 1, 1971, the vendor, was entitled, at his option, to cancel the agreement for the benefit of the purchaser and thereupon the earnest money of Rs.20,000 could be taken and retained by the vendor and the purchaser would not be entitled to recover the same. The Income-tax Officer assessed the sum of Rs.20,000 forfeited by the assessee but the Commissioner of Income-tax (Appeals) deleted the addition of Rs.20,000. On further appeal, the Appellant Tribunal confirmed the order of the appellate authority. On a reference:

Held, that the contract of sale was not entered into in the course of the business done by the assessee as the assessee was doing agency business. Therefore, the forfeited amount could not be considered as a capital gain or as a revenue receipt.

CIT v. A.V.M. Ltd. (1,984) 146.ITR 355 (Mad.); CIT v. Balaji Chitra Mandir (1985) 154 ITR 777 (AP); CIT v. Barium Chemicals Ltd. (1987) 168 ITR 164 (AP); CIT v. Hiralal Manilal Mody (1981) 131 ITR 421 (Guj.); CIT v. M.Ct. M. Corporation (Private) Ltd. (1995) 211 ITR 95 (Mad.); CIT v.. Travancore Rubber and Tea Co. Ltd. (1991) 190 ITR 508 (Ker); Davies (H.M. Inspector of Taxes) v. Shell Co. of China Ltd. (1952) 22 ITR (Suppl.) 1 (CA) and Sultej Cotton Mills Ltd. v. CIT (1979), 116 ITR 1 (SC) ref.

C.V. Rajan for the Commissioner.

R: Meenakshisundaram for the Assessee.

JUDGMENT

THANIKKACHALAM, J.---At the instance of the Department, the Tribunal referred the following two questions for the opinion of this Court under section 256(1) of the Income Tax Act, 1961:

"(1)Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs.20,000 being the deposit made by an intending buyer, forfeited and appropriated by the assessee, did not constitute business income of the assessee and as such was not liable to be taxed?

(2)Whether, on the facts and in the ,circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs.20,000 could not at all be considered as income to bring it within the term ' causal receipt' falling under section 10(3) of the Income-tax Act?"

The assessee is a private limited company. The assessment for 1974-75, was completed by the Income-tax Officer determining the total income at Rs.44,450. The company had earlier entered into an agreement with one Sri K. Periasamy to sell its land and superstructure situate at Trichy for a sum of Rs.4,20,000. The purchaser was to pay the vendor a sum of Rs.60,000 as earnest money towards the sale price, which was to be paid in two instalments (i) on the execution of the agreement, i.e., on October 11, 1971, Rs.20,000 and (ii) Rs. 40,000 on or before December 1, 1971. In the event of default in paying the further sum of Rs.40,000 on or before December 1, 1971, the vendor, may, at his option, cancel the agreement for the default of the purchaser and thereupon the earnest money of Rs.20,000 may be taken and retained by the vendor and the purchaser shall not be entitled to recover the same. The Income-tax Officer has treated the amount of Rs.20,000 as taxable on the ground that the amount of Rs.20,000 was received by the assessee during the course of the business and also as the company had itself treated the amount as revenue income and also utilised the same for declaration of dividends.

On appeal, the Commissioner of Income-tax (Appeals), following an earlier order of the Tribunal in the case of M.Ct. M. Corporation (P.) Ltd, v. I.T.O. in I.T.A. No.929/Mds of 1977-78, 'dated June 21, 1978, held that the receipt does not bear the character of income, profits or gains. Accordingly, the Commissioner of Income-tax (Appeals) deleted the addition of Rs.20,000. On further appeal, the Appellate Tribunal confirmed the order passed by the Commissioner of Income-tax (Appeals).

Before us, learned standing counsel appearing for the Department, submitted that Rs.20,000 was received as earnest money towards the sale price as security for fulfilling the contract. Therefore, it should be treated as revenue receipt earned during the course of business. Learned standing counsel further submitted that there is difference between the receipt of earnest money and the advance. Learned standing counsel submitted that if it is advance, then the seller is bound to return the same if the contract was not fulfilled. On the other hand, if it is earnest money, the seller can retain the same and treat it as a part of sale consideration when the sale was completed. Therefore, in the present case, according to learned standing counsel, the earnest money received by the assessee in the course of the business should be treated as revenue receipt since it does not bear the character of capital receipt. In order to support his contention, learned standing counsel relied upon a decision of this Court in CIT v. M. Ct. M. Corporation (Pvt.) Ltd. (1995) 211 ITR 95. According to the facts arising in that case, the assessee company engaged in trading, investment and money-lending business, negotiated for the sale of a house property belonging to it and, as the sale could not be completed, forfeited a certain sum deposited by the intending purchaser with the assessee. The Income-tax Officer held that the forfeited amount was income taxable under section 10(3) of the Income Tax Act, 1961. The Appellate Assistant Commissioner found that in the sale advertisement there was a provision to the effect that the amount deposited would be forfeited if the intending buyer could not complete the sale transaction and hence the amount forfeited was not capital but income casual in nature and taxable under the head "Other sources". The Tribunal held that the receipt did not have the character of income and the provisions of section 10(3) of the Act were not applicable to the receipt. On a reference, this Court held as under (headnote) (at page 96 of 211 ITR):

"The amount forfeited had to be regarded as an estimate of the loss of profits which the assessee would otherwise have made had the sale transaction been completed. By the receipt of the amount by the assessee, intending buyer was freed from the obligation to buy and the assessee was also enabled to offer the house for sale to others. The amount forfeited represented compensation for the loss of the income or profits to the assessee and had to be regarded as a revenue receipt as the capital asset continued to exist as before, not in any manner affecting the trading activities of the assessee. "

While rendering his judgment, this Court relied upon the decision of the Andhra Pradesh High Court in CIT v. Balaji Chitra Mandir (1985) 154 ITR 777, wherein it had been held that compensation paid for cancellation of a contract, not affecting the trading structure of the business or resulting in the deprivation of the source of income, leaving the person free to carry on his trade, is a revenue receipt and that where the cancellation of the agreement impaired the trading structure of the assessee or resulted in the deprivation of the source of income, such compensation in respect of the cancellation, is a capital receipt.

Learned standing counsel, also relied upon a decision of the Kerala High Court in CIT v. Travancore Rubber and Tea Co. Ltd. (1991) 190 ITR 508. According to the facts arising in that case, the assessee is a public limited plantation company. In the assessment year 1977-78 under section 144-B, the Income-tax Officer in the draft assessment order, proposed to treat a sum of Rs.3,95,299, representing the amount of earnest money and advance received by the assessee towards sale of old rubber trees which was forfeited, as income of the assessee. The Inspecting Assistant Commissioner, in his order under section 144-B of the Act, directed the Income-tax Officer not to include this amount as the income of the assessee, since he took the view that it was not a revenue receipt but a capital receipt, in the hands of the assessee. The Commissioner of Income-tax initiated proceedings under section 263 of the Act and in his order held that the said sum represented receipt of an income nature in the hands of the assessee. On appeal, the Income-tax Appellate Tribunal held there is no justification for treating the above amount as income of the assessee of the year. According to the Tribunal, the sum of Rs.3,95,229 cannot be considered to be a revenue receipt in the hands of the assessee. It was further held that the said amount will not be the income of the assessee for the assessment year 1977-78. On a reference, the High Court of Kerala held that the amount received on the above two counts have different legal import and incidence. Earnest deposit or earnest money is distinct and different from advance. It may be that the amounts paid under both counts will be given credit to if the contract is carried out. But, in case the purchaser fails to carry out the terms of the contract, the legal consequences flowing therefrom regarding the earnest deposit and advances are distinct and different. Accordingly, the High Court of Kerala directed afresh in accordance with law. Therefore, in the matter o; receipt of earnest money in a contract for sale of immovable property, no decision was taken by the Kerala High Court as to whether such a receipt is revenue receipt or capital in nature.

According to the facts arising in the decision reported in CIT v. Balaji Chitra Mandir (1985) 154 ITR 777 (AP), the assessee-firm was carrying on the business of exhibition of cinema films. In 1968, it leased its cinema hall to one B for a period of 151 weeks subject to the payment of a weekly rent of Rs.3,521. A sum of Rs.40,000 was deposited by the lessee with the assessee as security under the agreement. The lease agreement provided that if the lessee should fail to pay the hire as agreed for any week, the agreement would be cancelled and the amount of Rs.40,000 would be forfeited. From February 1969, the lessee committed default in the payment of the weekly rent for three weeks continuously and the assessee after notice to the lessee terminated the lease and forfeited the amount of Rs.40,000. Subsequent to the termination of the lease, the assessee leased to cinema hall to another person. The assessee claimed that the amount of Rs.40,000 was a capital receipt and not assessable in the assessment year 1973-74. On these facts, on a reference, the High Court of Andhra Pradesh held that the facts showed that the lease agreement was entered into by the assessee-firm in the course of its business, namely, exhibition of cinema films. The capital asset producing income was not the lease agreement but the cinema hall itself. The lease agreement was only a means to manage the cinema hall. The capital asset continued to exist as it was prior to the termination of the contract and also continued to produce income even after the termination of the agreement. Hence, the amount of Rs.40,000 received by the assessee as forfeiture of the security deposit constituted a revenue receipt. Since the lease agreement vas entered into by the assessee in the course of its business and the capital asset producing income was not the lease agreement but the cinema hall itself, the High Court of Andhra Pradesh came to the abovesaid conclusion.

Learned counsel appearing for the assessee in order to support his contention stated that the earnest money forfeited by the assessee was received in relation to the sale of an immovable property belonging to the company which is one of its assets and, therefore, the earnest money would also have the character of capital receipt. According to the learned counsel, as per the provisions of section 51 of the Income-tax Act, where any capital asset was on any previous occasion the subject-matter of negotiation for its transfer, any advance or other money received and retained by the assessee in respect of such negotiations shall be deducted from the cost for which the asset was acquired or the written down value or the fair market value, as the case may be, in computing the cost of acquisition. Therefore, according to learned counsel, the earnest money received by the assessee would go to add to the cost of acquisition of the asset. Hence, it is capital in nature.

Capital gain tax cannot be levied since there is no transfer. According to learned counsel, the assessee was doing agency business during the assessment year under consideration. The assessee was not doing real estate business in purchase and sale of properties. In the assessment year under consideration, one of the assets of the company was agreed to be sold to an intending purchaser. The purchaser paid earnest money but the contras was not fulfilled. The earnest money was forfeited. Hence, it would go to add to the cost of acquisition and, therefore, it cannot bear the nature of revenue receipt.

A receipt is not taxable when it is referable to fixed capital. It is taxable as a revenue item, when it is referable to circulating capital or stock in-trade. Reliance was also placed upon a decision of the Andhra Pradesh High Court in CIT v. Barium Chemicals Ltd. (1987) 168 ITR 164. While considering the provisions of sections 2(47) and 45 of the Income Tax Act. 1961, the High Court of Andhra Pradesh held that in order to decide whether or not a payment is a -revenue receipt, its true nature and substance must be looked into. If the payment is received in the ordinary course of the business of the assessee, for loss of stock-in-trade, it is a revenue receipt. If, on the other hand, the payment received is towards compensation for extinction or sterilization, partly or fully, of a profit-earning source, such receipt, not being in the ordinary course of the assessee's business, is a capital receipt.

Our attention was also drawn to a decision of the Gujarat High Court in CIT v. Hiralal Manilal Mody (1981) 131 ITR 421. According to the facts arising in that case, the total amount of Rs.24,431 was received by way of damages and the said amount was paid to the assessee on account of the breach of the agreement committed by the vendors. The said sum of Rs.24,431 represented damages which the vendors had agreed to pay to the assessee for the loss of a good bargain which the assessee had to forgo because the vendors were not prepared to execute the deed of conveyance, and did not represent income of the assessee and could not be included in the income of the assesee of the assessment year 1969-70. In the above said decision, the Gujarat High Court observed that ordinarily when a person purchased immovable property or purchased land,, it is treated as an investment and it is only in rare cases that purchase and sale of immovable property or land is treated as a business or adventure in the nature of trade. In such cases, the burden of proving that the particular transaction was an adventure in the nature of trade is on the Revenue.

Reliance was also placed upon a decision of this Court in CIT v. AN.M. Limited (1984) 146 ITR 355. According to the facts arising in that case, the assessee carrying on business as a distributor of cinematograph films gave positive prints of films to distributors who exhibited them in the cinema houses. Apart from the consideration received, the assessee collected from the distributors security deposit for the due fulfilment of the terms and conditions of the agreement between the parties and on the due fulfilment of the terms of the agreement the amount of deposit was refunded. The deposit was sometimes adjusted against the amounts payable by the distributors because the distributors did not send the collections but directed the assessee to set off or adjust the security deposit against his overdue collections. In the assessment year 1972-73, it happened that many of the film distributors who had taken films for exhibition did not take back the deposits so that there was surplus left after the adjustment. As the assessee had lost touch with persons who had made the deposits the assessee to due course appropriated the excess available with it and credited in its profit and loss account. On these facts, this Court held that these deposits did not bear the character of trading receipts when they were received and consequently they could not be converted into a trading receipt subsequently. This Court further held that the amounts representing the balance of the security deposits received by the assessee during the course of its business from its exhibitors and credited in its accounts for the assessment year in question were not taxable.

The Supreme Court in Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 while considering the provisions of section 10(1) of the Indian income-tax Act, 1922, held that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by him, on conversion into another currency, such profits or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.

Thus, we have seen in the present case, the assessee entered into a contract to sell an immovable property which is one of the items of its capital assets. Since the sale did not fructify and earnest money paid by the purchaser was forfeited, the contract of sale was not entered into in the course of the business done by the assessee as the assessee was doing agency business. The forfeited amount would go to increase the cost of acquisition of the capital assets

In Davies v. Shell Company of China Ltd. (1952) 22 ITR (Suppl.) 1 (CA), according to the facts arising in that case, the company made a practice of requiring its agents to deposit with the company a sum of money usually in Chinese dollars which was repayable when the agency came to an end. Previously, the company had kept in Shanghai Banks Chinese dollar deposits to an amount approximately equivalent to the agency deposits. But because of hostilities between China and Japan. the company transferred these sums to the United Kingdom and deposited the sterling equivalent with its parent company which acted as its banker. Owing to the subsequent depreciation of the Chinese dollar with respect of sterling the amounts eventually required to repay the agency deposits in Chinese dollars were much less than the amounts held by the company to meet its claims and substantial profit accrued to the company. The question arose whether the profit made by the company was assessable to tax. On these facts, the Court of Appeal held that it was not a trading profit, but it was simply the equivalent of an appreciation in a capital asset not forming part of the assets employed as circulating capital in the trade and it was, therefore, not assessable to tax.

Thus, a combined reading of the abovesaid judicial pronouncement would go to show that when a receipt is referable to fixed capital, it is not taxable and it is taxable as a revenue item when it is referable to circulating capital or stock-in-trade.

Thus, in the present case, we have already seen that the business of the assessee is not buying and selling of real estate. But the company was doing agency business. Therefore, by no stretch of imagination, can we say that the agreement to sell an immovable property, which is one of the assets of the company would relate to the business of the company. Therefore, the forfeited amount can be considered neither as a capital gain nor as a revenue receipt amenable to tax. Further, it remains to be seen that if the transaction is completed, then the assessee will be liable for capital gain tax.

In the decision in CIT v. M.Ct. M. Corporation (Pvt.) Ltd. (1995) 221 ITR 95 (Mad.), all the decisions cited before us were not brought to the notice of the Court while deciding the issue arising in that case. So also, the provisions of section 51 of the Act were not considered therein. Thus, considering the facts arising in this case in the light of the judicial pronouncements cited before us, we hold that there is no error in deciding that the earnest money received by the assessee for the sale of the property in question and forfeited did not become the business income of the assessee. In view of the foregoing reasons, we answer both the questions referred to us in lie affirmative and against the Department. There will be no order as to costs.

M.B.A./1594/FC Reference answered.