Liquidated damages paid cancelling earlier agreement to sell are allowed as deduction
Liquidated damages paid by the assessee for cancelling earlier agreement to sell immovable property are allowed as deduction, as expenditure in connection with transfer under Section 48.
The assessee in her return of income for the AY 1994-95 declared long-term capital gains from the sale of immovable property. The property was sold by a tripartite agreement to sell dated 4th November, 1993 amongst the purchaser who had paid R45 lakhs to the tenant to vacate the property and transfer possession, and R55 lakhs to the assessee for transfer of title and ownership rights in the property. Earlier on 10/04/1989, the assessee had entered into an agreement to sell the same property to one Anil Sharma for R15 lakhs and had also received R7.5 lakhs as advance. Subsequently, as per the agreement to sell, and mutual agreement, the assessee had paid R25 lakhs on 16/12/1993 to Anil Sharma for foregoing his right and claim under the agreement dated April 10/04/1989. Further, R7.5 lakhs which was received as advance by the assessee was also refunded by the final purchaser to Anil Sharma and had reduced it from payment of R55 lakhs to be paid to the assessee. Thus, the assessee had treated the payment of R25 lakhs to Anil Kumar Sharma as expenditure incurred wholly and exclusively in connection with transfer under Section 48 (i).
The Assessing Officer invoked Section 51 to tax R7.5 lakhs received from Anil Kumar Sharma and reduced it from the cost of acquisition. Further, the Assessing Officer held that R25 lakhs paid as liquidated damages cannot be allowed as a deduction for computation of capital gains since it was not incurred wholly and exclusively in connection with the transfer of the property to the purchaser. ITAT deleted the taxability of 7.5 lakhs noting that the advance received was not forfeited and the assessee had paid R25 lakhs to Anil Sharma, however, the ITAT held that payment of R 25 lakhs to Anil Sharma was towards personal liability of the assessee and was not attached to the capital asset sold. Thus, ITAT also disallowed the deduction of 25 lakhs from capital gains income. Aggrieved, the assessee preferred an appeal before the Delhi High Court.
Further, High Court held that the expression “expenditure” used in Section 48(i) should be given the same meaning as used in Section 37, except that expenditure may be also capital in nature and which may also cover the amount of loss, which has gone out of the assessee’s pocket. High Court further held that the words “wholly and exclusively” used in Section 48 are also found in Section 37 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.
High Court held that the 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. High Court noted that the purchaser was aware of the agreement to sell with Anil Sharma and had directly paid R7.5 lakhs by way of cheque to him and the assessee had placed on record the relevant agreements. Thus, there was a close nexus and connect between the payment of R25 lakhs and the transfer of the property to the purchaser resulting in income by way of capital gains and 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. Therefore, High Court allowed the deduction of R25 lakhs under Section 48(i).
Additionally, High Court clarified that this decision 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. Link and connection with the transfer of a capital asset and the expenditure must be inextricable and should be established.
High Court thus ruled in favour of assessee.