Facts of the Case

The central issue before the Delhi High Court was whether interest received by the assessee on the principal amount deposited in an auction—which was subsequently annulled—constituted a capital receipt or taxable income.

The assessee had participated in an auction conducted by Punjab National Bank and deposited the entire purchase consideration after being declared the highest bidder. However, the auction was later set aside through judicial proceedings. Pursuant to an order of the Punjab and Haryana High Court, the bank refunded the entire deposited amount along with the interest accrued thereon.

In its return for AY 2011-12, the assessee credited ₹3,19,07,676 (being interest on the refunded amount) to capital reserve and claimed corresponding TDS credit. The Assessing Officer treated this amount as taxable income, leading to appellate proceedings culminating before the High Court.

 Issues Involved

  1. Whether interest received on refund of auction deposit after cancellation of sale constitutes a capital receipt or revenue receipt.
  2. Whether such amount can be taxed as “income from other sources” under Section 56(2)(viii).
  3. Whether the receipt represents compensation, interest, or mere restitution of capital.

Petitioner’s (Revenue’s) Arguments

The Revenue contended that the amount received was compensatory in nature and therefore taxable. It argued that interest paid on such sums should be assessed as income from other sources under Section 56(2)(viii) of the Income Tax Act, which taxes interest on compensation or enhanced compensation.

Respondent’s (Assessee’s) Arguments

The assessee submitted that the amount was received solely due to cancellation of the auction and represented restitution of the funds originally deposited. It was not compensation for any business activity nor income arising from investment.

The assessee relied on judicial precedents, including:

  • CIT v. Saurashtra Cement Ltd. (Supreme Court)
  • Pr. CIT v. Pawa Infrastructure Pvt. Ltd.
  • Girish Bansal v. Union of India

Court Order / Findings

  • The payment arose because the auction sale was cancelled and the deposited amount had to be returned.
  • The assessee was not in the business of dealing in such property; hence the transaction did not constitute a revenue activity.
  • The amount returned represented restoration of the assessee’s capital, not income generated from use of money.
  • The additional sum paid by the bank was merely the interest earned on the deposited funds during the intervening period.
  • There was no debtor-creditor relationship giving rise to taxable interest.
  • Section 56(2)(viii) applies only to interest on compensation or enhanced compensation, which was not the case here. 

Important Clarification

The judgment clarifies that not all receipts termed as “interest” are taxable. Where the payment arises from restitution of capital following cancellation of a transaction and is intimately connected with a capital asset or right, it may retain the character of capital receipt.

The ruling underscores that the true nature and source of a receipt—not its nomenclature—determine taxability under the Income Tax Act.

Link to download the order -  https://www.mytaxexpert.co.in/uploads/1772177627_PRINCIPALCOMMISSIONEROFINCOMETAX4VsINSFINANCEINVESTMENTPLTD..pdf  

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