Facts of the Case

The assessee, engaged in construction and sale of commercial space, developed a multi-storeyed building “Gopal Das Bhawan” in Connaught Place, New Delhi. It followed the Completed Contract Method (CCM) under Accounting Standard 7.

After completion of the project (AY 1995–96), certain allottees refused to take possession due to change in usage of space by NDMC. The assessee:

  • Refunded advances amounting to Rs. 32,08,271
  • Paid additional compensation of Rs. 1,18,38,705 for surrender of rights

The assessee treated this compensation as revenue expenditure in the Profit & Loss Account.

However, the Assessing Officer treated the payment as capital expenditure, considering it as repurchase of flats.

Issues Involved

  1. Whether compensation paid to flat buyers for surrender of rights is revenue expenditure or capital expenditure.
  2. Whether such compensation was paid for extraneous considerations.
  3. Whether rental income from stock-in-trade property is income from house property or business income.

Petitioner’s (Assessee’s) Arguments

  • The flats constituted stock-in-trade, not capital assets.
  • Compensation was paid as a commercial decision to:
    • avoid litigation
    • maintain goodwill
    • resell property at higher value
  • Under CCM, expenses relating to business should be allowed when incurred.
  • Payment was made to protect business interests and reputation.
  • Compensation was not cost of acquisition but an independent business expenditure.

Respondent’s (Revenue’s) Arguments

  • Payment amounted to repurchase of flats, hence capital in nature.
  • Compensation was not mandated in agreements.
  • Quantum of payment was excessive and lacked justification.
  • Recipients treated the amount as capital gains, indicating capital nature.
  • ITAT held payment was for extraneous considerations.

Court Findings / Judgment

The Delhi High Court ruled in favour of the assessee, holding:

1. Compensation is Revenue Expenditure

  • Flats were part of stock-in-trade, not capital assets.
  • Payment was made for commercial expediency and business necessity.
  • It was not a repurchase; ownership transfer had not occurred.

2. Not for Extraneous Consideration

  • ITAT’s conclusion was based on surmises and conjectures.
  • Payment was justified to:
    • preserve goodwill
    • avoid disputes
    • protect business interests

3. Accounting Treatment

  • Under AS-2, such compensation is an extraordinary item and not part of inventory cost.
  • Under AS-7, CCM allows recognition of expenses in the relevant year.

4. Principle of Commercial Expediency

Relied on landmark rulings:

  • CIT v. Nainital Bank Ltd.
  • Shahzada Nand & Sons v. CIT

Expenditure incurred to maintain goodwill and business relations qualifies as allowable expenditure.

5. Rental Income Issue

  • Rental income from stock-in-trade property is taxable as Income from House Property, not business income.
  • Rule of consistency applied across assessment years.

6. Final Order

  • ITAT order set aside
  • Compensation allowed as business expenditure
  • Appeal of assessee allowed

 

Important Clarifications

  • Nature of expenditure depends on purpose, not treatment by recipient.
  • Same transaction can be capital for one party and revenue for another.
  • Commercial expediency includes goodwill preservation and business reputation.
  • Absence of contractual obligation does not disqualify expenditure.
  • Accounting standards (AS-2 & AS-7) play a crucial role in tax treatment.

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2019:DHC:1678-DB/SMD20032019ITA2102003.pdf

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