Holding

The liquidated damages are a capital receipt because they compensate for the sterilisation of a capital asset and are not part of the assessee's ordinary business income.

Summary

M/s Saurashtra Cement Ltd., a cement manufacturer, entered into a contract to purchase a new cement plant. The supplier failed to deliver the plant on time, and under a liquidated damages clause the assessee received Rs.8,50,000 as compensation. The Revenue argued that the amount was a revenue receipt and should be taxed, while the assessee contended it was a capital receipt. The Supreme Court examined the nature of the receipt, noting that the damages compensated for the sterilisation of a capital asset and were not part of the ordinary profit‑earning process. Applying the principle that compensation for loss of a source of income is a capital receipt, the Court held the amount to be a capital receipt and not taxable. Consequently, the appeal filed by the Revenue was dismissed.

Issues considered

Whether the liquidated damages received by the assessee from the supplier for delay in delivery of the cement plant constitute a capital receipt or a revenue receipt under the Income Tax Act

Legislation cited

Income Tax Act, 1961s. 256(1), s. 80J

Subjects

capital receiptrevenue receiptliquidated damagesincome taxsterilisation of capital assetSection 256Section 80Jassessment yearcement plantdelay in delivery

Judgment

[2010] 8 S.C.R. 404

A COMMISSIONER OF INCOME TAX, GUJARAT
v.
M/S. SAURASHTRA CEMENT LTD.
(Civil Appeal No. 3702 of 2003)

JULY 09, 2010
B
[D.K. JAIN AND C.K. PRASAD, JJ.]

Income Tax Act, 1961 - Liquidated damages received
by assessee from supplier of the cement plant and machinery
C on account of delay in supply of plant - Held: Is to be treated
as capital receipt - The delay in procurement of capital asset
i.e. the cement plant amounted to sterilization of the capital
asset of the assessee - The amount received by the
assessee towards compensation for sterilization of the profit
o earning source, being not in the ordinary course of their
business, was a capital receipt in the hands of the assessee.

The respondent-assessee was engaged in
manufacture of cement. It entered into an agreement for
purchase of additional cement plant. The supplier
E defaulted and failed to supply the plant and machinery
on the scheduled time and, therefore, as per the terms of
agreement, the assessee received an amount from the
supplier by way of liquidated damages.

F In the instant appeal filed by Revenue, the question
which arose for consideration was: "whether the
liquidated damages received by the assessee from the
supplier of the plant and machinery on account of delay
in the supply of plant is a capital or a revenue receipt?".
G
Dismissing the appeal, the Court

HELD: It is clear from the agreement in question that
the liquidated damages were to be calculated at 0.5% of

H 404
COMMISSIONER OF INCOME TAX,, GU_JA~AT, ".'· 405..
SAURASHTRA CEMENT LTD.

the price of the respective m~chin~ry ~nd equi~rrient for A
each month of delay in delivery completion, without proof
of the actual damages the assessee would have suffered
on account of the delay. The delay in supply could be-.of
the whole plant or a part thereof but the determination of
,. • j I • ' ·' • .., ~

damages-was not based upon the calculation made in B
'• I" •
• ' '
' - , •
' • i. . ~
respect of loss of profit on account of supply. of a
particular part of the plant. It is evident that the d~mage
to tne assessee was directly and intimately linked with the
procurement of a capital asset i.e. tt:ie 'cement plant, which
would obviously lead to delay in.coming into existence c
of the profit making apparatus, rather than a receipt in .the
course of profit earning process. The delay in
procurement of capital asset amounted to sterilization of
the capital asset of the assessee as the supplier had failed
to' suppl'y the .. plant within' time as stipula.ted iri 'the
agr~emeiit. T~e amou~t 'received_ by the ;a'ssesse·e; D
towards compensation· fo~ sterilization' of the 'profit
~ I " I , i: }
• I ~ -· " ' .I~ ''. I I ,

earning source, being not in the ordinary course of their,
business,
• ,_ I..
was a. capital receipt 'i·n , the hands of the.
. . l' ~ ~

assessee. [Para 13] [412_7A-EJ ,: -· ...;;·. . 'I ~ .111t ! E,
- ' Com.missioner of Income Tax, Nagpur v. Rai Bahadur·
Jairam Valji and Others (1959) ·35 ITR 148 (SC) and
Kettlewell B.ullen and.. Co .. Uc(_ ~;,-,~ommissioner of Income-
Tax, Calcutta· AIR
~., "'
~
.1965
'
SC
•
65,
, . ,.,
relied
:J :
on. , · I '

- C.I. T, Gujarat v_ Mis Elecon Engineering Co. 'Ltd. (1987) F
4 sec 530 and E.f.D.' Parry Ltd. v.'Commissioner of Income
T.a.~ (1998) 233 ITR 335 (Ma.dl.rreferred .to.
- .. - • . . 1' ' •

,,, .
Case Law· Reference: ··
;

, . i- ~·
G
. (1987) 4 sec 530 . referred to Para 2

1 , "· (195~).35 ITR ~,48 (SC) r~li_~d on, . Para 5
AIR 1965 SC 65 ·' relied on , .- Para 5
". ~~ i .... . L ' ., ,., ~ '
H
406 SUPREME COURT REPORTS [2010] 8 S.C.R.

A (1998) 233 ITR 335 (Mad) referred to Para 9

CIVIL APPELLATE JURISDICTION : Civil Appeal No.
3702 of 2003.

From the Judgment and Order dated 27.06.2001 of the
B High Court of Gujarat at Ahmedabad in Income Tax Reference
No. 44 of 1986.

R.P. Bhatt, H.R. Rao, B.V. Balaram Das for the Appellant.

C Bhargava V. Desai, Rahul Gupta and Nikhil Sharma for the
Respondent.

The Judgment of the Court was delivered by

D.K. JAIN, J. 1. This appeal, by special leave, at the
D instance of the Revenue is directed against the judgment and
order dated 27th June, 2001 delivered by the High Court of
Gujarat at Ahmedabad in Income Tax Reference No.44of1986.
By the impugned judgment, the High Court has answered the
following questions, referred to it by the Income Tax Appellate
E Tribunal, Ahmedabad (for short "the Tribunal") under Section
256(1) of the Income Tax Act, 1961 (for short "the Act"), in the
affirmative and in favour of the assessee.

(i) Whether the Tribunal has not erred in law on facts
in holding that the amount of Rs.8,50,000/- received
F by the assessee was not taxable as revenue
receipt in the hands of the assessee?

(ii) Whether the finding of the Tribunal that the receipt
relating to liquidated damages cannot be treated
G as a revenue receipt but must be held to be a
capital receipt not exigible to tax is correct in law?

(iii) Whether the assessee is entitled to the addition
made to the machinery during the year thus
determining the capital employed for the purpose
H
COMMISSIONER OF INCOME TAX, GUJARAT v. 407 .
SAURASHTRA CEMENT LTD. [D.K. JAIN, J.]

of claim under Section 80J of the Income Tax Act, A
1961?

2. At the outset, we may note that insofar as questior
No.(iii) is concerned, it was conceded on behalf of the Revenue
before the High Court that answer to the said question stood
B
concluded in favour of the assessee by the decision of this
Court in C./. T., Gujarat Vs. Mis Elecon Engineering Co. Ltd. 1 •
Relying on the said decision, the High Court answered the
question in favour of the assessee. Therefore, only question
Nos. (i) and (ii), which in effect involve only one issue, survive C
for our consideration.

3. The reference pertains to the Assessment Year 1974-
75 for which the relevant previous year ended on 30th June,
1973. The factual background in which the issue, covering both
the questions, has arisen, is as follows : D

The assessee, engaged in the manufacture of cement etc;
entered into an agreement with M/s Walchandnagar Industries
Limited, Bombay, (hereinafter referred to as "the supplier") on
1st September, 1967 for purchase of additional cement plant E
from them for a total consideration of Rs.1, 70,00,000/-. As per
the terms of contract, the amount of consideration was to be
paid by the assessee in four instalments.

The agreement contained a condition with regard to the
manner in which the machinery was to be delivered and the F
consequences of delay in delivery. Insofar as the present
appeal is concerned, clause No.6 of the agreement is relevant
and it reads as follows:

"6. xxx xxx xxx G
Delayed Deliveries:

In the event of delays in deliveries except the reason

1. (1987) 4 sec 530. H
408 SUPREME COURT REPORTS (2010] 8 S.C.R.

A of Force Majeure at para 5 mentior:ed above, the
Suppliers shall pay the Purchasers an agreed amount by
way of liquidated damages without proof of damages
actually suffered at the rate of 0.5% of the price of the
respective machinery and equipment to which the items
B were delivered late (sic), for each month of delay in
delivery completion. It is further agreed that the total amount
of such agreed liquidated damages shall not exceed 5%
of the total price of the plant and machinery."

As per the said clause in the agreement, in the event of
C delay caused in delivery of the machinery, the assessee was
to be compensated at the rate of 0.5% of the price of the
respective portion of the machinery for delay of each month by
way of liquidated damages by the supplier, without proof of
actual loss. However, the total amount of damages was not to
D exceed 5% of the total price of the plant and machinery.

4. The supplier defaulted and failed to supply the plant and
machinery on the scheduled time and, therefore, as per the
terms of contract, the assessee received an amount of
E Rs.8,50,000/- from the supplier by way of liquidated damages.

5. During the course of assessment proceedings for the
relevant assessment Year, a question arose whether the said
amount received by the assessee as damages was a capital
or a revenue receipt. The Assessing Officer negatived the claim
F of the assessee that the said amount should be treated as a
capital receipt. Accordingly, he included the said amount in the
total income of the assessee. Aggrieved, the assessee filed
an appeal before the Commissioner of Income Tax (Appeals), .
but without any success. The assessee carried the matter
G further in appeal to the Tribunal. Relying on the ratio of the
decisions of this Court in Commissioner of Income Tax,
Nagpur Vs. Rai Bahadur Jairam Valji and Others2 and
Kettlewell Bullen and Co. Ltd. Vs. Commissioner of Income-

H 2. (1959) 35 ITR 148 (SC)
COMMISSIONER OF INCOME TAX, GUJARAT v. 409
SAURASHTRA CEMENT LTD. [D.K. JAIN, J.]
Tax, Ca/cutta 3, the Tribunal came to the conclusion that the said A
amount could not be treated as a revenue receipt. According
to the Tribunal, the payment of liquidated damages to the
assessee by the supplier was intimately linked with the supply
of machinery i.e. a fixed asset on capital account, which could
be said to be connected with the source of income or profit B
making apparatus rather than a receipt in course of profit
earning process ~nd, therefore, it could not be treated as part
of receipt relating to a normal business activity of the assessee.
The Tribunal also observed that the said receipt had no
connection with loss or profit because the very source of c
income viz., the machinery was yet to be installed. Accordingly,
the Tribunal allowed the appeal and deleted the addition made
on this account.

6. Being dissatisfied with the decision of the Tribunal, as
stated above, at the instance of the Revenue, the Tribunal D
referred the afore-noted questions of law for the opinion of the
High Court. The reference having been answered against the
Revenue and in favour of the assessee, the Revenue is before
us in this appeal.
E
7. We have heard Mr. R.P. Bhatt, learned Senior Counsel
appearing for the Revenue and Mr. Bhargava V. Desai on
behalf of the assessee.

8. Mr. Bhatt submitted that although the said amount of
F
damages had been received by the assessee under clause 6
of the agreement for breach of contract, yet the said amount
had been received as compensation for the loss of profit, and
therefore, it is in the nature of a revenue receipt. According to
the learned counsel, it was on account of late commissioning
of the plant that the assessee could not commence production G
as per its schedule and thereby suffered loss in its profits, which
was compensated by the supplier and, therefore, the said
amount should have been considered as revenue receipt.

3. AIR 1965 SC 65. H
410 SUPREME COURT REPORTS [2010] 8 S.C.R.

A 9. Per contra, Mr. Desai, learned counsel appearing for
the assessee, while supporting the decision of the High Court
submitted that the amount received by the assessee was by
way of compensation for delay in the delivery and installation
of the plant and had a direct nexus with the capital asset and
B therefore, it was in the nature of a capital receipt. Learned
counsel also argued that answer to the questions stands
concluded in favour of the assessee by the decision of the High
court of Madras in E.l.D. Parry Ltd. Vs. Commissioner of
Income Tax4, which has attained finality on account of dismissal
c of the Civil Appeal preferred by the Revenue against the said
judgment.

10. Thus, the short question for determination is whether
the liquidated damages received by the assessee from the
supplier of the plant and machinery on account of delay in the
D supply of plant is a capital or a revenue receipt?

11. The question whether a particular receipt is capital or
revenue has frequently engaged the attention of the Courts but
it has not been possible to lay down any single criterion as
E decisive in the determination of the question. Time and again,
it has been reiterated that answer to the question must
ultimately depend on the facts of a particular case, and the
authorities bearing on the question are valuable only as
indicating the matters that have to be taken into account in
F reaching a conclusion. In Rai Bahadur Jairam Valji (supra), it
was observed thus:

"The question whether a receipt is capital or income has
frequently come up for determination before the courts.
Various rules have been enunciated as furnishing a key
G to the solution of the question, but as often observed by
the highest authorities, it is not possible to lay down any
single test as infallible or any single criterion as decisive
in the determination of the question, which must ultimately

H 4. [1998] 233 ITR 335 (Mad)
COMMISSIONER OF INCOME TAX, GUJARAT v. 411
SAURASHTRA CEMENT LTD. [D.K. JAIN, J.]
depend on the facts of the particular case, and the A
authorities bearing on the question are valuable only as
indicating the matters that have to be taken into account
in reaching a decision. Vide Van Den Berghs Ltd. v. ·
Clari<'. That, however, is not to say that the question is one
of fact, for, as observed in Davies (H. M. Inspector of B
Taxes) v. Shell Company of China Ltd. 6 , "these questions
between capital and income, trading profit or no trading
profit, are questions which, though they may depend no
doubt to a very great extent on the particular facts of each
case, do involve a conclusion of law to be drawn from those c
facts."
I
12. In Kettlewell Bullen and Co. Ltd. (supra), dealing with
the question whether compensation received by an agent for
premature determination of the contract of agency is a capital
or a revenue receipt, echoing the views expressed in Rai D
Bahadur Jairam Va/ji (supra) and analysing numerous
judgments on the point, this Court laid down the following broad
principle, which may be taken into account in reaching a
decision on the issue :
E
"Where on a consideration of the circumstances, payment
is made to compensate a person for cancellation of a
contract which does not affect the trading structure of his
business, nor deprive him of what in substance is his
source of income, termination of the contract being a F
normal incident of the. business, and such cancellation
leaves him free to carry on his trade (freed from the
contract terminated) the receipt is revenue : Where by the
cancellation of an agency the trading structure of the
assessee is impaired, or such cancellation results in loss G
of what may be regarded as the source of the assessee's
income, the payment made to compensate for cancellation
of the agency agreement is normally a capital receipt."

5. (1935 3 l.T.R. (Eng. Gas.) 17.
6. (1952) 22 l.T.R.(Suppl.) 1. H
412 SUPREME COURT REPORTS [2010] 8 S.C.R.

A 13. We have considered the matter in the light of the afore-
noted broad principle. It is clear from clause No.6 of the
agreement dated 1st September 1967, extracted above, that
the liquidated damages were to be calculated at 0.5% of the
price of the respective machinery and equipment to which the
B items were delivered late, for each month of delay in delivery
completion, without proof of the actual damages the assessee
would have suffered on account of the delay. The delay in supply
could be of the whole plant or a part thereof but the
determination of damages was not based upon the calculation
c made in respect of loss of profit on account of supply of a
particular part of the plant. It is evident that the damages to the
assessee was directly and intimately linked with the
procurement of a capital asset i.e. the cement plant, which
would obviously lead to delay in coming into existence of the
profit making apparatus, rather than a receipt in the course of
0
pr<0fit earning process. Compensation paid for the delay in
procurement of capital asset amounted to sterilization of the
capital asset of the assessee as supplier had failed to supply
the plant within time as stipulated in the agreement and clause
No.6 thereof came into play. The afore-stated amount received
E by the assessee towards compensation for sterilization of the
profit earning source, not in the ordinary course of their
business, in our opinion, was a capital receipt in the hands of
the assessee. We are, therefore, in agreement with the opinion
recorded by the High Court on question Nos. (i) and (ii)
F extracted in Para 1 (supra) and hold that the amount of
Rs.8,50,000/- received by the assessee from the suppliers of
the plant was in the nature of a capital receipt.

14. We, therefore, dismiss the appeal ~ith no grder as to
G costs.

B.B.B. Appeal dismissed.