Holding

The forfeited amounts are capital receipts, not revenue receipts, and must be treated as part of the cost of acquisition under Section 51 of the Income Tax Act.

Summary

Travancore Rubber and Tea Co. entered into three agreements to sell old rubber trees, receiving Rs 75,000 as earnest money and Rs 3,56,300 as advance. The purchasers defaulted, the agreements were terminated and the amounts were forfeited. The assessee claimed the forfeited sums were capital receipts and not taxable as revenue, a view upheld by the Assessing Officer but reversed by the Commissioner under Section 263. The Income Tax Appellate Tribunal and the Kerala High Court gave conflicting rulings on whether the earnest money was revenue income. The Supreme Court held that both the earnest money and advance constitute capital receipts, falling within Section 51 of the Income Tax Act and representing compensation for breach of contract under Section 74 of the Indian Contract Act, and therefore are not assessable as revenue income. The Court allowed the appeals and set aside the High Court order.

Issues considered

Whether the forfeited earnest money and advance received in an abortive sale of rubber trees are capital receipts or revenue receipts for income‑tax purposes.
Whether Section 51 of the Income Tax Act, 1961 applies to both advance and earnest (other) money, making them part of the cost of acquisition.
Whether compensation for breach of contract under Section 74 of the Indian Contract Act is to be treated as a capital receipt.

Legislation cited

Income Tax Act, 1961s. 256(1), s. 263, s. 51
Indian Contract Act, 1872s. 74

Subjects

capital receiptrevenue receiptforfeitureearnest moneyadvance moneySection 51Section 74income taxcapital gainsbreach of contractplantation

Judgment

A THE TRAVANCORE RUBBER AND TEA CO. LTD.
v.
COMMISSIONER OF INCOME TAX, TRIVANDRUM

MARCH 14, 2000

B [D.P. WADHWA AND RUMA PAL, JJ.]

Income Tax Act, 1961-Section SJ-Agreement for sale of old rubber
trees-Earnest money and advance amount received by assessee-Default in
payment of balance amounts by purchasers-Forfeiture of amounts by
c assessee as per agreement-Forfeited amounts-Capital or revenue receipt-
Held, the forfeited amounts relate to sale of capital asset and therefore a
capital receipt-Indian Contract Act, 1872-Section 74.

Appellant-assessee, a plantation company, is engaged in the business
of growing rubber and tea. The assessee entered into agreements with
D purchasers for sale of old rubber trees. Earnest money arid advance
amounts were paid to the assessee by the purchasers as per the agree-
ments. The assessee forfeited the amounts on default in payment of the
balance amounts by the purchasers as per the agreements. The assessee, in
its returns, claimed the forfeited amounts as revenue receipts not exigible
to tax which was upheld by the Assessing Officer. The Commissioner of
E Income Tax, invoking revisionary powers under Section 263 of the Income
Tax Act, 1961 held that the forfeited amounts as revenue income exigible
to tax. In appeal by the assessee, the Tribunal set aside the order of the
Commissioner. On reference, High Court remanded the matter to the
Tribunal to decide it afresh taking into account the difference between
earnest money and advance. On remand, the Tribunal concluded that the
F forfeiture of advance amount is a revenue receipt not chargeable to tax
while the earnest money is assessable under the head "income from other
sources". On reference, the High Court held that the amounts were
income chargeable to tax.
In appeal to this Court, the assessee contended that the quality and
nature of a receipt for income tax purposes is fixed once and for all which
G
cannot be altered on account of subsequent operation.
Revenue contended that the amounts which were not receiv~d ini-
tially as trading receipts could eventually be regarded as business income
by reason of subsequent events.
-
H Allowing the appeals, the Court
290
TRAVANCORE RUBBER AND TEA CO. v. C.I.T. 291
HELD : 1.1. The assessee,does not carry on the business of selling A
trees. When the assessee entered into agreements for sale of old and
unyielding rubber trees, the advance consideration received was capital
receipt. H the sale had gone through, then the consideration would have
been subject to capital gains. The cancellation of the sale of capital assets
would not subsequently change the nature of the receipt of the forfeited
amounts. The specific provisions of Section 51 of the Income Tax Act, 1961 B
which provide for the computation of the cost of acquisition for determin-
ing the capital gains arising from the transfer of a particular asset fortify
this view. [295-D-F; 296-F]
1.2 Where there is a transfer of a capital asset, if there was a previous
occasion when there were negotiations for its transfer, and if "advance or C
other money" had been received and retained by the assessee in respect of
such negotiations, such amounts will in effect be added to the value of the
capital asset impacting on the ultimate assessment of capital gains. For this
purpose, no distinction is made between moneys received and retained by
way of 'advance' and 'other money'. The phrase 'other money' would
cover deposits made by the purchaser for guaranteeing due performance of D
the contracts and not forming part of the consideration. The monies re-
ceived on the previous occasions and retained by the vendor/assessee can-
not, therefore, be treated as a revenue receipt. [297-A-B]
1.3. There were negotiations for transfer of the rubber trees in
question, between the assessee and the purchasers which did not fructify in
sale. The amount'! forfeited referred only to the capital asset of the E
assessee and were directly related to the sale of such capital asset. The
Tribunal correctly held that the advance money for sale of the rubber
trees formed part of the capital asset of the assessee and that the saJe, if
materialised, would have resulted in a gain exigible to capital gains tax,
provided there is a gain arising out of the same. But the Tribunal erred in
overlooking the phrase 'or other mony' in Section 51 of the Act in holding F
that the earnest money did not come within purview of the section. There
is a distinction between earnest money and advance but that distinction
loses its significance in the context of the express language of Section 51 to
include 'other money' in addition to 'advance'. [297-D-E]

1.4. The amount was forfeited by the assessee as per the terms of the G
agreement. The terms has to be construed as providing for compensation
for breach of contract under Section 74 of the Indian Contract Act, 1872.
• The assessee's right to recover the compensation was to place the assessee
in the same position as if the breach had not taken place. H the agreed
sums of money under the agreements had been received by the assessee,
they would have been credited as a capital receipt. Therefore, the forfeited ff
292 SUPREME COURT REPORTS [2000] 2 S.C.R.
A amounts must also be treated as capital receipt. [298-A; D-E]

1.5. The High Court erred in proceeding on the basis that the
agreements in question were agreements for sale hut did not effect a sale.
The terms of the agreements clearly show that they were agreements of
sale where both payment of the price and delivery were deferred. Had the
B purchasers paid the purchase price in the agreed instalments their right to
take delivery of the trees under the agreement was complete. -[298-F]

Commissioner of Agricultural Income Tax, Kerala v. Kailas Rubber &
Co. Ltd., (1996) 60 ITR 435; AKTM Vzshnudatta Anantharjanam v. Commis-
sioner of Agricultural Income Tax, Trivandrum, (1970) 78 ITR 58, relied on.
c Commissioner of Income Tax v. Motor & General Insurance Ltd., 94
ITR 582Del. DB; Commissioner of Income Tax, Tamilnadu v. AVM Ltd., 146
ITR 355; Commissioner of Income Tax v. Karam Chand 11iapar, [1996] 10
SCC 577; Maula Bux v. Union ofIndia, AIR (1970) SC 1955; Shree Hanuman
Cotton Mills & Anr. v. Tata Air Craft Ltd., AIR (1970) SC 1986 and Commis-
D sioner ofIncome Tax v. Travancore Rubber and Tea Co. Ltd., (1991) 190 ITR
509, referred to.

Morley (Inspector of Taxes) v. Tattersall, (1939) 7 ITR 316 and London
and Thames Haven Oil Wharves Ltd. v. Attwooll (Inspector of Taxes), (1968)
70 ITR 460, referred to.
E Jay's The Jewellers Ltd. v. !RC, 29 Tax Cases 274 : (1974) 2 AH ER
762 and Elson (Inspector of Taxes) v. Prices Tailors Ltd, (1963) 1 All ER
231, referred to.

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 385-386 of
1999.
F
From the Judgment and Order dated 9.4.96 of the Kerala High Court
in I.TR. Nos. 37-38 of 1992.

Joseph Vellapally, M.P. Vmod and Tarun Gulati for the Appellant.

M.L. Verma, S.W.A Quadri, Ms. Sushma Suri and S.K. Dwivedi for
G the Respondent.

The Judgment of the Court was delivered by

RUMA PAL, J. The assessment year in question is 1977-78. The issue
is whether the amounts received by the assessee/appellant in respect of an
H abortive sale transaction of rubber trees are capital or revenue receipts?
TRAVANCORE RUBBER AND TEA CO. v. C.I.T. [RUMA PAL, J.] 293
The assessee is a plantation company engaged in the business of A
growing rubber and tea. In 1975, it entered into three agreements with three
purchasers for sale for old rubber trees. Each of the purchasers paid a certain
amount by way of earnest money and another amount by way of advance
under their respective agreements. The total amount of earnest money
received by the assessee under the three agreements was Rs. 75,000 and the
total amount by way of advance was Rs. 3,56,300. All the three purchasers B
defaulted in payment of the balance amounts. The agreements were accord-
ingly terminated and the amounts of earnest money and advance were
forfeited by the assessee. The assessee filed three suits before the Subordi-
nate Judge, Kottayam in this connection. The assessee's right to retain the
amounts of earnest money and advance was confirmed by the Court. In 1979,
the assessee was eventually successful in selling the old rubber trees to a C
third party but at a loss.
In the assessee's return for the assessment year in question, the
assessee claimed that the amounts forfeited were not taxable as revenue
receipts. The Assessing Officer upheld the contention of the assessee.
However, the Commissioner of Income Tax sought to revise the assessment D
under Section 263 of the Act and held that the amounts forfeited were
revenue income and assessable to income tax. The assessee preferred an
appeal before the Income Tax Appellate Tribunal. The Tribunal set aside the
order of the Commissioner and restored the finding of the Assessing Officer.
At the instance of the Revenue, the Income Tax Appellate Tribunal E
referred the following two questions of law for the decision of the High Court
under Section 256(1) of the Act :
(1) Whether, on the facts and in the circumstances of the case, the
Tribunal was right in law in holding that the sum of Rs.
3,95,229 cannot be considered to be a revenue receipt in the
hands of the assessee? F

(2) Whether on the facts and in the circumstances of the case, the
Tribunal was justified in finding that the sum of Rs. 3,95,229
is not the income of the assessee for this assessment year and
directing the Income Tax Officer to modify the assessment?
G
The High Court's decision (which has been subsequently reported in
1991 Vol. 190 ITR 509 - Commissioner of Income Tax v. Travancore Rubber

.... and Tea Co. l.Jd. was that the Tribunal should have kept in mind the
difference between earnest money and advance while deciding the issues
· raised. The High Court delineated the difference between the legal character
of the two amounts and remanded the matter back to the Income Tax H
294 SUPREME COURT REPORTS [2000] 2 S.C.R.
A Appellate Tribunal to decide the matter afresh.

On remand, the Tribunal considered various terms of the agreements
and came to the conclusion that the receipt by way of forfeiture of advance
was not assessable as a revenue receipt but that the earnest money was so
assessable as income under other sources.

B At the instance of both the assessee as well as the Revenue, the
following questions were referred by the Tribunal to the High Court of
Kerala for its opinion :

At the instance of the assessee.

c (1) Whether on the facts and in the circumstances of the case the
Tribunal was right in law in holding that the earnest money deposit
of Rs. 75,000 received by the assessee in respect of the agreements
for sale of old and lmeconomic rubber trees is revenue income
assessable to income-tax when forfeited consequent to termination
of the said agreements for breach thereof by the purchasers.
D At the instance of the Department :
(2) Whether, on the facts and in the circumstances of the case, the
Tribunal is right in law and fact in holding that the receipt by way
of forfeiture of advance amount arising to the assessee, -

E (a) is a benefit arising to the assessee in the course of its
plantation business?

(b) is not or cannot be subject to tax?

(3) Whether, on the facts and in the circumstances of the case and
in view of the fact that the trees were transferred i.e. cut and
F removed ultimately by agreement dt. 22.7.1979, the tribunal is, -
(i) facnially incorrect in holding that "it is an undisputed fact
that the trees had not been been cut and removed or at
least there is no evidence ..... ?
(ii) legally and factually right in "rejecting the contention"
G of the Revenue after having rightly accepted the conten-
tion of the Revenue that the receipt would be exigible to
income-tax for capital gains?
(4) Whether, on the facts and in the circumstances of the case if the
answer to question No. 2 is in favour of the Revenue should not the
H Tribunal have in view of the provisions contained in Section 51 of
TRAVANCORE RUBBER AND TEA CO. v. C.l.T. [RUMA PAL, J.] 295
the Income Tax Act and read with the decision of the Supreme A
Court in 131 ITR 451 given appropriate direction to the assessing ,
authority?"

The High Court by its judgment dated 9th April 1995 answered the first
question only. It held that both the amounts received by the assessee by way
of forfeiture could not be considered in relation to "any other thing other than B
the situation of forfeiture" and once it is held that forfeiture puts an end to the
agreement in question as a necessary sequitur, it followed that it "puts an end
to the character as is understood by the parties and to the amounts covered
thereby" and that the amounts in question were income receipts in the context
of the situation. Adverting to Section 51 of the Act, the High Court was of
the view that the factual situation envisaged under Section 51 was absent in C
the assessee' !i case, that the amounts that were with the assessee after forfeiture
could not "be said to have been retained by the assessee in respect of the
transaction" and finally, that application of Section 51 "is contemplated or can
be thought of at a stage prior to the execution of the agreement in question,
at a stage of negotiation deal with receipt of advance or other money and
retention thereof." D
We are, unfortunately, unable to accept the reasoning or th.e conclusion
of the High Court. The assessee does ;1ot carry on the business of selling
trees. The question whether the sale proceeds of old and unyielding rubber
trees grown and used for obtaining income as latex therefrom are capital
receipt and whether the sale proceeds of unyielding trees purchased many E
years back as yielding trees are capital receipt was answered in the
affirmative by the Constitution Bench of this Court in Commissioner of
Agricultural Income Tax, Kerala v. Kailas Rubber & Co. lJd., (1966) Vol.
60 ITR 435. See also AK.TM Vishnudatta Anantharjanam v. Commi{sil>ner
of Agricultural Income Tax, Trivandrum, (1970) 78 ITR 58.
... F
When the assessee entered into the three agreements for sale of old and
l ' ubyielding rubber trees what was received by way of advance consideration

was, therefore, capital receipt. Had sale gone through there would be no
question but that the consideration would l;>e subject to capital gains. The
question is does the character of the receipt change because the sale was not
subsequently effected? G
\ ~ .
Learned counsel for the assessee relied on Morley (inspector of Taxes)

- v. Tattersall, (1939) 7 ITR 319; (followed 'in Commissioner of Income Tax
v. Motor & General Insurance lJd., 94 ITR 582 (Del) (DB); Commissioner
of Income Tax, Tamilnadu v. AVM lJd. 146 ITR 355) to contend that the
question and nature of a receipt for income tax purposes were fixed once and H
296 SUPREME COURT REPORTS [2000) 2 S.C.R.
A for all when the subject of the receipt was received and that no subsequent
operation could change the nature of the receipt.

Learned counsel for' the respondent countered the agreement and cited
Commissioner of Income Tax v. Karam Chand Thapar, [1996) 10 SCC 577
where this Court noted the decisions in Jay's The Jewellers Ltd..v. !RC, 29
B Tax Cases 274: (1947) 2 All ER 762 and Elson (Inspector of Taxes) v. Prices
Tailors Ltd., ·(1963) 1 All ER 231 with approval as limiting the principle
enunciated in Tattersall's case. It was held by this Court that the proposition
enunciated in Tattersall' s case was ~ot absolute and that in given cases
amounts which were not received initially as trading receipts could eventu-
aily be regarded as business income by reason of subsequent events. The
C subsequent event must be such that 'a different quality is imprinted' on the
receipt. An example of such subsequent even was found in the case of Joy's
The Jewellers (supra) where :

"It has been categorically laid down that the money, which belonged
to the customers and which arose out of sale of customer; s property
D could become a trading receipt when the customers did not or could
not make any claim against that money in law and amount was taken
by the assessee to its profit and loss account. In fact, it was
emphasised that that was the correct accounting practice. Atkinson,
J. pointed out that a new asset could come into existence automati-
cally by operation of law. When no demand for payment was made
E common sense requires that such amount should be entered into
profit and loss account for the year and be treated as taxable."

However, in our view, the cancellation of a sale of capital assets would ' .....
not be such a subsequent event so as change the nature of the receipt of the
forfeited amounts.
F The specific provisions of Section 51 of the Income Tax Act, 1961
which provide for the computation of the cost of acquisition for determining
the capital gains arising from the transfer of a particular asset fortif:Y th'is'
view. Section 51 reads :

"51. Advance money received. - Where any capital asset was on any
G previous occasion the subject of negotiations for/its transfer, any
advance or other money received and retained tfy 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
marlcet value, as the case may be, in''Computing the cost_ of
acquisition."
H (emphasis added)
TRAVANCORE RUBBER AND TEA CO. v. C.I.T. [RUMA PAL, J.] 297

Thus where there is a transfer of a capital asset, if there was a previous A
occasion when there were negotiations for its transfer, and if "advance or
other money" had been received and retained by the assessee in respect of
such negotiations, such amounts will in effect be added to the value of the
capital asset impacting on the ultimate assessment of capital gains. For this
purpose, no distinction is made between moneys received and retained by
way of 'advance' and 'other money'. The phrase 'other money' would cover, B
for example, deposits made by the pur~haser for guaranteeing due perform-
ance of the contracts and not forming part of the consideration. The monies
received on the previous occasions and retained by the vendor/assessee
cannot therefore, be treated as a revenue receipt. Section 51 to the extent
stated thus preserves the rule in Tattersall's case.
c
In the case before us there were negotiations for transfer of the rubber
trees in question, which did not fructify in sale. The amounts forfeited
referred only to the capital asset of the assessee and-were directly related to
the sale of such capital asset. The Tribunal correctly held that the advance
money for sale of the mbber trees formed part of the .capital asset of the
assessee and that the sale, if materialised, would have resulted in a gain D
exigible to capital gains tax, provided there is a gain arising out of the same.
But the Tribunal erred in overlooking the phrase 'or other money' in Section
51 in holding that the earnest money did not come within the purview of
Section 51. No doubt, as held by the High Court in the decision reported in
(1990) Vol. 190 ITR 509 (supra), there is a distinction between earnest
money and advance, but that distinction loses its significance in the context E
of the express language of Section 51 to include 'other money' in addition
to 'advance.'

The matter may be considered from another aspect. The amount
forfeited by the assessee was in terms of clause 16 of the agreement which
reads :
F
"It the event of the Purchaser failing to p~y any of the instalments
hereby agreed to be paid by him on the date specified or violating
any of the terms on its part to be perf01med, the Vendor shall have
the right and liberty to cancel all rights hereby granted to the
Purchaser any time after such violation and to realise from the
Purchaser forthwith in a lump the entire balance amount then G
remaining to be paid. In the event of the balance amount remaining
unpaid on demand the purchaser will not have any claim or right
over the Rubber Trees standing or cut nor can he claim from the
Vendor the earnest money deposit or the instalments paid till date. "
(emphasis added) H
298 SUPREME COURT REPORTS [2000] 2 S.C.R.
A Such a clause has been construed as providing for compensation for
breach of contract under Section 74 of the Indian Contract Act, 1872. [See
Maula Bux v. Union of India, AIR (1970) SC 1955 and Shree Hanuman
Cotton Mills and Another v. Tata Air Craft Ltd., AIR (1970) SC 1986.]

In determining whether compensation received for breach of a contract
B is a capital or trading receipt, the relevant rule has been formulated by
Diplock L., J. in London and Thames Haven Oil Wharves Ltd. v. Attwooll
(Inspector of Taxes) (1968) 70 ITR 460 at p.488 as :

"Where, pursuant to a legal right, a trader receives from another
person compensation for the trader's failure to receive a sum of
money which, if it had been received, would have been credited to
c the amount of profits (if any) arising in any year from the trade
carried on by him at the time when the compensation is so received,
the compensation is to be treated for income tax purposes in the
same way as that sum of money would have been treated if it had
been received, instead of the compensation."
D The logic of the principle is that the assessee's right to recover the
compensation was to place the assessee in the same position as if the breach
had not taken place. Applying the rule to this case, if the agreed sums:cl
money under the agreements had been received by the assessee, they would
have been credited in its account as a capital receipt. That being so, the
E forfeited amounts must also be treated as capital receipt. '

Finally, the High Court erred in proceeding on the basis that the
agreements in question were agreements for sale but did not effect a sale. The
terms of the agreements cleatly show that they were agreements of sale were
both payment of the price and delivery were deferred. Had the purchasers paid
F the purchase price in thP, agreed instalments their right to take delivery of the
trees under the agreement was complete.

For the reasons aforesaid, we allow the appeals and set aside the order
of the High Court and answer the question refe~ed to it by the assessee in
the negative. There will be no order as to costs.
G
B.S. Appeals allowed.