Case Overview (2)

8/4/2019 Case Overview (2)

http://slidepdf.com/reader/full/case-overview-2 1/8

CORPORATE TAX MANAGEMENT

REPORT ON CASE STUDY

INCOME TAX DEPT. OF GUJARAT VS M/SSAURASHTRA CEMENT LTD.

SUBMITTED TO-PROF. ZOHRA BI

8/9/2011

Submitted By: Group 2

Abhishek Sharma 10SBCM0369

Amit Kumar 10SBCM0491

Ankita Das 10SBCM0376

Vamsi Kurella 10SBCM0242

Vishakha Suri 10SBCM0548



Page | 2

Contents

Case Overview ......................................................................................................................................... 3

Introduction ............................................................................................................................................ 3

Agreement between the assessee and the supplier ................................................................................. 3

Clause 6 of the above agreement ......................................................................................................... 4

Representatives of the case ..................................................................................................................... 4

Issue of the case ...................................................................................................................................... 5

Judgement for the case............................................................................................................................ 5

High court of Gujarat, Ahemdabad Judgement ........................... ................................ .......................... 6

Supreme Court Judgement .................................................................................................................. 6

Conclusion ............................................................................................................................................... 7

Bibliography ............................................................................................................................................ 8



Page | 3

Case Overview

This case is in between the Income Tax Department of Gujarat vs. M/s Saurashtra Cement Ltd.

where M/s Saurashtra Cement Ltd. came into an agreement from M/s Walchandnagar Industries

ltd. to purchase cement manufacturing machinery for their plant. But due to some unfortunate

situation this agreement clause could not deliver in time for which the supplier (M/s

Walchandnagar Industries Ltd.) had to pay the damages i.e. Liquidated Damages to the purchaser

(M/s Saurashtra Cement Ltd.) as per the agreement. Liquidated damage amount received by the

purchaser was considered by them as Capital Receipt which is not taxable under Indian Income

Tax Act, 1961, but Income Tax Department of Gujarat considered that receipt amount as

Revenue Receipt which is 100% taxable under Indian Income Tax Act, 1961. Due to this

disagreement this case further went to Tribunal i.e. High Court and Supreme Court.

Introduction

Liquidated Damages means a fair representation of losses in situations where actual damages are

difficult to ascertain. In certain legal contracts, this provision allows for the payment of a

specified sum, should one of the parties be in breach of contract. This is a case which guides us

about the treatment of receipts in the form of Liquidated Damages.

Agreement between the assessee and the supplierThe assessee (M/s Saurashtra Cement Ltd.), engaged in the manufacture of cement etc; entered

into an agreement with M/s Walchandnagar Industries Limited, Bombay (supplier), on 1st

September, 1967 for purchase of additional cement plant 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 installments. The agreement contained a condition with regard to the manner in

which the machinery was to be delivered and the consequences of delay in delivery.



Page | 4

Clause 6 of the above agreement

In their agreement they clearly mentioned the clause which stated that the supplier (M/s

Walchandnagar Industries ltd.) shall pay the purchaser (M/s Saurashtra Cement ltd.) 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 were delivered

late, for each month of delay in delivery completion. It was further agreed that the total amount

of such agreed liquidated damages shall not exceed 5% of the total price of the plant and

machinery.

In this case the M/s Walchandnagar Industries Ltd. delayed in the delivery of machinery for

which they paid damages in the form of Liquidated Damages.

Price of Machinery 1,70,00,000

Damages paid in % 0.5%

Damages Amount 8,50,000

By the amount of damages paid by the supplier it is understood that the damages were paid for 1

month delay in their delivery of machinery.

Representatives of the case

1. Mr. R.P. Bhatt ± Income Tax Department, Lawyer

2. Mr. Bhargava V. Desai ± Lawyer of Assessee



Page | 5

Issue of the case

y The assessment year of the company when the issue happened was 1974-1975 and

previous year was 1975-1976.

y The supplier (M/s Walchandnagar Industries Ltd.) delivered the equipment late by 1

month and paid M/s Saurashtra cement Ltd. Rs. 8,50,000/- as per the contract.

y M/s Saurashtra Cement Ltd. treated the amount received from the delay in payments as

capital receipts. But it was not approved by Commissioner of Income Tax.

y The assessee carried the matter further in appeal to the Tribunal.

y Mr. Bhatt argued that the compensation had been received by the assessee under clause 6

of the agreement.

y Mr.Bhatt argued that due to the late delivery of machinery the assessee suffered losses;

the amount provided by the supplier was compensation for the loss and which should be

considered as revenue receipt.

Law on compensation Compensation paid for delay to the procurement of capital assets amounts to compensation for

sterilization of the assessee's profit-earning source and cannot be said to have been incurred in

the ordinary course of business.Thus, such compensation must be treated as a capital receipt in

the hands of the assessee.

Judgement for the case

This case was sensitive enough for both the parties i.e. assessee and CIT that it required both

high court and Supreme Court judgment.



Page | 6

High court of Gujarat, Ahemdabad Judgement

The judgement given on 27 June, 2001 states that 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 making

apparatus rather than a receipt in course of profit earning process and, 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

income viz., the machinery was yet to be installed. Accordingly, the Tribunal allowed the appeal

and deleted the addition made on this account.

Being dissatisfied with the decision of the Tribunal, the Commissioner of Income Tax appealed

to the Supreme Court for judgment.

Supreme Court Judgement

CIT filed the civil appeal no. 3702 of 2003 against the High Court Judgement and the assessee to

the Supreme Court. The Supreme Court held that on account of the supplier having failed to

supply the plant within the time stipulated in the agreement, Clause 6 (providing for the remedy

of liquidated damages) came into play. The court observed that it was evident that the damages

to the assessee were directly and intimately linked with the procurement of a capital asset (i.e.,

the cement plant). The damages would lead to a delay in the establishment of the assessee's

overall profit-making business and could easily be perceived as a receipt in the course of the

profit-earning process (i.e., a revenue receipt). However, the court concurred with the

observations of the Income Tax Appellate Tribunal that the incoming receipt was not a revenue

receipt: it had no connection with any loss or profit, as the source of income (i.e., the machinery

itself) was yet to be installed. Accordingly, on 09 July, 2010 the court held that the amount

received by the assessee towards compensation for sterilization of its profit-earning source was

not received in the ordinary course of its business and thus was a capital receipt, not a revenue

receipt.



Page | 7

Conclusion

From the whole case we can come to the conclusion that the liquidated damages pertaining to the

delay in delivery of the capital asset (Machinery) should be considered as capital receipt, as we

know that the revenue receipt is considered when the compensation involved is due to some

operational activities. If the machinery would have been installed it would have been considered

under capital account and the compensation received would have been directly related to the

revenue receipt but here the machinery though being involved with the operation but was not

installed yet.

So the Judgements of the respected High Court and Supreme Court related to the issue were fair

enough to call it as JUSTICE TO THE LAW.



Page | 8

Bibliography

1. http://www.ejurix.in/Cases/SC/SC-2010/09Jul2010%20(GJX)%200007%20SC.htm

2. http://indiankanoon.org/doc/583481/

Case Overview (2)

Documents

Transcript of Case Overview (2)