income-tax Officer Vs. Hazari Lal Marwah and Sons - Court Judgment

Excerpt:
1. this is an appeal by the revenue against the order of the cit(appeals)-iv, new delhi dated 8-12-1987 deleting an addition of rs. 7,71,560.2. the assessee is a registered firm engaged in the business of executing contracts. under a contract agreement dated 17-3-1961/28-4-1961 the assessee-firm had executed a work contract of construction of the provisions for main & branch (zonal) sewers, manholes, flushing tanks, vent shafts, etc. etc. at ferozepur cantt., ferozepur (punjab). execution of the said contract work had been started in the year 1961 but the same could be completed in july 1965.during that period the assessee-firm received payments of its interim bills but dispute arose with regard to the payment of the final bill.as per clause 70 of the contract agreement the dispute was referred for adjudication to brig. s.r. bagga, the sole arbitrator. both the parties preferred their cross-claims before the arbitrator. the claims preferred by the assessee firm included demand of interest @ 12 per cent per annum on,- (d) on award amount from date of award to date of implementation of the award.3. the arbitrator gave his award on 18-6-1981 awarding rs. 23,12,104.77 (after setting off the claim of union of india) to the assessee. the arbitrator rejected its claim for interest at (a) above, but accepted its claim at (6), (c) and (d) by awarding interest at the reduced rate of 9 per cent per annum. the assessee-firm received the payment of awarded amount and interest of rs. 7,71,560 on 22-7-1981.4. in the finally revised return for the assessment year 1982-83, filed on 7-2-1986 declaring income at rs. 1,57,050 the assessee excluded the amount of interest of rs. 7,71,560 and security refund of rs. 25,000 from the computation of its total income on the ground that those amounts represented capital receipts in its hands. this contention was based on orissa high court decision in the case of govinda choudhury & sons v. cit 11977] 109 itr 497.5. the ito accepted the assessee's contention with regard to the amount of rs. 25,000, representing refund of security deposit. he, however, rejected its claim for exclusion of the interest amounting to rs. 7,71,560 on the grounds that the same was incidental to the carrying on of the business of execution of work as a contractor, was paid to the assessee on account of loss of its earnings from funds withheld by mes deptt. for long and was in the nature of trading receipt assessable under the head "income from profits and gains of business". in arriving at the above conclusions the ito distinguished the case of govinda choudhury & sons (supra) and, instead, relied upon the decisions in the cases of cit v. south india pictures ltd. 11956] 29 itr 910 (sc), cit v. rai bahadur jairam valji [1959] 35 itr 148 (so and cit v. manna ramji & co. [1972] 86 itr 29 (so. the assessee-firm appealed to the cit(appeals).6. the cit(appeals)held that the interest had been awarded as ex-gratia by the arbitrator as there was neither a contractual nor a statutory obligation to pay such an interest in the instant case. he, therefore, treated the interest payment on capital account and excluded the same from computation of assessee's total income.7. the learned departmental representative vehemently urged that the amount in question was received by the assessee on account of loss of its earnings from funds withheld by mes deptt. that the amount awarded as interest was incidental to and arose out of the carrying on of the business of execution of work as a contractor and hence a trading receipt and that by its own act and conduct of demanding and rectifying the interest-payment the assessee had admitted the existence of an implied agreement between the parties for payment of interest on delayed payments of bills. the learned departmental representative thus fully supported the ito's order and relied upon the cases referred to by the ito in the assessment order.8. dr. narayanan, the learned counsel for the assessee-firm, on the other hand, pointed out to the award of the arbitrator and submitted that assessee's claim for payment of interest @ 12 per cent on the amount withheld by mes deptt. from 1965 to 1980 as mentioned at (a) above, was specifically rejected by the arbitrator and, therefore, it was not at all correct to say that the interest payment of rs. 7,71,560 was made to the assessee-firm on account of loss of its earnings during that period from the funds withheld. the learned counsel urged that since the right of the assessee to receive interest of rs. 7,71,560 had not resulted from any contractual or statutory obligation of union of india, it was not more than an ex-gratia payment having the unchallengeable colour and character of a capital receipt hence not liable to tax. in support of this contention reliance was placed on govinda choudhury & son's case (supra). in our opinion the order under appeal calls for a slight modification only.9. payment of interest is generally made on account of loss of one's earnings from his funds withheld by the other. the right of the creditor to receive interest on his funds which have been withheld by the debtor originates from either a contract between the parties or from some statutes like civil procedure code, 1908, interest act of 1839, land acquisition act, 1894, etc. when the right to interest so originates the source of obligation of the debtor to pay interest lies in the contract or the relevant statute. when the interest is earned from either of the two sources, i.e., contract and/or statute, it is a revenue receipt, hence income of the recipient liable to tax. however, if the payment or receipt of interest does not so originate either from a contract or a statute it is ex-gratia payment taking the colour and character of capital receipt and hence not liable to tax. the logic behind this difference between the two receipts is quite simple.interest, whether it is contractual or statutory, represents the profit the creditor might have made if he had the use of money or it represents the loss he suffered because he had not that use. it is something in addition to the capital amount, though it arises out of it. but when it takes the colour or character of ex-gratia' payment though it makes an addition to the capital yet it does not arise out of it, no doubt it may have a reference to it. for its source, then, does not lie in any right of the creditor to receive or the obligation of the debtor to pay under any contract or statute. it is granted on ex-gratia basis.10. in the case of t.n.k. govindaraju chetty v. cit [19671 66 itr 465 the supreme court has laid down that where interest has been awarded under statute or under contract the same is income exigible to tax and where it is not attributable to either statute or contract, but has been awarded on ex-gratia basis, it would partake the character of compensation. this principle has been followed by kerala high court in the case of cit v. periyar & pareekanni rubbers ltd. [1973 ] 87 itr 666 and by orissa high court in the case of govinda choudhury & sons (supra) relied upon by dr. narayanan. the cases relied upon by the ito are totally besides the point though the principles enunciated therein are subject to no dispute.11. in the instant case the position comes to this. the relationship between the creditor (the assessee) and the debtor (union of india) was no doubt governed by the terms and conditions of the contract agreement which made a specific provision for referring the dispute to a sole arbitrator but it made no provision either creating a right in favour of the creditor-assessee to receive interest on the withheld amount or a corresponding obligation on the debtor union of india to pay such interest. moreover, it did not empower the arbitrator to grant interest for the period the same was withheld, pendentelite or future. section 34 of the code of civil procedure 1908, as was held by supreme court in the case of thawardas pherumal v. union of india air 1955 sc 468, was not applicable to the proceedings before the arbitrator as the same had not ensued from any application under the provisions of the arbitration act or a suit filed before a civil court. the military engineers service contractor's labour regulations, which governed the work contract in this case, also made no provision for creditor's right to receive and/or debtor's obligation to pay interest on withheld amounts.it is thus clear that pendentelite and future interest awarded in this case under (6) & (d) above respectively is not attributable either to any statute or contract but was awarded by the arbitrator on ex-gratia basis. arbitrator's not awarding interest for the period from 1965 to 1980 |at (a)| clearly speaks of the absence of any contract to pay and receive interest for the period the money of creditor was withheld by the debtor.12. the award of interest of rs. 11,812.50 [at (c) above] @ 9 per cent on security deposit of rs. 25,000, however stands on different footing.paragraph 22 in chapter iii of the contract agreement, inter alia, provides that: all compensation or other sums of money payable by the contractor to the govt. under the terms of this contract or under any other contract with govt. may be deducted from, or paid by the sale of a sufficient part of the security deposit or from the interest arising therefrom or from any sums which may be due or may become due to the contractor by the govt. on any account whatsoever and in the event of his security deposit being reduced by reason of any such deduction, or sale as aforesaid, the contractor shall within 10 days thereafter, make good in cash or securities, endorsed as aforesaid, any sum or sums which may have been deducted from or realised by the sale of, his security deposit or any part thereof.13. in the words "or from the interest arising therefrom" occurring in the language of paragraph 22 above, we read an implied obligation of union of india to pay, with a corresponding right of the assessee to receive interest on security deposit. the interest of rs. 11,812.50 as mentioned in the award (c) is attributable to the contract between the parties and hence it makes assessee's income liable to tax. to that extent revenue's appeal should succeed.14. in the result, the appeal is partly allowed to the extent mentioned above.

Judgment:
1. This is an appeal by the revenue against the order of the CIT(Appeals)-IV, New Delhi dated 8-12-1987 deleting an addition of Rs. 7,71,560.

2. The assessee is a registered firm engaged in the business of executing contracts. Under a contract Agreement dated 17-3-1961/28-4-1961 the assessee-firm had executed a work contract of construction of the provisions for Main & Branch (Zonal) Sewers, Manholes, Flushing Tanks, Vent Shafts, etc. etc. at Ferozepur Cantt., Ferozepur (Punjab). Execution of the said contract work had been started in the year 1961 but the same could be completed in July 1965.

During that period the assessee-firm received payments of its interim bills but dispute arose with regard to the payment of the Final Bill.

As per clause 70 of the Contract Agreement the dispute was referred for adjudication to Brig. S.R. Bagga, the sole Arbitrator. Both the parties preferred their cross-claims before the Arbitrator. The claims preferred by the assessee firm included demand of interest @ 12 per cent per annum on,- (d) on award amount from date of award to date of implementation of the award.

3. The Arbitrator gave his Award on 18-6-1981 awarding Rs. 23,12,104.77 (after setting off the claim of Union of India) to the assessee. The Arbitrator rejected its claim for interest at (a) above, but accepted its claim at (6), (c) and (d) by awarding interest at the reduced rate of 9 per cent per annum. The assessee-firm received the payment of awarded amount and interest of Rs. 7,71,560 on 22-7-1981.

4. In the finally revised return for the assessment year 1982-83, filed on 7-2-1986 declaring income at Rs. 1,57,050 the assessee excluded the amount of interest of Rs. 7,71,560 and security refund of Rs. 25,000 from the computation of its total income on the ground that those amounts represented capital receipts in its hands. This contention was based on Orissa High Court decision in the case of Govinda Choudhury & Sons v. CIT 11977] 109 ITR 497.

5. The ITO accepted the assessee's contention with regard to the amount of Rs. 25,000, representing refund of security deposit. He, however, rejected its claim for exclusion of the interest amounting to Rs. 7,71,560 on the grounds that the same was incidental to the carrying on of the business of execution of work as a contractor, was paid to the assessee on account of loss of its earnings from funds withheld by MES Deptt. for long and was in the nature of trading receipt assessable under the head "income from profits and gains of business". In arriving at the above conclusions the ITO distinguished the case of Govinda Choudhury & Sons (supra) and, instead, relied upon the decisions in the cases of CIT v. South India Pictures Ltd. 11956] 29 ITR 910 (SC), CIT v. Rai Bahadur Jairam Valji [1959] 35 ITR 148 (SO and CIT v. Manna Ramji & Co. [1972] 86 ITR 29 (SO. The assessee-firm appealed to the CIT(Appeals).

6. The CIT(Appeals)held that the interest had been awarded as ex-gratia by the Arbitrator as there was neither a contractual nor a statutory obligation to pay such an interest in the instant case. He, therefore, treated the interest payment on capital account and excluded the same from computation of assessee's total income.

7. The learned departmental representative vehemently urged that the amount in question was received by the assessee on account of loss of its earnings from funds withheld by MES Deptt. that the amount awarded as interest was incidental to and arose out of the carrying on of the business of execution of work as a contractor and hence a trading receipt and that by its own act and conduct of demanding and rectifying the interest-payment the assessee had admitted the existence of an implied agreement between the parties for payment of interest on delayed payments of bills. The learned departmental representative thus fully supported the ITO's order and relied upon the cases referred to by the ITO in the assessment order.

8. Dr. Narayanan, the learned counsel for the assessee-firm, on the other hand, pointed out to the Award of the Arbitrator and submitted that assessee's claim for payment of interest @ 12 per cent on the amount withheld by MES Deptt. from 1965 to 1980 as mentioned at (a) above, was specifically rejected by the Arbitrator and, therefore, it was not at all correct to say that the interest payment of Rs. 7,71,560 was made to the assessee-firm on account of loss of its earnings during that period from the funds withheld. The learned counsel urged that since the right of the assessee to receive interest of Rs. 7,71,560 had not resulted from any contractual or statutory obligation of Union of India, it was not more than an ex-gratia payment having the unchallengeable colour and character of a capital receipt hence not liable to tax. In support of this contention reliance was placed on Govinda Choudhury & Son's case (supra). In our opinion the order under appeal calls for a slight modification only.

9. Payment of interest is generally made on account of loss of one's earnings from his funds withheld by the other. The right of the creditor to receive interest on his funds which have been withheld by the debtor originates from either a contract between the parties or from some statutes like Civil Procedure Code, 1908, Interest Act of 1839, Land Acquisition Act, 1894, etc. When the right to interest so originates the source of obligation of the debtor to pay interest lies in the contract or the relevant statute. When the interest is earned from either of the two sources, i.e., contract and/or statute, it is a revenue receipt, hence income of the recipient liable to tax. However, if the payment or receipt of interest does not so originate either from a contract or a statute it is ex-gratia payment taking the colour and character of capital receipt and hence not liable to tax. The logic behind this difference between the two receipts is quite simple.

Interest, whether it is contractual or statutory, represents the profit the creditor might have made if he had the use of money or it represents the loss he suffered because he had not that use. It is something in addition to the capital amount, though it arises out of it. But when it takes the colour or character of ex-gratia' payment though it makes an addition to the capital yet it does not arise out of it, no doubt it may have a reference to it. For its source, then, does not lie in any right of the creditor to receive or the obligation of the debtor to pay under any contract or statute. It is granted on ex-gratia basis.

10. In the case of T.N.K. Govindaraju Chetty v. CIT [19671 66 ITR 465 the Supreme Court has laid down that where interest has been awarded under statute or under contract the same is income exigible to tax and where it is not attributable to either statute or contract, but has been awarded on ex-gratia basis, it would partake the character of compensation. This principle has been followed by Kerala High Court in the case of CIT v. Periyar & Pareekanni Rubbers Ltd. [1973 ] 87 ITR 666 and by Orissa High Court in the case of Govinda Choudhury & Sons (supra) relied upon by Dr. Narayanan. The cases relied upon by the ITO are totally besides the point though the principles enunciated therein are subject to no dispute.

11. In the instant case the position comes to this. The relationship between the creditor (the assessee) and the debtor (Union of India) was no doubt governed by the terms and conditions of the Contract Agreement which made a specific provision for referring the dispute to a sole Arbitrator but it made no provision either creating a right in favour of the creditor-assessee to receive interest on the withheld amount or a corresponding obligation on the debtor Union of India to pay such interest. Moreover, it did not empower the Arbitrator to grant interest for the period the same was withheld, pendentelite or future. Section 34 of the Code of Civil Procedure 1908, as was held by Supreme Court in the case of Thawardas Pherumal v. Union of India AIR 1955 SC 468, was not applicable to the proceedings before the Arbitrator as the same had not ensued from any application under the provisions of the Arbitration Act or a suit filed before a Civil Court. The Military Engineers Service Contractor's Labour Regulations, which governed the work contract in this case, also made no provision for creditor's right to receive and/or debtor's obligation to pay interest on withheld amounts.

It is thus clear that pendentelite and future interest awarded in this case under (6) & (d) above respectively is not attributable either to any statute or contract but was awarded by the Arbitrator on ex-gratia basis. Arbitrator's not awarding interest for the period from 1965 to 1980 |at (a)| clearly speaks of the absence of any contract to pay and receive interest for the period the money of creditor was withheld by the debtor.

12. The award of interest of Rs. 11,812.50 [at (c) above] @ 9 per cent on security deposit of Rs. 25,000, however stands on different footing.

Paragraph 22 in Chapter III of the Contract Agreement, inter alia, provides that: All compensation or other sums of money payable by the Contractor to the Govt. under the terms of this Contract or under any other Contract with Govt. may be deducted from, or paid by the sale of a sufficient part of the Security Deposit or from the interest arising therefrom or from any sums which may be due or may become due to the Contractor by the Govt. on any account whatsoever and in the event of his Security Deposit being reduced by reason of any such deduction, or sale as aforesaid, the Contractor shall within 10 days thereafter, make good in cash or securities, endorsed as aforesaid, any sum or sums which may have been deducted from or realised by the sale of, his Security Deposit or any part thereof.

13. In the words "or from the interest arising therefrom" occurring in the language of paragraph 22 above, we read an implied obligation of Union of India to pay, with a corresponding right of the assessee to receive interest on security deposit. The interest of Rs. 11,812.50 as mentioned in the award (c) is attributable to the contract between the parties and hence it makes assessee's income liable to tax. To that extent revenue's appeal should succeed.

14. In the result, the appeal is partly allowed to the extent mentioned above.