ITAT Allows Contractual Compensation Deduction; Rejects Colourable Device Allegation

The assessee, an individual engaged in manufacturing activities, sold 350,000 equity shares of a company for Rs 21.87 crore. Prior to this, he had entered into agreements with two other parties for the sale of the same shares but failed to complete those transactions due to the inability to obtain necessary approvals. As per contractual terms, he paid compensation of Rs 7.84 crore to the original buyers for cancellation of agreements and claimed the same as a deduction while computing long-term capital gains.

The Assessing Officer treated the arrangement as a colourable device to reduce tax liability and disallowed the claim. The disallowance was made on grounds such as absence of registered agreements, lack of stamp duty, and the financial position of recipient companies. The CIT(A), however, deleted the addition, holding the payments to be genuine. The Revenue challenged this relief before the Tribunal.

Issue Raised: Whether compensation paid for cancellation of share sale agreements can be allowed as a deduction while computing long-term capital gains, or whether such an arrangement constitutes a colourable device to evade tax.

Tribunal Held: The Tribunal upheld the order of the CIT(A) and dismissed the Revenue’s appeal. It was observed that the recipient companies were established business entities, assessed for tax, and had duly offered the compensation for tax. No material was brought on record to show that the transactions were sham or non-genuine. The Tribunal noted that there is no legal requirement for registration of agreements relating to the sale of shares, and the absence of higher stamp duty does not invalidate such agreements.

The compensation paid was in accordance with contractual obligations and not merely for breach, and the assessee ultimately earned higher profits by selling shares at a better price. It emphasised that commercial decisions of a businessman cannot be substituted by the Assessing Officer’s judgement. Further, the Tribunal held that the CIT(A) was justified in considering materials available in the public domain and conducting necessary enquiries. Finding no infirmity in the order, the Tribunal allowed the deduction of Rs. 7.84 crore as legitimate expenditure and rejected the allegation of tax avoidance.

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