The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) held that compensation received pursuant to a consent decree for relinquishment of a “right to sue” is a capital receipt and cannot be subjected to capital gains tax under Section 45 of the Income Tax Act, 1961. A Bench comprising Judicial Member Amit Shukla and Accountant Member Girish Agrawal dismissed the Revenue’s appeals and upheld the relief granted to the assessees.

The assessees were among a group of individuals who had entered into agreements with Aadi Properties LLP for allotment of commercial space in a proposed real estate project. However, the project was subsequently abandoned and the promised commercial premises could not be delivered. The assessees instituted legal proceedings before the Bombay High Court seeking appropriate reliefs against the developer.

Pursuant to a consent decree dated 10.07.2017, the parties amicably settled the dispute. The assessees received compensation in lieu of their right to sue for damages arising from the developer’s inability to provide the agreed commercial space. During reassessment proceedings, the Assessing Officer treated the compensation as consideration arising from transfer of a capital asset and brought the amounts to tax as long-term capital gains under Section 45.

The Commissioner (Appeals) deleted the additions by following an earlier Tribunal decision involving another recipient of compensation under the same consent decree. Aggrieved by the relief granted, the Revenue carried the matter before the Tribunal.

Before the Tribunal, the Revenue contended that the assessees had acquired enforceable rights under the agreements and that receipt of compensation amounted to transfer or relinquishment of a capital asset liable to tax under the head “Capital Gains”.

“Since specific performance of the allotment of commercial premises was not possible, damages in lieu of the plaintiff’s right to sue would thus be the only relief/remedy.”

The Tribunal noted that the Bombay High Court’s consent decree itself recorded that specific performance of the original arrangement had become impossible because the project had undergone substantial changes and the contemplated commercial premises were no longer available. Consequently, the only surviving remedy was a claim for damages, resulting in a mere right to sue.

Relying upon earlier Tribunal decisions involving similarly placed parties, as well as the judgements of the Bombay High Court in Abbasbhoy A. Dehgamwalla and Sterling Construction Investment, the Tribunal observed that a mere right to sue is not transferable in view of Section 6(e) of the Transfer of Property Act, 1882. Since such a right is not capable of transfer, receipt of compensation for surrender of the right to sue cannot be regarded as consideration for transfer of a capital asset.

“A mere right to sue cannot be transferred.”

Thus, the Tribunal held that the compensation received by the assessees represented a non-taxable capital receipt and could not be brought to tax as capital gains. The Revenue’s appeals were therefore dismissed.

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