Security deposit received from the licensee with a view to secure due performance of its obligations under the leave-and-licence agreement is in the nature of loan and is in the capital field — Forfeiture of such security deposit upon premature terminatio

The assessee was into the business of warehousing,
property leasing, trading in chemical and textile auxiliaries. The assessee
entered into a leave-and-licence agreement with Concord Motors Ltd., a
subsidiary of Tata Motors Ltd. for a period of two terms of three years each. A
lock-in period of five years and six months was provided in the agreement. The
lease rent was treated as business income. During the assessment year under
consideration, the agreement was terminated prematurely by the licensee when 16
months were still remaining out of the lock-in period. On termination of the
lease, the assessee forfeited the interest-free security deposit received by it
from the licensee which was for an amount of Rs.1.50 crore under a separate
security deposit agreement and Rs.5 lakh under a leave-and-licence agreement.
Further, the assessee had received an amount of Rs.24,37,500 as damages for
premature termination from the licensee. This amount was paid on account of
hardship and inconvenience suffered by the assessee as damages. The assessee
treated entire receipt as capital receipt. The AO treated it as revenue receipts
and as taxable income. Upon further appeal, the CIT(A) upheld the order of the
AO.

A perusal of the terms of agreements clearly shows
that the security deposit is a capital receipt. The deposit is not in the nature
of advance for goods or services, nor could it be qualified as in relation to
the rental component. It is in the nature of loan and is in the capital field.
On a perusal of the termination agreement, it is clear that the forfeiture of
security deposit in question is not in lieu of rental payments and the assessee
is not in default. The forfeiture of security deposit does not partake the
character of income, because a capital receipt cannot be said to have converted
itself into a trading receipt on signing the agreement.

In a decision of Morely (Inspector of Taxes) v.
Tattersall, (1939) 7 ITR 316 (CA), it is clearly laid down that the quality and
nature of receipt for income-tax purpose are fixed once and for all when it is
received and that it does not change its character subsequently. This decision
has been followed in the case of K.M.S. Lakshmanier & Sons v. CIT, (1953) 23 ITR
202 (SC) and it has been observed that one of the conditions is that it is to be
adjusted against a claim arising out of a possible default of a depositor,
cannot alter the character of the transaction or the fact that the purpose for
which the deposit is made is to provide a security for the due performance of a
collateral contract, cannot invest the deposit with a different character. It
remains a loan of which the repayment in full is conditioned by the due
fulfilment of obligations under the collateral contract.

In a subsequent decision of CIT v. T.V. Sundaram
Iyengar & Sons Ltd., (1996) 222 ITR 344 (SC), the above decision of Morely
(Inspector of Taxes) v. Tattersall was considered and held that if an amount is
received in the course of trading transaction, even though it is not taxable in
the year of receipt as being of revenue character, the amount changes its
character when the amount becomes the assessee’s own money because of limitation
or by any other statutory or contractual right. In the case on hand, the
original receipt was in the nature of a loan and never had a revenue character
as it was not at any time a trading receipt as in the case of T.V. Sundaram
Iyengar & Sons.

Further, in the case of Mahindra & Mahindra Ltd. v.
CIT, (2003) 261 ITR 501 (Bom.), it is held that subsequent waiver of principal
amount of loan was not assessable u/s.28(iv) of the Act.

Therefore, the forfeiture of security deposit
amounting to Rs.1.55 crore is not taxable. However, the payment of lump sum
consideration of Rs.24.37 lac is in lieu of the rents and is in the revenue
field unlike the remission of a loan liability. Therefore the same was rightly
taxed as such.