The Hindu Business Line : Taxing windfall gains

Any amount in the nature of a windfall and not likely to recur cannot be brought under the ambit of taxation. The only exception is where certain receipts are deemed to be income by a fiction of law. Courts have emphasised that the onus of proving that an amount is in the nature of a casual receipt is on the tax-payer.

Since income-tax is only to be levied on income or a revenue receipt, any amount in the nature of a windfall and not likely to recur cannot be brought under the ambit of taxation. The only exception is where certain receipts are deemed to be income by a fiction of law.

This point was considered by the Punjab and Haryana High Court in C.I.T. v. Swastik Metal Works (274 I.T.R. 280). The assessee, a registered firm, was in the business of manufacturing and sale of brass, zinc and copper sheets. The assessee placed an order with a supplier in New York, through its agent in Mumbai, for 90 tonnes of copper ingots valued at $1,03,805.87.

The assessee also opened a letter of credit with Mercantile Bank Ltd. The supplier despatched the goods on August 11/12, 1965 by a steamer and received the value thereof from Mercantile Bank through its agent in America against the delivery of documents of title to the goods alongwith the bill of exchange drawn upon the assessee and endorsed in favour of the bank in terms of the letter of credit. The bank presented the bill of exchange to the assessee on August 20, 1965. Meanwhile, hostilities broke out between India and Pakistan. The government of Pakistan ordered that the cargo of the steamer which was on its way from New York to India via Karachi be discharged at Karachi and confiscated it.

After expiry of the due date for payment, the bank caused the presentation of the bill of exchange to the assessee through a notary public. The bank also filed a claim for payment of insurance money on account of loss of the cargo because the goods despatched by were covered by a policy of insurance for $1,14,495. The insurance company accepted the bank's claim and paid the amount specified in the policy.

DEVALUATION `BONUS'

By that time, the Indian rupee had been devalued against the dollar. As a result, the bank received Rs 8,60,217.88 as the equivalent of $1,14,495. When the assessee came to know that the bank had realised Rs 8,60,217.88 as against Rs 4,99,063 paid by it towards the cost of goods, it demanded Rs 3,54,808 from the latter. The bank did not comply with the demand of the assessee which then filed a suit in the Delhi High Court. The suit was finally compromised and the bank paid Rs 1,42,000.

The Assessing Officer held that the amount received by the assessee from the bank was a trading receipt and liable to be treated as such under Section 41(1). The Appellate Assistant Commissioner confirmed the addition, but the Tribunal deleted it. On a reference, the Court held that the assessee had not claimed the value of the goods lost in any assessment year and no allowance had been granted by the Assessing Officer. The cost of the goods was paid by the bank and the insurance company had reimbursed the bank.

Due to the devaluation of the rupee, the bank received Rs 8,60,217.88 against the payment of Rs 4,99,063 made to the supplier of the goods. It was, thus, clear that the benefit on devaluation of the rupee belonged to the bank and not to the assessee whose relation with the bank was merely that of a debtor and creditor. The Delhi High Court held that the amount received by the assessee as a result of the settlement arrived at between the parties was nothing more than a casual receipt and not a trading receipt.

The court further held that Section 41(1) had no application in this case because this provision applied only where an allowance or deduction has been allowed and, subsequently, the assessee had obtained, in cash or any other manner, any amount in respect of such loss or expenditure or some benefit in respect of a trading liability by way of remission or cessation thereof.

LANDMARK DECISION

The Supreme Court in a landmark decision in Universal Radiators v. C.I.T. (201 I.T.R. 800) considered this point. The facts were that a manufacturer of radiators for automobiles booked copper ingots from an American corporation for being brought to Mumbai where they were to be rolled into strips and sheets and then despatched to the appellant for being used for manufacture. While the ingots were at sea, hostilities broke out between India and Pakistan, and the vessel carrying the goods was seized by the authorities in Pakistan.

The appellant's claim for the price of the goods was ultimately settled in its favour by the US insurer. The Indian rupee was devalued and, therefore, the appellant got Rs 3,43,556 against its payment of Rs 2,00,164 at the pre-devaluation rate. The appellant claimed that the difference was not taxable. The Assessing Officer and the Appellate Assistant Commissioner rejected the claim, but the Appellate Tribunal reversed the appellate order.

The Supreme Court held that so long as the ingots did not reach Mumbai and were not converted into strips and sheets, the connection with the appellant's business was remote and any payment made in respect of the loss of the ingots could not be said to accrue from business. Thus, any devaluation surplus could not be treated as income from the business of the assessee.

The apex Court, relying on its earlier decision in C.I.T. v. Canara Bank Ltd. (63 I.T.R. 328), held that even in case of stock-in-trade, no trading activity would be deemed to be carried on where the stock gets blocked or sterilised. Hence, any devaluation surplus arising in respect of such assets would be on capital account.

Relying on this decision, the Supreme Court held in the Universal Radiators' case that taxability of an amount paid on settlement of an insurance claim would depend upon the nature of the payment and the purpose of the insurance. Any amount received from a trading or business activity would be liable to tax as business profit even if it is casual in nature. However, where an amount is received due to fortuitous circumstances or is a windfall, such amount would not be taxable under the Act.

It may be pointed out in this context that an amount received from an insurance company on account of damage to, or destruction of, any capital asset is deemed to be a profit taxable as capital gain under Section 45(1-A) of the Act. However, the insurance claim must be in respect of such calamities referred to in this provision.

A SOURCE FOR INCOME

Before concluding, it would be interesting to refer to a decision of the Bombay High Court in Mehboob Productions Pvt. Ltd. v. C.I.T. (106 I.T.R. 758). In this case, the Court laid down that income is a monetary return expected by a tax-payer for the labour or skill bestowed, or for the capital invested by him. Income must, therefore, come from a definite source. A payment may be made liable to income-tax although it may be received voluntarily. However, it must accrue to the assessee by virtue of holding any office.

On the other hand, a windfall is an unexpected acquisition of income or an advantage. According to the Court, windfall profits may arise by virtue of the exigencies of an economic situation or due to political or international events whereby some profits may accrue. Finally, courts have emphasised that the onus of proving that an amount is in the nature of a casual receipt is on the tax-payer. If this burden of proof is not discharged, the tax department would be justified in assessing the amount as income.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)

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