[BREAKING] Setback for ITC Ltd: Calcutta HC rules Rs. 32.42 Cr from Hotel Rights Relinquishment is Revenue Receipt, Not Capital Receipt [Read Order]

The Calcutta High Court ruled that Rs. 32.42 Crores received for relinquishment of right to Operate Hotel under operating licence is Revenue receipt and not  Capital Receipts. The court set aside the orders passed by the CIT(A) and the ITAT, thus ruling in favour of the Income Tax Department.

The bench of Justices Surya Prakash Kesarwani and Rajarshi Baradwaj observed that “..we hold that the sum of Rs. 32.42 crores received by the respondent assessee shall not fall under long term capital gain. The findings recorded by the ITAT that the aforesaid sum of Rs. 32.42 crores constituted long term capital gain is perverse. The impugned order of the ITAT to the extent it relates to the aforesaid sum of Rs. 32.42 crore cannot be sustained….. It is held that the receipt in question of Rs. 32.42 crores in the hands of the respondent assesse is revenue receipt and not capital receipt.”

The respondent, ITC Ltd., engaged in various business activities, disclosed a revised total income of Rs. 3040,47,74,966/- for the assessment year 2006-07. During the assessment proceedings, the Assessing Officer added Rs. 32.42 crores received from ELEL under an agreement dated 11.05.2005, which ITC claimed as long-term capital gains.

The Assessing Officer, however, treated it as a revenue receipt. The CIT (A) and ITAT ruled in favor of ITC, classifying the amount as long-term capital gain. Consequently, the revenue filed an appeal asserting that the Rs. 32.42 crores is a revenue receipt.

Under a 1986 agreement, ELEL Hotels & Investment Ltd. granted ITC a license to operate the Sea Rock Hotel for 25 years, with an option to renew for another 25 years. The license fee was 23% of the hotel's gross turnover. ITC had the right to terminate the contract with 24 months' notice and held no ownership interest in the hotel. If ITC claimed any tenancy or leasehold interest, ELEL could compel ITC to purchase the hotel at a mutually agreed price.

A settlement agreement on 11.05.2005 resolved ongoing civil litigations, with Rs. 32.42 crores allocated to the license agreement in dispute. While ITC treated this amount as a capital receipt, the Assessing Officer classified it as a revenue receipt and levied tax accordingly in the assessment order dated 31.12.2009 for the year 2006-07. The CIT (A) and ITAT ruled it as a capital receipt, leading to the current appeal by the revenue.

The revenue’s counsel submitted numerous submissions that the agreement dated 3.5.1986 was part of ongoing business activities between ELEL and ITC Ltd. prior to the agreement, making the receipt in question a revenue receipt.

Further added that the 3.5.1986 agreement was a license that did not confer any right, title, or interest to ITC Ltd. The Rs. 32.42 crores received was the result of a business transaction, not a relinquishment of any right, title, or interest in the property. Thus, the receipt is clearly a revenue receipt as the license excluded any interest in the property.

To support the arguments, the counsel stated numerous supreme court judgments including Associated Hotels of India Ltd. Vs. R. N. Kapoor, Yazdani International Private Limited vs. Auroglobal Comtrade Private Limited & Others ..etc.

While, J. P. Khaitan, senior advocate, assisted by Ms. Nilanjana Banerjee Pal, submitted several points in defense of ITC Ltd.'s position:

1. The agreement dated 3rd May 1986, is a license granting the right to run and operate the hotel, which constitutes a capital asset under Section 2(14) of the Income Tax Act, 1961. Its relinquishment by the 11th May 2005 agreement and the consent terms/award by the sole arbitrator on the same date is a transfer of a capital asset as per Section 2(47) of the Act.
2. The transfer of this long-term capital asset for Rs. 32.42 crores resulted in a long-term capital gain under Section 45 of the Act, 1961, and ITC has paid the corresponding tax. The Tribunal correctly classified the transfer as a long-term capital gain under Section 45 of the Act.
3. The transfer of this long-term capital asset for Rs. 32.42 crores resulted in a long-term capital gain under Section 45 of the Act, 1961, and ITC has paid the corresponding tax. The Tribunal correctly classified the transfer as a long-term capital gain under Section 45 of the Act.
4. The right conferred under the agreement is a property right, and its transfer through relinquishment resulted in a long-term capital gain. The term "property" is not defined in the Act, so its ordinary meaning applies, supporting the classification of the right to operate the hotel as property under Section 2(14) of the Act. This view is supported by the Supreme Court judgment in Ahmed G. H. Ariff vs. CWT (1969) 2 SCC 471.

Khaitan relied on several judgments to support his arguments including Ahmed G. H. Ariff, Techno Shares and Stocks Ltd. vs. Commissioner of Income Tax, Oberoi Hotel Pvt. Ltd. vs. Commissioner of Income Tax and Commissioner of Income Tax vs. Smt. Laxmidevi Ratani.

Khaitan referred to the Supreme Court's analysis in Oberoi Hotel Pvt. Ltd. vs. Commissioner of Income Tax (1999) 3 SCC 127, which distinguishes between compensation for rights under a trading contract (revenue receipt) and compensation for the loss of office ( capital receipt ). The agreement in question conferred the right to operate the hotel, making the Rs. 32.42 crores received by ITC a capital receipt for the loss of the source of income.

The counsel argued that the judgments cited by the appellant's counsel are distinguishable from the present case, and the correct legal position is reflected in the judgments cited by the respondent/assessee.

The bench found that ITC has been providing services to ELEL to run their hotel since 1983 under a commercial contract dated 03.05.1986. ITC collected all revenue from the hotel, incurred operating expenses, and paid ELEL a percentage of the gross turnover. The licence agreement was a trading contract, and receipts under it were always revenue in nature. ITC never had any right, title, or interest in the hotel or ELEL’s properties.

The 11.05.2005 settlement agreement resolved various disputes between the parties, including terminating the operating license. The Rs. 32.42 crores received by ITC was part of the settlement to resolve all disputes and claims related to the operating license, not a transfer of any capital asset.

The bench referred to the Commissioner of Income Tax, UP, Lucknow vs. Gangadhar Baijnath (1972), where the Supreme Court distinguished between capital and revenue receipts. Fixed capital is retained by the owner for profit, while circulating capital is used to yield profit. ITC had no fixed capital investment in running the hotel under the "Operating License Agreement," but introduced circulating capital. Thus, the Rs. 32.42 crore received by ITC from ELEL was a revenue receipt from a trading contract, not for the transfer or loss of any capital asset. The use of "relinquishment" in the settlement and consent terms does not make the receipt a capital one.

The Calcutta High Court noted that the "Operating License Agreement" dated 03.05.1986 was a trading and service contract where ITC rendered services to ELEL to run the hotel. ITC had no ownership rights in the hotel, only the right to operate it. The Rs. 32.42 crores received by ITC was part of a settlement to resolve all disputes related to this business contract, not for the transfer of any capital asset. The amount was thus a revenue receipt, forming part of ITC's total income, and not a capital receipt.

Therefore, the bench ruled in favor of the revenue and against ITC Limited. The court concluded that the substantial question of law is answered in favour of the Revenue/Appellant and against the respondent assessee.

It was thus determined that the receipt of Rs. 32.42 crores by the respondent assessee is a revenue receipt and not a capital receipt. Consequently, the impugned order passed by the ITAT, which treated Rs. 32.42 crores as long-term capital gain, was set aside. The present appeal was allowed accordingly.

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