ORDER
Ashok Bhan, J.
Income Tax Appellate Tribunal (hereinafter referred to as the Tribunal) at the instance of the assessee, has referred the following two questions of law under section 256(1) of the Income Tax Act, 1961, (hereinafter referred to as the Act) to this court for its opinion along with the statement of case. The questions that arise from the order of the Tribunal in ITA No. 345/Bang/1987, dated 13-7-1994, relates to the assessment year 1983-84.
“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was not entitled to the deduction of interest accrued on the defaulted payment of royalty as deduction while computing the capital gains on the transfer of royalty rights ?
2. The interest accrued on the defaulted payment of royalty having been suffered tax in the respective assessment years, whether the assessee was entitled to the reduction out of sale consideration of the rights to receive the royalty and other incidental benefits to the third party for the purposes of computation of capital gains?
Facts
2. Assessee is a public limited company. M/s Brush Electrical Engineering Co. Ltd. (BEEC), a concern incorporated in England, entered into an agreement with an Indian company, namely, M/s Southern Switchgear Ltd. (hereinafter referred to as SSL) on 12-12-1963. As per this agreement, BEEC agreed to furnish technical data and information and to give certain other incidental services to the SSL which were required for the manufacture of switchgear products specified in the agreement. SSL in consideration was required to pay royalty to the BEEC. SSL committed defaults in paying royalty amount as per the collaboration agreement. The aggregate of the arrears due came to Rs. 13,92,025 as on 12-8-1966. There was a supplemental agreement between BEEC and SSL by a document dated 12-8-1966. That was only to provide for the covenants which they subsequently entered into in regard to the collaboration agreement.
3. On 16-10-1975, M/s Industrial Credits & Development Syndicate Ltd. (hereinafter referred to as ‘the assessee’) entered into an agreement whereby the assessee agreed to pay the arrears due by SSL to the BEEC directly, and in consideration, the BEEC agreed to release their right to receive royalty due from SSL and thereafter every year in favour of the assessee.
4. On 23-8-1976, BEEC brought about tripartite agreement. By the said agreement the rights under the agreement entered into between BEEC and SSL on 12-12-1963, and 12-8-1966, were made over to the assessee to receive royalty and benefits now due and hereafter to become due. It was also stipulated therein that SSL would pay all amounts and other benefits now due and hereafter to become due in accordance with the said agreement for the period from 1-1-1974, up to the period stipulated in the agreement. It was made clear that in spite of the terms and conditions referred to in the agreement, the same would remain valid and effective and was binding upon the parties concerned.
5. The assessee did not receive any payment on or subsequent to 23-8-1976 from SSL. The following amounts representing the interest due to the assessee from SSL from the years 1978-79 to 1982-83 was assessed to tax in the hands of the assessee although the assessee had not received these amounts:
Asst. yr.
Amount Rs.
1978-79
2,99,285
1979-80
83,521
1980-81
83,521
1981-82
83,521
1982-83
83,521
6,33,369
These amounts were assessed to tax in the hands of the assessee as the assessee was maintaining its accounts on mercantile basis.
6. On 31-3-1982, the assessee made an agreement with the Thana Electric Supply Company Ltd. (hereinafter referred to as ‘the TESCL). Under this agreement the assessee made over its rights which it had acquired from BEEC under the agreement dated 23-8-1976, to TESCL, for a sum of Rs. 29,00,000. For the assessment year 1983-84 the assessee filed its return. The assessing officer added a sum of Rs. 15,07,975 as income by way of capital gains received from TESCL in the hands of the assessee being the difference of the consideration received minus the cost of acquisition of the capital asset.
7. The assessee being aggrieved filed an appeal before the Commissioner (Appeals) raising a dispute in regard to the income by way of capital gains. It was contended that the rights transferred by the assessee to TESCL is not an asset falling under section 2(14) of the Act. In the alternative it was claimed that the assessee be given a deduction on the interest accrued on the deferred payment of royalty while computing the capital gains on the transfer of royalty rights. Both the claims were negatived by the Commissioner (Appeals).
8. Assessee carried a further appeal before the Tribunal. It was also rejected. Thereafter the assessee filed a petition under section 256(1) of the Act which was accepted and at the instance of the assessee the questions referred to in para No. 1 of this judgment have been referred to this court for its opinion.
9. Counsel for the parties have been heard at length.
Questions 1 and 2 :
10. As the questions raised before us arise from the same set of facts and are the facets of the same argument (alternatively) we propose to deal with both of them together.
11. Section 2(14) of the Act defines ‘capital asset’ to mean property of any kind held by an assessee, whether or not connected with his business or profession, excluding those set out in the said provision. Section 45 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided, would be chargeable to income-tax under the head ‘Capital Gains’ and shall be deemed to be the income of the previous year in which the transfer took place. Section 48 provides the mode of computation and deductions. It provides that the income chargeable under the head ‘Capital Gains’ shall be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely..
(i) expenditure incurred wholly and exclusively in connection with such transfer,
(ii) the cost of acquisition of the capital asset and the cost of any improvement thereto.
12. The assessee’s case would not fall under clause (i). Under clause (ii) the assessee is entitled to the deduction of ‘cost of acquisition of the capital asset’ and the ‘cost of any improvement’ made to the capital asset. Section 55 defines ‘cost of any improvement’ in relation to capital asset to mean where the capital asset became the property of the previous owner or the assessee before the 1-1-1964, and the fair market value of the asset on that day is taken as the cost of acquisition at the option of the assessee, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset on or after the said date by the previous owner or the assessee. And, in any other case, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property, and, where the capital asset became the property of the assessee by any of the modes specified in sub-section (1) of section 49, by the previous owner. But would not include any expenditure which is deductible in computing the income chargeable under the head ‘Income from house property’, ‘profits and gains of business or profession’, or ‘Income from other sources’.
13. The point for consideration is whether the amount of interest accrued to the assessee on the defaulted payment of royalty could be given as a deduction on the transfer of the royalty rights or the assessee having suffered tax on the interest accrued on the defaulted payments would be entitled to the reduction of the rights to receive the royalty or other incidental benefits to the third party for the purpose of computing of the capital gains.
14. Interest due from SSL can in no sense be taken as an improvement made to the asset and, therefore, it would not attract the definition of “the cost of improvement’. To bring it within the meaning of ‘cost of improvement’, the expenditure in making the addition and alteration to the capital asset has to be an expenditure of capital nature. Assessee has not incurred any expenditure of capital nature in making additions or alterations to the capital asset. In fact no additions or alterations have either been made or shown to have been made. Improvement is something which would raise the value of the asset. We fail to see as to how the interest due from SSL could improve the value of the asset. SSL had failed to discharge its primary debt to repay the principal amount. Unpaid amount of interest due on the principal amount would not enhance the value of the asset. The argument raised on the premise that there was an improvement of the asset cannot be accepted and has rightly been rejected by the Tribunal.
15. BEEC had a bundle of rights which had been born out of the consultancy agreement dated 12-12-1963, as modified by the supplementary agreement dated 12-8-1966. The right to receive interest, in case of default by the SSL was one of the rights. The right by itself was not an independent asset. The asset was the aggregate of all the rights which the BEEC had acquired on account of the agreements which it had made with SSL. The assessee also transferred to TESCL the same bundle of rights without splitting it, in anyway. The right to receive interest is directly related to the act on the part of the debtor who made a default. The right to receive any amount by way of interest is the consequence of the default by the debtor. Rs. 6,33,369 was the amount due to the assessee from SSL on account of the default committed. The assessee had transferred the bundle of rights arising out of the consultancy agreements acquired by it as one asset and sold them as one asset. If right to receive the interest was a separate right, and therefore, a separate asset, it should have been so transferred in the agreement made with TESCL. When a debt is transferred as an actionable claim by the creditor, the transferee would never agree to acquire that right for the same amount. SSL had not paid any of the instalments of royalty for the last 10 years. It is difficult to imagine and think that TESCL would have paid the same amount of Rs. 6,33,369 to acquire a right to receive the same amount from SSL.
16. Counsel for the assessee placed before us the agreements which had been entered into between BEEC and SSL the tripartite agreement entered between the assessee BEEC and SSL and the agreements entered between the assessee and TESCL. On a perusal of the agreement between the assessee and the TESCL, we find that the assessee had not transferred the right to receive the interest as a separate right. The assessee had sold its rights in its entirety without splitting them. If it is so, then the only transfer made was of one capital asset in favour of TESCL for the consideration mentioned in the document and the deduction of the amount of interest claimed cannot be allowed from any standpoint of diagnosis.
17. It was next argued that the assessee having suffered tax on the interest accrued on the defaulted payments of royalty for the respective assessment year, the assessee was entitled to reduction out of the sale consideration of the right to receive the royalty and other incidental benefits to the third party for the purpose of computation of the capital gains. This argument is again not well founded. The assessee was maintaining its account on accrual basis. On the amount due from SSL, the assessee had earned interest at the rate of 6 per cent per annum on the amount due on accrual basis. It was required to be added to his income and taxed as such irrespective of the fact whether the assessee had received the amount of interest or not. The tax had been levied on the basis of accrued income. The assessee would not become entitled to the reduction of the amount due on the defaulted payment of royalty as it did not form part of the consideration received. Inclusion of interest amount in the income of the assessee for the assessment year and the fact that assessee suffered tax on it as it was maintaining its accounts on mercantile basis would not entitle the assessee to claim reduction of unrecovered amount of interest from the sale consideration.
18. For the reasons stated above, we are of the opinion that the Tribunal was right in holding that the assessee was not entitled to the deduction of the amount of interest accrued while computing the capital gains on the transfer of royalty rights and further that the assessee was not entitled to the reduction out of the sale consideration apart from the rights to receive the royalty and other incidental benefits for the purpose of computing of capital gains. The questions referred to us are answered in the affirmative, i.e., in favour of the revenue and against the assessee. No costs.