A buyer defaulted and I forfeited his earnest money and advance on a sale of a capital asset that never went through. Is the forfeited money taxable income?
No, on the law as it then stood. The Supreme Court held that money received as advance or earnest on the proposed sale of a capital asset is a capital receipt, and the cancellation of the sale is not a subsequent event that changes its character. Section 51 confirms this: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition when the asset is eventually sold. The distinction between earnest money and advance loses its significance, because section 51 covers 'other money' as well. The appeals were allowed.
Decided by the Supreme Court (Supreme Court of India; D.P. Wadhwa and Ruma Pal JJ. Judgment by Ruma Pal J) on 2000-03-14, reported as (2000) 243 ITR 158; 2000 (3) SCC 715; AIR 2000 SC 1980; (2000) 109 Taxman 250; (2000) 3 JT 458 (SC). It bears on section 51, section 45, section 4 of the Income Tax Act 1961, in Capital Gains matters.
This is the leading authority on forfeited advances against a capital asset, and it does three separate things. It confirms that what would have been a capital receipt if the sale had gone through stays a capital receipt when the sale fails. It holds that section 51 makes no distinction between earnest money and advance, so the elaborate law on that distinction does not decide the tax question. And it applies the compensation rule from London and Thames Haven Oil Wharves, that compensation for breach takes the character of the sum it replaces. Read it against the two limits it acknowledges: Karam Chand Thapar, where a subsequent event can imprint a different quality on a receipt, and the fact that Parliament has since brought forfeited advances into charge as income from other sources.
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The assessee was a plantation company growing rubber and tea. In 1975 it agreed to sell old rubber trees to three purchasers, taking earnest money of Rs 75,000 in all and advances totalling Rs 3,56,300. All three defaulted, the agreements were terminated and the amounts were forfeited under clause 16 of the agreements. The assessee's right to retain them was confirmed by the Subordinate Judge at Kottayam. In 1979 it eventually sold the trees to a third party, at a loss. For assessment year 1977-78 the assessing officer accepted that the forfeited sums were not revenue receipts, but the Commissioner revised the assessment under section 263 and held them taxable. The Tribunal restored the assessing officer's view. On a reference the Kerala High Court held the Tribunal should have distinguished earnest money from advance and remanded. On remand the Tribunal held the forfeited advance was not assessable but the earnest money was, as income from other sources. On fresh references at the instance of both sides the High Court held that forfeiture ended the agreement and with it the character of the amounts, so both were income receipts, and that section 51 had no application. The assessee appealed.
The appeals were allowed, the High Court's order set aside, and the question referred at the assessee's instance answered in the negative. Sale proceeds of old and unyielding rubber trees are capital receipts, so what was received by way of advance consideration on the agreements to sell them was capital. Cancellation of a sale of capital assets is not a subsequent event of a kind that changes the nature of the receipt. Section 51 puts the matter beyond doubt: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition, and no distinction is drawn there between advance and other money. The Tribunal was right that the advance formed part of the capital asset but wrong to leave the earnest money out of section 51. The High Court was also wrong to treat the agreements as agreements for sale that did not effect a sale; they were agreements of sale in which payment and delivery were deferred.
The Court started from the character of the asset. On the Constitution Bench decision in Kailas Rubber and on Vishnudatta Anantharjanam, proceeds of old unyielding rubber trees grown for latex are capital, and the assessee was not in the business of selling trees. So had the sales gone through the consideration would have borne capital gains. The assessee relied on Morley v Tattersall, that the nature of a receipt is fixed once and for all when it is received. The Revenue relied on Karam Chand Thapar, where this Court, approving Jay's The Jewellers and Elson v Prices Tailors, held that Tattersall is not absolute and that a subsequent event may imprint a different quality on a receipt, as where money belonging to customers is taken to profit and loss because no claim can any longer be made to it. The Court held that the cancellation of a sale of a capital asset is not such an event, and that section 51 preserves the rule in Tattersall to that extent, because it directs the retained money to be set against cost when the asset is later transferred, which is a capital treatment. The phrase 'other money' in section 51 is wide enough to cover a deposit taken to guarantee performance and not forming part of the price, so the distinction between earnest money and advance, real though it is in contract, drops out. The Court then reached the same result by a second route. Clause 16 of the agreement is a provision for compensation for breach under section 74 of the Contract Act. On the rule stated by Diplock LJ in London and Thames Haven Oil Wharves, compensation for the failure to receive a sum is treated as that sum would have been treated. The instalments, had they come in, would have been credited as capital, so the forfeited amounts are capital too.
the cancellation of a sale of capital assets would not be such a subsequent event so as change the nature of the receipt of the forfeited amounts
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Handle my notice → Ask a CA on WhatsAppNo, on the law as it then stood. The Supreme Court held that money received as advance or earnest on the proposed sale of a capital asset is a capital receipt, and the cancellation of the sale is not a subsequent event that changes its character. Section 51 confirms this: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition when the asset is eventually sold. The distinction between earnest money and advance loses its significance, because section 51 covers 'other money' as well. The appeals were allowed. This was decided by the Supreme Court (Supreme Court of India; D.P. Wadhwa and Ruma Pal JJ. Judgment by Ruma Pal J) and bears on section 51, section 45, section 4 of the Income Tax Act 1961. It is reported as (2000) 243 ITR 158; 2000 (3) SCC 715; AIR 2000 SC 1980; (2000) 109 Taxman 250; (2000) 3 JT 458 (SC). This is the leading authority on forfeited advances against a capital asset, and it does three separate things. It confirms that what would have been a capital receipt if the sale had gone through stays a capital receipt when the sale fails. It holds that section 51 makes no distinction between earnest money and advance, so the elaborate law on that distinction does not decide the tax question. And it applies the compensation rule from London and Thames Haven Oil Wharves, that compensation for breach takes the character of the sum it replaces. Read it against the two limits it acknowledges: Karam Chand Thapar, where a subsequent event can imprint a different quality on a receipt, and the fact that Parliament has since brought forfeited advances into charge as income from other sources. If it applies to you, the first step is this: Check the year. For forfeitures on or after 1 April 2014 the receipt is charged as income from other sources under section 56(2)(ix) and section 51 no longer applies to it, so this case will not save you.
The assessee was a plantation company growing rubber and tea. In 1975 it agreed to sell old rubber trees to three purchasers, taking earnest money of Rs 75,000 in all and advances totalling Rs 3,56,300. All three defaulted, the agreements were terminated and the amounts were forfeited under clause 16 of the agreements. The assessee's right to retain them was confirmed by the Subordinate Judge at Kottayam. In 1979 it eventually sold the trees to a third party, at a loss. For assessment year 1977-78 the assessing officer accepted that the forfeited sums were not revenue receipts, but the Commissioner revised the assessment under section 263 and held them taxable. The Tribunal restored the assessing officer's view. On a reference the Kerala High Court held the Tribunal should have distinguished earnest money from advance and remanded. On remand the Tribunal held the forfeited advance was not assessable but the earnest money was, as income from other sources. On fresh references at the instance of both sides the High Court held that forfeiture ended the agreement and with it the character of the amounts, so both were income receipts, and that section 51 had no application. The assessee appealed. The matter was decided on 2000-03-14 by the Supreme Court (Supreme Court of India; D.P. Wadhwa and Ruma Pal JJ. Judgment by Ruma Pal J). On those facts the Supreme Court held as follows. The appeals were allowed, the High Court's order set aside, and the question referred at the assessee's instance answered in the negative. Sale proceeds of old and unyielding rubber trees are capital receipts, so what was received by way of advance consideration on the agreements to sell them was capital. Cancellation of a sale of capital assets is not a subsequent event of a kind that changes the nature of the receipt. Section 51 puts the matter beyond doubt: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition, and no distinction is drawn there between advance and other money. The Tribunal was right that the advance formed part of the capital asset but wrong to leave the earnest money out of section 51. The High Court was also wrong to treat the agreements as agreements for sale that did not effect a sale; they were agreements of sale in which payment and delivery were deferred.
The Court started from the character of the asset. On the Constitution Bench decision in Kailas Rubber and on Vishnudatta Anantharjanam, proceeds of old unyielding rubber trees grown for latex are capital, and the assessee was not in the business of selling trees. So had the sales gone through the consideration would have borne capital gains. The assessee relied on Morley v Tattersall, that the nature of a receipt is fixed once and for all when it is received. The Revenue relied on Karam Chand Thapar, where this Court, approving Jay's The Jewellers and Elson v Prices Tailors, held that Tattersall is not absolute and that a subsequent event may imprint a different quality on a receipt, as where money belonging to customers is taken to profit and loss because no claim can any longer be made to it. The Court held that the cancellation of a sale of a capital asset is not such an event, and that section 51 preserves the rule in Tattersall to that extent, because it directs the retained money to be set against cost when the asset is later transferred, which is a capital treatment. The phrase 'other money' in section 51 is wide enough to cover a deposit taken to guarantee performance and not forming part of the price, so the distinction between earnest money and advance, real though it is in contract, drops out. The Court then reached the same result by a second route. Clause 16 of the agreement is a provision for compensation for breach under section 74 of the Contract Act. On the rule stated by Diplock LJ in London and Thames Haven Oil Wharves, compensation for the failure to receive a sum is treated as that sum would have been treated. The instalments, had they come in, would have been credited as capital, so the forfeited amounts are capital too. In the words reproduced by the source cited on this page: "the cancellation of a sale of capital assets would not be such a subsequent event so as change the nature of the receipt of the forfeited amounts"
It was decided by the Supreme Court on 2000-03-14 and is reported as (2000) 243 ITR 158; 2000 (3) SCC 715; AIR 2000 SC 1980; (2000) 109 Taxman 250; (2000) 3 JT 458 (SC). Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On section 51, section 45, section 4, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The appeals were allowed, the High Court's order set aside, and the question referred at the assessee's instance answered in the negative. Sale proceeds of old and unyielding rubber trees are capital receipts, so what was received by way of advance consideration on the agreements to sell them was capital. Cancellation of a sale of capital assets is not a subsequent event of a kind that changes the nature of the receipt. Section 51 puts the matter beyond doubt: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition, and no distinction is drawn there between advance and other money. The Tribunal was right that the advance formed part of the capital asset but wrong to leave the earnest money out of section 51. The High Court was also wrong to treat the agreements as agreements for sale that did not effect a sale; they were agreements of sale in which payment and delivery were deferred. It arises in Capital Gains matters, on section 51, section 45, section 4 of the Income Tax Act 1961, and was decided by Supreme Court of India; D.P. Wadhwa and Ruma Pal JJ. Judgment by Ruma Pal J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. For earlier years, reduce the cost of acquisition by the forfeited sum when the asset is finally sold, and keep the computation on record so the deduction is not lost. Do not concede on the earnest money merely because it is called earnest money; section 51 speaks of advance or other money and the label does not matter. Show that the amount forfeited relates to a capital asset and to the failed transfer of it, and that the assessee is not in the business of dealing in that asset.
Superseded by amendment. The reasoning on the character of a forfeited advance stands for years governed by section 51 alone. But a later amendment charges a sum forfeited on a failed negotiation for the transfer of a capital asset as income from other sources under section 56(2)(ix), with section 51 correspondingly restricted, so for forfeitures from assessment year 2015-16 onwards the result is the other way. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The library had carried a second page for this same judgment at /caselaw/case/travancore-rubber-and-tea-v-cit-forfeited-advance/; the two have been merged and that address now redirects here. The later amendment noted under validity was not verified against a source in this session; read section 51 and section 56(2)(ix) as they stand for the year you are dealing with. The judgment sets out section 51 under a misprinted heading, '57. Advance money received.' The Court answered only the question referred at the assessee's instance; the questions referred at the Department's instance, including the effect of the eventual 1979 sale, were not separately dealt with. Whether the forfeited sums were in fact deducted from cost in the later year is not on the record read. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeals were allowed, the High Court's order set aside, and the question referred at the assessee's instance answered in the negative. Sale proceeds of old and unyielding rubber trees are capital receipts, so what was received by way of advance consideration on the agreements to sell them was capital. Cancellation of a sale of capital assets is not a subsequent event of a kind that changes the nature of the receipt. Section 51 puts the matter beyond doubt: advance or other money received and retained on an earlier negotiation for transfer is deducted from the cost of acquisition, and no distinction is drawn there between advance and other money. The Tribunal was right that the advance formed part of the capital asset but wrong to leave the earnest money out of section 51. The High Court was also wrong to treat the agreements as agreements for sale that did not effect a sale; they were agreements of sale in which payment and delivery were deferred.
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