Earnest money forfeited by an assessee in relation to the sale of an immovable property, which is a capital asset, is not taxable income.

Headnote:
INCOME TAX - Whether earnest money forfeited and appropriated by the assessee constituted business income and liable to be taxed - Whether the sum could be considered as income to bring it within the term 'causal receipt' falling under section 10(3) of the Income-tax Act, 1961.
Fact of the Case:

The assessee, a private limited company, entered into an agreement to sell its land and superstructure for a sum of Rs. 4,20,000. The purchaser paid Rs. 20,000 as earnest money, which was to be forfeited if the purchaser failed to pay the remaining amount by a certain date. The purchaser defaulted, and the assessee forfeited the earnest money. The Income-tax Officer treated the forfeited amount as taxable income, but the Commissioner of Income-tax (Appeals) and the Appellate Tribunal held that it was not taxable.
Finding of the Court:

The court held that the earnest money forfeited by the assessee was not taxable income. The court reasoned that the earnest money was received in relation to the sale of an immovable property belonging to the company, which was a capital asset. The court also noted that the assessee was not in the business of buying and selling real estate, and that the agreement to sell the property was not entered into in the course of the business done by the assessee.
Issues: 1. Whether the earnest money forfeited and appropriated by the assessee constituted business income and liable to be taxed? 2. Whether the sum could be considered as income to bring it within the term 'causal receipt' falling under section 10(3) of the Income-tax Act, 1961?
Ratio Decidendi: The court relied on several judicial pronouncements to support its decision. The court held that a receipt is not taxable when it is referable to fixed capital, but it is taxable as a revenue item when it is referable to circulating capital or stock-in-trade. The court also noted that the provisions of section 51 of the Income-tax Act, which deals with the computation of cost of acquisition of capital assets, support the conclusion that the earnest money forfeited by the assessee was not taxable income.
Final Decision: The court answered both questions referred to it in the affirmative and against the Department. There was no order as to costs.

Judgment :-

THANIKKACHALAM, J.

At the instance of the Department, the Tribunal referred the following two questions for the opinion of this court under section 256(1)) of the Income-tax Act, 1961 :

"1. Whether, on the facts and in the circumstances of the case, the Appellant Tribunal was right in holding that the sum of Rs. 20, 000 being the deposits made by an intending buyer, forfeited and appropriated by the assessee, did not constitute business income of the assessee and as such was not liable to be taxed ?

2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 20, 000 could not at all be considered as income to bring it within the term 'causal receipt' falling under section 10(3) of the Income-tax Act ?" *

The assessee is a private limited company. The assessment for 1974-75, was completed by the Income-tax Officer determining the total income at Rs. 44, 450. The company had earlier entered into an agreement with one Sri K. Periasamy to sell its land and superstructure situate at Trichy for a sum of Rs. 4, 20, 000. The purchaser was to pay the vendor a sum of Rs. 60, 000 as earnest money towards the sale price, which was to be paid in two instalments (i) on the execution of the agreement, i. e., on October 11, 1971, Rs. 20, 000 and (ii) Rs. 40, 000 on or before December 1, 1971. In the event of default in paying the further sum of Rs. 40, 000 on or before December 1, 1971, the vendor, may, at his option, cancel the agreement for the default of the purchaser and thereupon the earnest money of Rs. 20, 000 may be taken and retained by the vendor and the purchaser shall not be entitled to recover the same. The Income-tax Officer has treated the amount of Rs. 20, 000 as taxable on the ground that the amount of Rs. 20, 000 was received by the assessee during the course of the business and also as the company had itself treated the amount as revenue income and also utilised the same for declaration of dividends.On appeal, the Commissioner of Income-tax (Appeals), following an earlier order of the Tribunal in the case of M. Ct. M. Corporation (P.) Ltd. v. ITO in I. T. A. No. 929/Mds of 1977-78 dated June 21, 1978, held that the receipt does not bear the character of income, profits or gains. Accordingly, the Commissioner of Income-tax (Appeals) deleted the addition of Rs. 20, 000. On further appeal, the Appellate Tribunal confirmed the order passed by the Commissioner of Income-tax (Appeals).

Before us, learned standing counsel appearing for the Department, submitted that Rs. 20, 000 was received as earnest money towards the sale price as security for fulfilling the contract. Therefore, it should be treated as revenue receipt earned during the course of business. Learned standing counsel further submitted that there is difference between the receipt of earnest money and the advance. Learned standing counsel submitted that if it is advance, then the seller is bound to return the same if the contract was not fulfilled. On the other hand, if it is earnest money, the seller can retain the same and treat it as a part of sale consideration when the sale was completed. Therefore, in the present case, according to learned standing counsel, the earnest money received by the assessee in the course of the business should be treated as revenue receipt since it does not bear the character of capital receipt. In Order to support his contention, learned standing counsel relied upon a decision of this court in CIT v. M. Ct. M/ Corporation Pvt. Ltd. According to the facts arising in that case, the assessee company engaged in trading, Investment and money-lending business, negotiated for the sale of a house property belonging to it and, as the sale could not be completed, forfeited a certain sum deposited by the intending purchaser with the assessee. The Income-tax Officer held that the forfeited amount was income taxable under section 10(3) of the Income-tax Act, 1961. The Appell

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