Rajaratnam.

1. These four appeals, two by the assessee and two by the revenue, arise out of the common order of the Commissioner (Appeals), in the case of Shri Durga Engg. Co., Kakinada for the assessment years 1979-80 and 1980-81.

2. The assessee is a firm doing business as a contractor. During the years under consideration, the assessee was a sub-contractor for excavation work for Nagarjuna Sagar Right canal. The assessee was being assessed at a net profit rate of 6.5 per cent for the lack of proper accounts. The basis for arriving at 6.5 per cent was that the ITO considered the normal profit to be 11.5 per cent of which the assessee had to give 5 per cent to the main contractor. It was for this reason that 6.5 per cent was estimated for the assessment years 1970-71 and 1971-72. For the assessment year 1972-73, the return was accepted inasmuch as the assessee showed slightly higher margin and not because the books were found acceptable. There was no work done in the intervening period between 1972-73 and the assessment years under consideration.

3. The assessee-firm received during the accounting year 1-11-1977 to 31-10-1978 (assessment year 1979-80) two cheques from Andhra Pradesh Government PWD of the value of Rs. 7,12,122.35. Similarly, in the assessment year 1980-81 (for the accounting year ended 31-10-1979), it received Rs. 1,67,779. The two assessments under appeal have tried to rope in these cheques for taxation purposes. The reason prompting the Government for payment of these cheques is like this. The assessee-contractor was engaged in the excavation of Nagarjuna Sagar Right canal, particularly the Koppukonda Deep Cut Rock. The contract was initiated in the assessment year 1970-71 and was carried on till the assessment year 1972-73. At the close of the assessment year 1972-73, disputes arose between the assessee-firm and the Government. The cause for the dispute was that the probable quantity of hard rock excavation work as prescribed in the contract was 2,913 units, while in actual execution the hard rock was found to be 7,850 units. The assessee had incurred large sums of additional expenditure for which the terms of the then existing contract did not provide for. To decide on the value of additional work done and the loss to be reimbursed, an arbitrator was appointed. According to his award which was made the rule of Court on two occasions, the amounts referred to at the beginning of this paragraph were paid by Executive Engineer, Karampudi on two dates—23-5-1978 and 10-6-1978. Similarly, in the next assessment year, a third cheque was received for Rs. 1,67,779. The total of these 3 cheques are Rs. 9,29,779. The ITO exhibited the above lumpsum amount under the following sub-heads identifying the purpose for which the amount was paid :

The ITO found that from out of the above itemised payments, the following were considered by him to be capital in nature :

The ITO excluded the above amounts from Rs. 9,29,901. From out of the balance, he treated items (1) and (6) together these are amounts paid for work done and not billed for Rs. 3,01,812 : payment at full agreement rates Rs. 47,647. On these two items, he levied a net profit rate of 6.5 per cent and assessed the assessee on an income of Rs. 22,715. He treated item 4, compensation amount of Rs. 3,45,280 and interest receipts, Rs. 1,41,410 as amounts wholly in the nature of income. He subjected them to tax in these two assessment years but gave deduction for arbitration expenses of Rs. 20,000 and Rs. 10,000, respectively. There was also question of registration. Inasmuch as the ITO treated the assessee as an unregistered firm. The assessee filed appeals before the Commissioner (Appeals) questioning both the decisions on the question of status and the computation of the assessee’s business income.

4. The first appellate authority, on the question of status, set aside the order of the ITO. Even on the question of quantum of assessment, he had set aside the assessments with certain directions. These directions have not satisfied either party. That is why there are cross-appeals on quantum aspect of the assessments. The first appellate authority was also not satisfied with the treatment by the ITO of certain items of receipts as capital receipts. He justified the exclusion of some of the items while he wanted the ITO to consider taxing some others. The main dispute related to the character of the receipts to the extent of Rs. 3,45,280 for breach of contract by the department. The assessee had claimed that it is capital receipt. The first appellate authority found that the main item of dispute was that the assessee had done extra work in respect of excess quantity of hard rock to the extent of Rs. 1,82,911 cft. This was not considered by the department. The assessee claimed compensation for this work as well as other compensations. The payment that was decided by arbitrator was Rs. 3,01,812, while the compensation for breach of contract in respect of the same item was worked out to Rs. 3,45,280, as against the assessee’s claim of Rs. 4 lakhs. While it is clear that the extra work was on the basis of the contracted rate, it is not clear as to how the compensation for breach of the contract was worked out either in the claim by the assessee or in the arbitration award. The parties have not filed relevant papers. The categorical finding of the first appellate authority in paragraph 16 of the said order is as under :

"At this stage, it is necessary to point out the superfluity in what the ITO had done in aggregating the receipts for the assessment purposes, those receipts relating to the compensation amount of Rs. 3,45,280 and the amount paid to the contractor for the work done and the payment of full agreement rates. As far as the assessment is concerned all these amounts are receipts in the course of and as recompense to executing contract works and, therefore, are revenue receipts or trade receipts. Compensation for breach of contract claimed under section 73 of the Indian Contract Act, for non-fulfilment of the contractual obligations of the department as a result of which the contractors were put to loss." ‘(Item 7 of the Statement of Claims)’ and 1,82,911 cft. of excess quantity of hard rock measured but not billed for and part bill of some other items’—[Item 2(b) of the Statement of Claims] represents the obverse and inverse of the same claim. The entire claim and compensation arose out of the fact that the appellant executed hard rock of 7,850 units, whereas under the contract, the probable quantity was understood and estimated to be 2,913 units between the contracting parties (see the Court’s decree dated 13-2-1978). If this discrepancy were not there, then there would have been no claim, no award and no damages. Even assuming without admitting that there can be distinction for the Assessing Officer both the receipts are to be reflected in the credit side and claim for expenses has to be allowed. That is why I stated at the beginning that the postings in the accounts of the appellant in this regard are scientific. In my view, the compensation of Rs. 3,45,280 cannot obviously be a capital receipt as claimed by the appellant. The compensation arising out of the execution of contracts, be it reimbursement of actual loss or be it a recompense for loss of profits, are part of the receipts in the course of and incidental to trade and, hence, are assessable to tax."

It is his factual finding that though there were two amounts in respect of extra work done by the assessee, they have same character. The first appellate authority wanted that both the receipts should be taken as having one and the same character as part of trading receipts. The ITO had estimated the net profit of the assessee on what he considered to be a trading receipt at 6.5 per cent as the assessee was a sub-contractor and had to pay 5 per cent to the main contractor. In respect of compensation amount, he considered that the entire receipt had income character as there was no outgo from the same. He was also of the view that the entire interest income would be taxable. He split up the receipts on this basis. The first appellate authority thought that the entire approach was wrong. Having decided that the compensation amount had the same character as extra payment received by the assessee, he thought that the assessee’s books should be re-examined in the light of his finding. He wanted the entire expenditure to be considered. He wanted that books should be made the basis of a fresh assessment in the light of what he had decided. He also made some remark about some work in progress. He set aside the assessment in the light of these directions. Ordinarily, there would have been no case for second appeal when the assessment is set aside. But neither party is satisfied with the approach of the first appellate authority.

5. The assessee contends that the view of the first appellate authority that Rs. 3,45,280 is a trading receipt and not capital receipt is not correct. The alternative argument is that the assessment should be based upon 6.5 per cent profit on the entire receipts as in earlier years. The assessee made out a statement of accounts for the entire work for all the years to suggest that the assessee had suffered a loss of Rs. 4 lakhs, though this was found to be arithmetically incorrect and that the assessee had an overall profit of Rs. 1,20,690, if we reckon interest also as trading receipts and loss of Rs. 20,720 otherwise. At any rate, there is no doubt that the books, if correctly disclose an income which is much lower than the estimate that would result in pursuance of the order of the first appellate authority. It is contended that this would be an unfair result.

6. On the other hand, the departmental appeals pointed out that the first appellate authority had failed to appreciate that the assessee’s books were always considered subject to estimate. Hence, any computation on the basis of assessee’s book is not considered a proper course. The remarks made about the work in progress are also questioned.

7. The learned counsel for the assessee argued that the payment of Rs. 3,45,280 was specifically stated by the arbitrator to be for breach of contract on the part of the department. Thus, he claimed that this payment is of capital nature and that it should go out of the purview of income computation altogether. Alternatively, it was contended that the fair course would be to estimate a reasonable profit. As for the argument that there is no corresponding expenditure involved in respect of the amount received for breach of the contract, he contended that the very description of the amount as compensation shows that the assessee had to incur expenditure. The assessee had to maintain staff and had to conduct the litigation. In fact, the work in progress shown from year to year in the books also shows that there was continuation of the establishment. In fact, the assessee’s accounts showed that the assessee had incurred expenses at work site during the intervening period to the extent of Rs. 1,46,000, which included arbitration fees, interest on borrowings, besides commission on receipts payable to the principal. He claimed that it will not be fair to adopt different bases for arriving at the profit for different years in respect of one and the same contract. Even an estimate on all receipts including compensation would result in an income which is very much higher than the book profits. Under these circumstances, it was contended that the fairest course would be to adopt an estimate. It was claimed that the departmental appeals more or less require the same result. As for interest part of it, it was contended that it can never be considered as assessee’s income. The payment was neither statutory nor was it a matter of contract. The decision of the Orissa High Court in the case of Govinda Choudhary & Sons v. CIT [1977] 109 ITR 497 was relied upon. It was claimed that the facts are identical with the assessee’s case.

8. The learned departmental representative, on the other hand, contended that the assessee’s accounts were unreliable. The first objection was that the direction of the Commissioner (Appeals) that the final computation has to be made on the basis of the assessee’s books, would go against the manner of computation in earlier years. It was also contended that his observation relating to the deduction for work in progress is not consistent with the manner of computation in the earlier years where the assessee’s trading results were rejected and estimate was made solely with reference to the receipts. In other respects, he defended the order of the first appellate authority and relied upon the order of the ITO in all respects.

9. We have considered the records as well as the arguments. We find that the entire receipts (other than interest) from the Government on claim made by the assessee as a result of arbitration proceedings have to be reckoned as having one and the same character. Though the first appellate authority thought that the ITO was right in excluding some items and wrong in excluding some other items, we do not think that there is any possibility of dissecting the items other than interest in the manner that had been done by the authorities. The first appellate authority himself found that the compensation received for breach of contract to the extent of Rs. 3,45,280, was integrally linked with the extra work done by the contractors for which there was no payment to the assessee. There was considerable delay in settling the accounts. As rightly pointed out by the appellate authority, the compensation in the facts and circumstances of the assessee’s case was part and parcel of the payment for extra work at the stipulated rate. In other words, the payment of Rs. 3,01,812 and the payment of Rs. 3,45,280, though worked out on two different bases, represent the assessee’s dues in respect of work done but not paid for. The first appellate authority was right in considering that both had the same nature. Even in respect of the other payments like amounts wrongfully forfeited, refund of hire charges charged in excess, release of wrongfully withheld arrear money and bills, difference in rate, etc., they are also trading receipts. In this sense, we have to consider the entire amount other than interest as belonging to one category being payment for work done. Where wrongful withholdings are released, such released amounts are also trading receipts because they were initially withheld on the basis that the work was either not up to the mark or the assessee had claimed excess in its bills. Hence, we would consider the entire receipts listed in paragraph 3 of this order other than interest as trading receipts. We would, however, not disturb the split up of these receipts in the two years on the basis of receipts as had been done by the ITO since this was the method consistently followed in the earlier years in the assessee’s assessments.

10. We have already noticed that the payment of Rs. 3,45,280 has the same character as the other amount of Rs. 3,01,812 as trading receipts. In this view, we confirm the order of the first appellate authority. We would, however, like to give the following reasoning for our conclusion in one of the orders to which one of us (Accountant Member) was a party in IT Appeal No. 318 (Mad.) of 1980 for the assessment year 1977-78, dated 20-10-1981 :

"We have carefully considered the facts and the arguments presented before us. The assessee is a contractor and Pochampad contract is one of the many contracts undertaken by him in his business as contractor. Pochampad contract is, no doubt, one of the assessee’s major contracts. But assessee had undertaken equally major contracts in the past as a registered A Class contractor had executed other major projects like Breakwater Project in Tuticorin, Harbour, Earthen Dam at Cochin, Dam work at Sharawathy Project in Karnataka, overbridges and railway embankments with tunnels and bridges in Hassan-Mangalore Railway Project, etc., and has been in this line of business for nearly two decades. It is, therefore, not possible that this contract which is only one of his many contracts is a capital asset in the facts of the assessee’s case. In the case of Short Bros. Ltd. v. IR 12 TC 955, Court of Appeals held that the compensation received for cancellation of a contract for building two steamers, to be a revenue receipt in the ordinary course of the company’s trade and taxable in the accounting period when it was payable and was in fact paid. Similarly, in Household v. Grimshaw 34 TC 366, the receipt by a professional author for release from an obligation under an ‘exclusive’ agreement for three years was a revenue receipt as the assessee’s profession as author did not come to an end as a result of this termination of the contract. No doubt, House of Lords in Van Den Bergh Ltd. v. Clark 19 TC 390 held that compensation received for cancellation of pooling arrangement with an elaborate scheme was a capital receipt, because the agreement far from being made in the ordinary course of business, affected the entire organisation and, therefore, the framework of the business creating a congeries of right in the nature of capital asset. It is not so in the case before us. The Supreme Court in the case of CIT v. South India Pictures Ltd. [1956] 29 ITR 910 applied the decision of Short Bros.’ case and distinguished Van Den Bergh’s case while holding that compensation for termination of agreement for distribution of three films in the case of a film distributor was a revenue receipt. These guidelines based on English decisions were reiterated by the Supreme Court in the case of CIT v. Rai Bahadur Jairam Valji [1959] 35 ITR 148 and repeatedly affirmed by the Supreme Court on three other occasions in CIT v. Vazir Sultan & Sons [1959] 36 ITR 175, Godrej & Co. v. CIT [1959] 37 ITR 381 (SC) and Kettlewell Bullen & Co. Ltd. v. CIT [1964] 53 ITR 261 (SC) besides having been followed by a number of High Courts. It is not necessary to discuss the case law cited by the learned counsel as one can have no quarrel with the propositions canvassed by him that damages receipted for loss of sterilisation of a capital asset is a capital receipt and does not cease to be a capital receipt merely because such compensation is determined with profit or additional cost as index or a measure of such compensation. Even so, his undisputed legal propositions do not help in the facts of the case on our finding that contract from Pochampad Project is one of the assessee’s many contracts in his business as a contractor. On this fact alone as mentioned earlier, the law is well settled at the level of the Supreme Court and such law is in favour of the revenue and against taxpayer in this case."

No doubt, the facts of the assessee’s case are somewhat different, but the conclusion cannot be different in the assessee’s case. The assessee is a sub-contractor, which made the assessee’s position weaker inasmuch as the assessee’s receipt is on account of the claim made on behalf of the principal. The breach of contract is between the Government and the principal. Even assuming that this makes no difference, it is not shown that the assessee-firm was formed or incorporated only for taking up a particular sub-contract work. The assessee is in contract line. Though the contract during the years was only one being major one at that, it cannot be said that the assessee’s contract itself was a capital asset. Again, the breach was not fundamental so as to sterilise the capital asset itself. Breach was in performance of the contract. It is for this reason, we are of the view, that the extract of the decision cited earlier in this paragraph should support the inference of the first appellate authority that the receipts other than interest have to be treated as contract receipts, only with the modification that the entire receipts other than interest would have to be so treated without considering section 41(2) of the Income-tax Act (‘the Act’) or the ad hoc finding of the first appellate authority that any part of it constitutes capital receipt.

11. The next contention relates to the manner in which the profit from these contract receipts have to be worked out. The assessee’s accounts were rejected. Even for these years, the ITO estimated the net income at 6.5 per cent from receipts, which he accepted as normal revenue receipts. The first appellate authority himself while holding that the computation has to be on the basis of books, wanted examination of the accounts on various points because he was not otherwise convinced about them. The grounds of appeal filed by the department also question the finding of the first appellate authority that the income should be computed with reference to the books of account. It is pointed out there in that the income from this contract has been estimated year after year without reference to the books of account. It was for this reason, it questions the incorrectness of the work in progress which is the connecting link between the profits of various years, if the books of account were to be accepted. The assessee has also never been serious either in the past or in this year for acceptance of the books. Hence, the order of the first appellate authority that remanded the matter on the question of books was not justified. The only question would be whether in view of the lumpsum the normal profit rate estimated at 6.5 per cent, considering the assessee is a sub-contractor, who has to part with 5 per cent to his principals, could be treated as reasonable. For this limited purpose, the book result and the return of income made by the assessee year after year may have relevance. If the books for the entire contract show a higher profit then the profit assessed in all the years, there is no reason why the estimate should be limited to 6.5 per cent of the contract receipts. As pointed out in an earlier paragraph, though the loss is not as much as pointed out by the assessee, the result is far below 6.5 per cent. It is under these circumstances, we are of the view that 6.5 per cent on all the receipts made in these two years, should be repeated even as done by the ITO, on receipts which he considered as contract receipts. This estimate is not only consistent with the past assessment but is also fair, in our opinion, to the parties concerned. This will also avoid the necessity of considering the various items of expenses as incurred by the assessee during the period of lull in the contract, amounts claimed as trimming charges, real value of work in progress, the question of allowability or otherwise or arbitration charges, etc., including interest payments. The estimate directed is of net income on the contract receipts and this will give a quietus to a number of other problems. It is for this reason that we resolve the question of estimate in this manner. We, therefore, direct adoption of rate of 6.5 per cent on actual receipts other than interest in these two years.

12. We have yet to consider the question of treatment to be accorded to the interest component of the amount received. Interest was also received in the two years and the total amount in these years was Rs. 1,41,410. The assessee relied upon the decision of the Orissa High Court in the case of Govinda Choudhury & Sons (supra). It is the assessee’s contention that the payment being neither statutory nor contractual, the decision of the Supreme Court in the case of T.N.K. Govindaraju Chetty v. CIT [1967] 66 ITR 465 would apply. But there are two distinguishing facts in this case, which in our opinion, should matter. Firstly, the amount with reference to which the interest is received is itself a revenue receipt and not a capital receipt. If the interest was paid for sterilising a capital asset along with compensation, it may form part of such capital receipt in the sense that the damages are partly worked out with reference to interest as a yardstick. In these circumstances, interest would not have the character of interest as such. In the assessee’s case, the interest is with reference to the amount due as part of contract receipts on the basis of our finding in an earlier paragraph. Secondly, the interest is not with reference to the date on which the breach occurred but with reference to the date on which the suit was filed. It cannot, therefore, be said that it is part of compensation money. Thirdly, the payment is not ex gratia payment as was found to be in Govinda Choudhury & Sons’ case (supra). In very similar circumstances, this very issue was decided by this Tribunal in the same case from which a different passage was extracted in the following words :

"What remains to be considered is the interest of Rs. 2,67,170. We have held that the interest relates to the assessee’s claim for recovery of dues from the Government for work done. Interest was stipulated by the Arbitrator. The assessee’s reliance on English case I.R. v. Ballantine on the interest point also does not help him as in that case, it relates to interest paid as part of damages held to be capital receipt. In fact, this decision was distinguished by the Supreme Court in T.N.K. Govindaraju Chetty’s case (supra) even where the principal related to a capital receipt. In assessee’s case the principal sum itself is of revenue nature and was found to be not by way of damages. It is also not an ex gratia payment as was found by us in this case, while it was found to be an ex gratia payment in the case of Govinda Choudhury & Sons (supra) relied upon by the learned counsel. It is not so strictly contractual or statutory interest as to be brought directly within the rationale of the decision of the Supreme Court in the case of T.N.K. Govindaraju Chetty (supra) and in the case of Dr. Shamlal Narula v. CIT [1964] 53 ITR 151 (SC). In this case, however, it is not part of damages at all because what was received by the assessee was not damages but only an enhanced rate for work done, such enhanced rate being given to cover additional cost and enable the assessee to retain the expected profits. Hence, the question is not whether interest is only a measure of damages because there are no damages. Interest in assessee’s case is not different from what a trader receives from his customer for delayed payment. In the cases cited, the interest though related to admittedly capital receipts was held to be nonetheless taxable. In fact, it is possible to hold that the interest in assessee’s case is payable in pursuance of a contract in the sense that it is paid for non-discharge of one of the obligations under the contract. In this view, the decisions of the Supreme Court could apply against the taxpayer. It can also be described as statutory because it was in pursuance of Arbitrator’s award under Arbitration Act. Even, otherwise interest in plain language is for user of assessee’s money withheld by Government. Since such moneys due from circulating capital of the assessee, it is of the revenue nature. It is not a measure of any damage by itself as the principal amount itself is not in the nature of damages of capital nature. Interest is also not in the nature of damages but interest, simpliciter. We hold it to be interest not merely because it is called interest, but it is, in fact, interest stipulated as such. In Westminster Bank Ltd. v. Riches [1947] 28 TC 159, 15 ITR (Suppl.) 86 even interest by way of damages, it was pointed out could be income and not capital receipt as there is nothing incompatible in damages being income. Only where damages are for wrongful withholding of or detention of money or other property, it could be a capital sum and not whereas in assessee’s case, interest is given for delayed receipt of contract amounts. In the result, it was rightly brought to tax."

In our view, on the facts and in the circumstances of the assessee’s case, the interest has character of interest and has to be taxed as interest. Since the amount is outside the purview of the contract, interest has to be reckoned and considered as income over and above the net income at 6.5 per cent directed to be included in the immediately preceding paragraph. Since interest was received in two years, interest income will also be assessed in the respective years of receipt as had been done for the contract receipts. In view of the fact that the assessments are made on cash receipts year after year on the basis of assessee’s accounts.

13. The assessee’s alternative claim that even interest if at all taxable should be treated as part of trading receipts cannot obviously be accepted as it is not a trading receipt. While there has been some outgoings, in respect of trading receipts, there has been and can be no such corresponding outgoing in respect of interest income. While upholding estimate of net income from contract receipts at 6.5 per cent, we have reckoned all outgoings including interest payments. Hence, the estimate of the net profit in respect of such interest income would not only be unrealistic but also eminently unfair to revenue. Hence, in this aspect of the matter, we have to uphold the finding of the first appellate authority that the interest income has to be treated as income subjected only to the observation that it would be assessed in the respective years of receipts.

14. In the result, all the four appeals either by the assessee or by the department are partly allowed in the manner indicated in the preceding paragraph.