[Opinion] A Treatise on the Taxation of Amount Received on Termination of Licence

V K Subramani – [2025] 172 taxmann.com 330 (Article)

When an expenditure is incurred and a corresponding income arises or accrues to the taxpayer, the nexus gets established between the said expenditure and income and therefore such expenditure is eligible for deduction. However, if the expenditure is unrelated or personal or capital in nature then such expenditure cannot be considered for determination or quantification of income of the taxpayer. It is a very old but time-tested rule that receipt of money in lieu of income is revenue receipt hence taxable and whereas a receipt of money in lieu of source of income, is a capital receipt. This concept continues to remain relevant even today despite the commercial world has its own uniqueness, complexities, peculiarities and sophistication in conduct of business. In the context of Income-tax, an income whether taxable under the head ‘house property’ or ‘business’ and similarly whether it is ‘business’ or ‘capital gain’ remains a prominent issue litigated since different sets of legal provisions operate based on the head of the income in which the said income is chargeable to tax.

This refresher takes note of the decision in the case of Pr. CIT v. ITC Ltd. [2024] 164 taxmann.com 88/467 ITR 465 (Cal) where the taxpayer offered the income as long-term capital gain (obviously because the rate of tax is on the lower side) and whereas the tax authorities taxed the income under the head business (since regular rate of tax would apply) and thus both the sides litigated the matter up to High Court who decided the matter in favour of the Revenue with a treat of legal precedents in this regard.

1. ITC Ltd’s Case

The assessee as most of us know is a reputed corporate giant engaged in multifarious activities. For the assessment year 2006-07 it admitted a total income of Rs.3041.43 crore which was subsequently revised by admitting Rs. 3040.48 crore. In the assessment proceedings one of the additions made by the Assessing Officer was Rs. 32.42 crore received from and entity by name ELEL Hotels & Investments Ltd (hereinafter referred to as EHIL and the hotel owned by it is referred as ELEL) in pursuance of a termination agreement dated 11th May, 2005.

The assessee admitted the said sum under the head ‘long-term capital gain’ and whereas the Assessing Officer taxed the same as income from ‘business’. The CIT (Appeals) and ITAT accepted the view of the taxpayer that the amount so received is taxable as a long-term capital gain. Unrelenting, the department knocked the doors of the High Court for taxing the said amount under the head ‘business’ instead of capital gain. This is the crux of the controversy resolved by the High Court in favour of the Revenue. Though it is simply stated that the issue was resolved in favour of the Revenue the process, the arguments and the references made for arriving at the decision prove to be a treatise despite the issues involved had to be decided more based on the facts of the case than on legal principles/precedents.

2. Factual Aspects

The assessee (ITC Ltd) vide agreement titled “Operating Licence Agreement” dated 01.10.1983 was operating the hotel ELEL owned by EHIL. Again, a fresh agreement was entered into which superseded the said agreement and it was titled as “Operating Licence Agreement” dated 03.05.1986. The agreement provided the assessee the right to operate a hotel by name “Sea Rock” from 01.07.1986 for a period of 25 years with an option to renew the licence for a further period of 25 years by giving a notice with not less than 24 months’ time before the expiry of the original licence period. The licence fee was calculated @23% of the gross turnover to be paid by the licence holder i.e. the assessee which has to be certified by its auditors. Before the end of the first term of 25 years of the agreement, the parties entered into a settlement agreement dated 11th May, 2005 by which the assessee became eligible to receive Rs.32.42 crore in settlement of all disputes between the parties.
The original agreement envisaged that the assessee would not have any right, title or interest in the hotel which it would be operating. The agreement also contained a condition that if the assessee claimed any tenancy or leasehold interest in the property or any part thereof or any right, title or interest inconsistent with or contrary to sole and exclusive ownership and possession of the asset by ELEL, the EHIL shall be entitled to call upon the assessee to purchase the hotel at the mutually agreed price of Rs.15 lakh per room irrespective of its use or Rs.75 crore whichever is higher. Further it was stated that the assessee shall pay the purchase consideration in 10 annual instalments by setting off the refundable of deposit of Rs.7.75 crore pro rata from each of the said annual instalments together with interest @15% per annum. Besides the above discharge of purchase consideration, the assessee shall pay the licence fee @23% till the entire purchase price is paid out to ELEL.

The substantial question of law before the High Court was as under:

“Whether receipt of money by the assessee on account of relinquishment of its right to operate a hotel as a licensee would constitute capital receipt exposing the assessee to capital gains tax or the same shall be treated as business receipt?”.

The agreement related to the subject matter of running a hotel owned by EHIL and the licence to operate was given by virtue of the said agreement.

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