Fixed Share Of Gross Receipts Paid To AOP Member Was Taxable Revenue Income, Not Exempt Profit: Supreme Court

The Supreme Court has held that the 35% share of gross sale proceeds received by Sanand Properties Pvt Ltd from an Association of Persons (AOP) formed for a Pune housing project was taxable business income and not an exempt share of profit, holding that the payment was insulated from project expenses and therefore bore the character of revenue rather than profit.

A bench led by Justice J.B. Pardiwala and Justice K V Viswanathan delivered the ruling in a dispute arising out of a joint development arrangement through an AOP named Fortaleza Developers.

Under Clause 7 of the agreement, Sanand Properties was entitled to receive 35% of the gross sale proceeds from the sale of flats, while development and construction expenses were to be met from the remaining 65%.

Accepting the Revenue's stand, the Court observed, “Even the words used in the clause itself are 'share of revenue/income', and not 'share of profit'. Hence, it would defy logic to say that the SPPL's income from the AOP is a share of its profit.”

The Court further held: “Profit is the surplus that remains after all the expenses have been deducted from the gross receipts. Since the SPPL's share remained insulated from the expenses of the AOP, the amount received by it lacks the essential characteristics of 'profit' and is, in pith and substance, a business receipt.”

The dispute arose from a joint development arrangement for a residential housing project in Pune through Fortaleza Developers, an AOP formed between Sanand Properties and Raviraj Kothari & Co.

Under Clause 7 of the AOP agreement, Sanand Properties was entitled to 35% of the gross sale proceeds from flats sold in the project. The remaining 65% was to be used for meeting project expenses, including construction and development costs.

Sanand Properties argued that the 35% amount represented its share of profit from the AOP. Since the AOP itself was separately taxable under the Income Tax Act, the same income could not again be taxed in its hands in view of Sections 86, 67A and 167B of the Act.

The Income Tax Department argued that this was not a profit-sharing arrangement, but a clear case of revenue sharing because the 35% amount became payable directly from flat sales before deduction of any expenses.

Agreeing with the Revenue, the Court held that the structure of Clause 7 showed the payment was linked to gross receipts rather than net profits.

The bench observed that in a normal profit-sharing arrangement, business expenses are first deducted, and only the remaining surplus is distributed. Here, however, Sanand Properties' entitlement remained insulated from project costs and losses.

Another factor that weighed with the Court was the language of Clause 7 itself, which described the entitlement as “share of revenue/income” rather than “share of profit.”

The case also involved the validity of reassessment proceedings initiated by the Income Tax Department.

The dispute began after a survey under Section 133A was conducted at the assessee's premises in December 2010. During the survey, the department recovered the AOP agreement, audited financial statements of Fortaleza Developers, books of account, the development agreement, an auditor's communication on computation of receivables, and sample sale agreements.

According to the Revenue, these materials showed that the income had wrongly been treated as exempt profit instead of taxable revenue. Based on this material, the department reopened assessments for AY 2007-08 and AY 2008-09.

Sanand Properties challenged the reopening, arguing that these materials were already available during the original scrutiny assessment and that the reassessment amounted to a mere change of opinion.

Rejecting this argument, the Supreme Court held: “To constitute a 'change of opinion', there must first be a conscious application of mind and a formation of an opinion during the original assessment proceedings. Where no such opinion was formed in the first instance, the Revenue is not precluded from reopening the assessment.”

The Court found that although the original assessment proceedings referred to the AOP arrangement, the Assessing Officer had not formed any conscious opinion on whether the 35% receipt under Clause 7 was profit or revenue. The reopening was therefore valid.

Clarifying the scope of reassessment, the Court held: “A document not referred to in those reasons recorded under Section 148 cannot be used to justify the validity of the reopening, as the assessee must not be deprived of a fair opportunity to dispute such grounds.”

On the issue of contractual interpretation, the bench held that “interpretation of contractual clauses is a question of law,” allowing it to independently interpret Clause 7 despite contrary findings by the ITAT and the Bombay High Court.

Accordingly, the Court upheld the reassessment proceedings and held that the 35% amount received by Sanand Properties from the AOP constituted taxable business income.

For Appellants: AOR Anil Katiyar, Senior Advocate Manisha T. Karia, AOR Anita Bafna, Advocate Shreya Gupta, Advocate Ananya Arora, Advocate Deepin Sahni, Advocate Vishal Navale, Advocate Varun Khetwani

For Respondents: Senior Advocate Manisha T. Karia, Advocate Shreya Gupta, Advocate Ananya Arora, Advocate Vishal Navale, Advocate Varun Khetwani, AOR Anita Bafna, Advocate Deepin Deepak Sahni, Additional Solicitor General Raghavendra P. Shankar, AOR Madhulika Upadhyay, Advocate Karan Lahiri, Advocate Navanjay Mahapatra, Advocate Sarthak Karol, AOR Sudarshan Lamba, AOR Vipin Kumar