Mesne profits are recompensed by the Court to the landlord for wrongful possession of his property by the tenant even after the termination of the lease. Often a dispute is waged on the taxability of such sum. Section 2(12) of the Code of Civil Procedure defines mesne profits as follows :
“(12) ‘mesne profits’ of property means those profits which the person in wrongful possession of such property actually received or might with ordinary diligence have received therefrom, together with interest on such profits, but shall not include profits due to improvements made by the person in wrongful possession.”
The Madras High Court in Commissioner of Income-tax Vs. Mariappa Gounder (P.)(147ITR676) held that they are Liable to be assessed as income. In explaining the true meaning of the terms “ mesne profits” the Court observed that the award of mesne profits is an award of compensation for the true owner’s deprivation of the yearly income from the property. The true principle to be applied is that where compensation is paid for deprivation of a capital asset or for a restraint on trading or the conduct of a business undertaking as such, it would be a capital receipt in the hands of the recipient of the compensation. A similar consideration will prevail in cases where compensation is received for immobilization, sterilization, destruction or loss of an assessee’s capital asset even without affecting his business as such. In such cases it can truly be said that the compensation is in substitution, not of income, but of the very source of income (Under the present legislation even such receipts would be chargeable to capital gains tax). The High Court held that mesne profits are not of that kind. Even the measure of mesne profits, as the definition in the Code of Civil Procedure makes clear, is the income which the person in wrongful possession derives from the property or might with due diligence have obtained from the property. Mesne profits are, therefore, a substitute for actual returns from investment. In this category therefore must be included any sum awarded by a court in restitution of interest, dividends or any other yield out of property, in contrast to awarding compensation, recompense or damages for any loss, sterilization or damage to capital assets as such.
The Calcutta High Court in Commissioner of Income-tax v. Lila Ghosh (Smt.) (205ITR9) held that mesne profits are in the nature of damages and, therefore, a capital receipt not chargeable to tax.
The Kerala High Court in Commissioner of Income-tax v. Annamma Alexander (Mrs.) (191ITR551) though proceeded on the lines of the interpretation made by the Madras High Court in Mariappa case (supra) yet chose to make a further distinction between “interest proper” and “damages by way of interest”. The Court held that mesne profits are only an award of compensation for the loss of property or injury to the capital. The High Court took the view that mesne profits are received for wrongful occupation of property. It is in the nature of damages, which the court may mould according to the justice of the case. Mesne profits themselves being award of compensation in the nature of damages and not taxable, interest thereon which is an integral part of the mesne profits is also not a revenue receipt and will not be taxable as income. In a dissenting note the Court pronounced that the fact that mesne profits are estimated with reference to the profits that the person in wrongful possession of such property actually received or would have ordinarily received for the purpose of computation or determination of the compensation would not in any way render them an “income” or a revenue receipt. The amount of interest received on mesne profits cannot be treated as a revenue receipt.
The Court have from time to time held that the real question, for the purpose of deciding whether the Income tax Acts apply, is whether the added sum is capital or income, not whether the sum is damages or interest. The Madras High Court has fulfilled this object in reporting its judgment while the Kerala and the Calcutta High Court perhaps missed out on this basic principle of the law.
The Patna High Court in Commissioner of Income-tax Vs. Maharajadhiraj Sir Kameshwar Singh (No. 2) (23ITR212) following this principle held that which reaches the hand of the recipient as interest upon a principal sum is income liable to income-tax, notwithstanding that it may come to him in a single sum and as the result of a hostile suit. In this case the assessee was the owner of a textile mill, which was closed several years prior to the relevant accounting year. The manager of the mill sold away the machinery of the mill and a sum of Rs. 13,363 was due from him to the assessee on this account. During the accounting year the assessee realised as a result of litigation between him and the manager a sum of Rs. 25,530, which included the principal, interest and certain other expenses. The Income-tax authorities calculated the interest to be Rs. 10,497 and taxed the amount in the assessee’s hands. The assessee contended that the amount was not taxable because it was really not interest but was in the nature of damages for retention of money. Even the Kerala and the Calcutta High Court sin the context of mesne profits and interest thereon held that they are in the nature of damages.
This sharp difference of opinion is deemed to have been arrested by the introduction of section 25B by the Finance Act, 2000. Clause (b) under this section is meant to tax sums received by way of arrears of rent that are not charged to income tax for any previous year.