Commissioner of Income-Tax, Nagpur Vs.
Rai Bahadur Jairam Valji & Ors  INSC 96 (7 October 1958)
AIYYAR, T.L. VENKATARAMA GAJENDRAGADKAR, P.B.
CITATION: 1959 AIR 291 1959 SCR Supl. (1) 110
CITATOR INFO :
E&D 1959 SC 814 (24,52,54) R 1959 SC1352
(8) RF 1961 SC1579 (30,31,34) RF 1964 SC 758 (12) RF 1965 SC 65 (5,31,33) R
1971 SC1590 (9) R 1972 SC 386 (12) R 1973 SC 515 (9) R 1973 SC1011 (15,20) D
1987 SC 500 (36) RF 1992 SC1495 (31)
Income Tax-Capital or Revenue
receipt-Compensation for premature termination of contract-Whether trading
receipt -Liability to tax-lndian Income-tax Act, 1922 (XI of 1922).
The respondent had been carrying on business
in the production and supply of limestone since 1920, and under an agreement
entered into with the Bengal Iron Company was supplying all its requirements of
limestone and dolomite.
Sometime later the Indian Iron and Steel
Company took over all the assets and liabilities of the former company.
Subsequently differences having arisen
between the respondent and the Indian Iron and Steel Company they entered into
an agreement on May 9, 1940, in settlement of all the disputes between them
whereby, inter alia, the respondent was to work a quarry of the company for a
period Of 25 years and to supply the limestone quarried there from to the
company according to its requirements and to get from the railway authorities
facilities for transporting the limestone more economically; and it was agreed
that till such facilities were given, the respondent was to be paid Rs. 4000/every
month. Under the agreement the respondent had the right to work other quarries
of his own and supply limestone so quarried to other purchasers. The railway
authorities having declined to grant facilities, it became impossible to carry
out the agreement in the manner contemplated by the parties, who, thereupon,
entered into a fresh agreement on August 2, 1941, terminating 111 the agreement
dated May 9, 1940, on certain terms. The agreement provided inter alia (1) that
the Company should pay " Rs. 2,50,000/to the sellers as solatium besides
the monthly installments of Rs. 4000/-", remaining unpaid under the
contract dated May 9, 1940, (2) that the company should purchase limestone from
the respondent for a period of 12 years, and (3) that the respondent was to be
appointed the loading contractors of the Company for loading iron ore. On a
question as to whether the sum of Rs. 2,50,000/was liable to tax, the
respondent claimed that it was not, 'being a capital receipt but the income-tax
authorities held that it was a trading receipt and was income chargeable to
tax. The High Court however held on a reference under s. 66(1), that the income
was not chargeable to tax, and hence the present appeal. In support of the
appeal, the respondent contended inter alia that (1) the contract dated May 9,
1940, was for a period of 25 years of which more than 23 years had still to run
at the time of the settlement, and it was therefore an asset of an enduring
character, capital in character, and the compensation paid therefor was a
capital receipt, and (2) that the true character of the agreement was that it
brought into existence an arrangement which would enable the respondent to
carry on a business and was not itself any business, and any payment made for
the termination of such an agreement was a capital receipt.
Held, that the contract of May 9, 1940, was
entered into by the respondent in the ordinary course of his business and that
the sum of Rs. 2,50,000/which was paid as solatium for the cancellation of that
contract, was a revenue receipt and was chargeable to tax.
There is a distinction between a contract
entered into in the usual course of business and an agency contract. While it may
be possible to regard the latter as merely a framework for doing business, the
former constitutes the business itself, and, therefore, compensation paid for
the termination of the former kind of contract must be held to be revenue,
whereas compensation paid for the termination of the latter might be capital in
It would make no difference in the character
of the receipt, when it is compensation for cancellation of a trading contract,
whether its performance is to consist of a single act or a series of acts
spread over a period.
Case law reviewed.
Van Den Berghs Ltd. v. Clark,  A.C.
CIVIL APPELLATE JURISDICTION : Civil Appeal
No. 109 of 1954.
Appeal by special leave from the judgment and
order dated April 21, 1950, of the former Nagpur High Court in Misc.
Civil Case No. 135 of 1949.
112 R. Ganapathy Iyer and R. H. Dhebar, for
Radhavinod Pal, J. M. Thakar and I. N.
Shroff, for the respondents.
1958. October 7. The Judgment of the Court
was delivered by VENKATARAMA AIYAR J.-This is an appeal against the judgment of
the High Court of Nagpur in a reference under s. 66(1) of the Indian Income-tax
Act (XI of 1922), hereinafter referred to as the Act, and the point that is
raised for our determination is whether a sum of Rs. 2,50,000 received by the
respondent on August 2, 1941, is chargeable to income tax. While, according to
the Department, the amount in question is a revenue receipt liable to be
included in the chargeable income, according to the respondent it is capital
receipt not liable to tax. The Appellate Tribunal held, affirming the decisions
of the Income-tax Officer and the Appellate Assistant Commissioner, that the
amount in question was a trading receipt, and was income liable to be assessed.
On the application of the respondent, it referred the following question for
the decision of the High Court:
" Whether in the circumstances of the
case the sum of Rs. 2,50,000 received by the assessee as damages or
compensation for the premature termination of the contract of 9th May 1940 is
income assessable within the meaning of the Indian Income-tax Act." The
reference was heard by Sen and Deo, JJ., who held, disagreeing with the
Tribunal, that the sum of Rs. 2,50,000 was a capital receipt in the hands of
the respondent, and that it, was not liable to be taxed. The appellant then
filed an application under s. 66(A)(2) of the Act for a certificate to appeal
to this Court, but that was dismissed, the learned judges holding that the law
on the subject was well settled. The appellant thereafter applied to this Court
for special leave under Art. 136, and the same was granted, and hence this
113 The question whether a receipt is capital
or income has frequently come up for determination before the courts.
Various rules have been enunciated as
furnishing a key to the solution of the question, but as often observed by the
highest authorities, it is not possible to lay down any single test as
infallible or any single criterion as decisive in the determination of the
question, which must ultimately depend on the facts of the particular case, and
the authorities bearing on the question are valuable only as indicating the
matters that have to be taken into account in reaching a decision. Vide Van Den
Berghs Ltd. v. Clark (1).
That, however, is not to say that the
question is one of fact, for, as observed in Davies (H. M. Inspector of Taxes)
v. The Shell Company of China Ltd. (2) " these questions between capital
and income, trading profit or no trading profit, are questions which, though
they may depend no doubt to a very great extent on the particular facts of each
case, do involve a conclusion of law to be drawn from those facts ". Vide
also the observations of Lord Greene, M. R. in Rustproof Metal Window Co., Ltd.
v. Commissioners of Inland Revenue (3). That being so, we must first examine
the facts of the present -case, and then consider whether on those facts and in
the light of the applicable principles, the sum of Rs. 2,50,000 received by the
respondent is a capital or a revenue receipt.
The respondent is a businessman whose trading
activities run in several channels. He is a railway contractor; he runs a rice
mill and a sugar factory; he is a supplier Of limestone and dolomite. It is
with the last of these businesses that we are concerned in these proceedings.
The respondent had acquired a quarry at Paraghat and had been himself working
it and selling limestone quarried out of it to, among others, a Company called
the Bengal Iron Company, Ltd. On January 5, 1935, the said Company entered into
an agreement with the respondent for the purchase of all its requirements of
limestone and dolomite from (1)  A.C. 431. (2) (1951) 32 Tax Cas. 133
(3) (1947) 29 Tax Cas. 243, 266.
15 114 the latter at rates specified therein,
and these rates were subsequently modified by another agreement between the
parties dated December 21, 1935. In 1936 the Company went into liquidation, and
its assets and liabilities were taken over by another Company called the Indian
Iron and Steel Company, Ltd. under a scheme of amalgamation dated September 8,
1936. This Company continued to purchase limestone and dolomite from the
respondent for some time, but later on, finding that the rates were uneconomic
owing to increase in the railway freight, it decided to purchase its
requirements from other sources, and by notice dated May 29, 1939, informed the
respondent accordingly. Thereupon, the respondent filed Suit No. 211 of 1940 in
the High Court of Calcutta for specific performance of the contract dated
January 5, 1935, as modified on December 21, 1935, and for an injunction
restraining the Indian Iron and Steel Company, Ltd. from purchasing limestone
or dolomite from any person other than the plaintiff, and on March 13, 1940, an
injunction in those terms was actually issued against the Company.
Thereafter, the Company and the respondent
entered into an agreement in settlement of all the disputes between them, and
the same was embodied in a document dated May 9, 1940.
As it is this document that forms the source
for the payment of Rs. 2,50,000 to the respondent, it is necessary to refer to
the terms thereof in some detail. Under this agreement, the respondent was to
work a quarry of the Company at a place called Gangapur for a period of 25
years and to supply the limestone quarried therefrom to the Company according
to its requirements. This quarry, it should be stated, was situated near Kulti
where the Company carried on its smelting operations, and obviously it would
reduce the working expenses, if limestone required therefor could be got from
Gangapur. There were, however, no facilities in Gangapur railway station for
transporting the goods from the quarry, and so it was arranged that the
authorities should be moved for permission to construct a siding at Gangapur,
and that the cost thereof should be borne 115 by the Company. It was expected
that it would take 18 months before the siding could be completed, and it was
agreed that during that period the respondent was to be paid Rs. 4,000 every
month. Thereafter, the respondent was to be paid at the rate of Rs. 2-9-0 per
ton of limestone which might be loaded in the railway wagons to be arranged for
by the Company. The working of the quarry was left entirely in the hands of the
respondent. It was he that was to purchase the machinery and the appliances
necessary for quarrying.
He was to engage his own workmen and put up
all the requisite superstructures. After the limestone was raised from the
quarry, he was to get it cleaned and Tendered merchantable, and it was
thereafter to be loaded in the wagon. There are two clauses in the agreement to
which reference might be made. Under cl. 6, the respondent agreed " to
supply to the Company such other quantities of limestone, if any, as the
Company may order besides Kulti requirements ". Clause 13 of the agreement
enjoined that the respondent was not to engage, during the subsistence of the
agreement, in any other contract business for the working of any quarry within
an area of 20 miles from the Company's quarry, but this was subject to the
proviso that the respondent was free to work any quarry belonging to and held
To continue the narration, the railway
authorities did not agree to the construction at Gangapur of a siding and a loopline
to the quarry, and so it became impossible to carry out the agreement in the
manner contemplated by the parties.
It is in this situation that the parties came
together, and on August 2,1941, entered into a new agreement and it is with
this that we are directly concerned in this appeal.
The agreement recites that the Company
feeling difficulty in working their mines referred to in the contract dated May
9, 1940, made a proposal for termination of the said contract on certain terms,
and that was agreed to. The terms of the agreement are (1) that the Company
should pay " Rs. 2,50,000 to the sellers as solatium besides the monthly installments
of Rs. 4,000 ", remaining unpaid under the contract dated May 9, 1940; (2)
116 that the Company should take all the limestone required for its furnaces at
Kulti from the respondent for a period of 12 years on terms and conditions set
out in an agreement; (3) that the respondent was to be appointed the loading
contractors of the Company for loading all iron ore at Monoharpore for a period
of 12 years from January 1, 1942, on the terms and conditions specified in a
separate agreement. Pursuant to this agreement, the respondent was paid a sum
of Rs. 2,50,000 and the two agreements relating to the purchase of limestone and
the loading of iron ore at Monoharpore were also executed. The balance due on
account of monthly payment of Rs. 4,000 provided in the agreement of May 9,
1940, was also duly paid. Now, on these facts, the question is whether the sum
of Rs. 2,50,000 received by the respondent was capital or revenue.
Before discussing the principles applicable
to the facts as stated above, it is necessary to deal with a contention raised
on the facts of the case on behalf of the respondent.
Dr. Radha Binode Pal, who appeared for him,
argued that for the purpose of carrying out the agreement dated January 5,
1935, the respondent had executed works of a capital nature such as
construction of quarters, tenements and the like, and had incurred expenses
exceeding Rs. 4 lakhs -on that account, that all this had to be thrown away
when the if quarry at Paraghat had to be abandoned, and the sum of Rs. 2,50,000
was really a reimbursement of the amount spent by him as above and was
therefore a respondent, the position in law would no doubt be as contended for
by him. But have those facts been established ? In his statement before the
Income-tax Officer, the respondent merely stated that the amount in question
was paid as consideration for the termination of the contract of 1935 and not
of 1940, and it is pointed out by the Tribunal that the respondent did not
substantiate even this assertion. There was no allegation that capital expenses
had been incurred in the execution of the contract of 1935, and that the amount
in question was paid as compensation there for;
117 nor is there any evidence on that
question. In deed, when it is remembered that the quarry at Paraghat had been
abandoned before the contract dated May 9, 1940, was entered into, it is
difficult to imagine how any amount paid as compensation for the cancellation
of that contract can have any connection with expenses incurred with reference
to that quarry. We must hold that the sum of Rs. 2,50,000 was not paid as
compensation for expenses thrown away and cannot be held to be a capital
receipt on that account.
Now, the contention on behalf of the
appellant is that the contract dated May 9, 1940, was one entered into by the
respondent in the ordinary course of his business, that the sum of Rs. 2,50,000
was paid admittedly as solatium for the cancellation of that contract, that the
payment really represents the profits which the respondent could have made, had
the contract been performed, and that it is therefore a revenue receipt; and a
number of authorities were quoted in support of this contention. We shall now
refer to the more important of them. ID Short Bros. Ltd. v. The Commissioners
of Inland Revenue (1), the facts were that the appellant Company which was
carrying on business as shipbuilders had entered into a contract to build two
steamers and later on, agreed to its cancellation on receipt of a sum of pound
1,00,000. The question was whether this was a capital or revenue receipt.
Rowlatt, J., held that it was merely a receipt in a going concern and was
revenue, and that was affirmed by the Court of Appeal, Lord Hanworth, M.R.,
observing that such a contract as the one before him was liable in the ordinary
course of business to be altered or terminated on terms and the payment of
pound 1,00,000 in settlement of the rights under the contract was an adjustment
made between the appellants and their clients in the ordinary course of
business. Similar observations are to be found in the judgment of Sargant, L.
J. and Lawrence, L. J. It may be noted on the facts of the present case that
the agreement of January 5, 1935, was modified on December 21, 1935, and the
disputes which arose with reference thereto (1) (1927) 12 Tax Cas. 955.
118 were settled by the agreement of May 9,
1940, which was, in turn, replaced by agreement dated August 2, 1941. The
agreements dated May 9, 1940, and August 2, 1941, could therefore be properly
said to be adjustments made in the ordinary course of business.
In The Commissioners of Inland Revenue v. The
North fleet Coal and Ballast Co., Ltd. (1), the respondent Company which was
the owner of a chalk quarry had entered into a contract with a purchaser for
the supply of certain quantity of chalk for a period of ten years. After some
time, the purchaser wanted to be relieved from the contract, and the respondent
agreed to its termination on receipt, of pound 3,000. The point for decision
was whether that was a capital or a revenue receipt. In holding that it was the
latter, Rowlatt, J., observed:
" If the contract had gone forward those
sums would have come into profits every year and now that they are represented
by a commutation, so far as that is concerned, the point seems to be concluded
by Short's case (2) ".
One of the contentions urged on behalf of the
assessee was that the contract being for a term was a capital asset, that the
effect of the subsequent agreement terminating it on payment of pound 3,000 was
in substance to assign the unexpired portion of the contract for a
consideration, and that it would be a capital receipt on the principle laid
down in John Smith & Son v. Moore(1). In repelling this contention,
Rowlatt, J., observed :
"These contracts are not being sold.
They are not being even extinguished really for this purpose. What is happening
is that the profits under them are being taken;
something is being taken in respect of the
profits of them.
That is the position. This sum represents the
profits of the Company -on the contracts, treating them as contracts which
nationally have earned or are going to earn a profit." And the decision in
John Smith & Son v. Moore was distinguished.
(1) (1927) 12 Tax Cas. 1102.
(2) (1927) 12 Tax Cas. 955.
(3) (1921) 12 Tax Cas. 266, 119 In John Smith
& Son v. Moore (1), it may be stated that the executors sold some
outstanding contracts for the supply of coal to the son of the testator for a
consideration, and it was held that the payment made by the son for the
purchase of the contracts was in his hands a capital expense. The payment was
not given by one party to a contract to the other in cancellation of the
agreement but by a stranger to the contract to one of the parties thereto for
an assignment of his rights thereunder. In Jessee Robinson & Sons v. The
Commissioners of Inland Revenue (2), the appellant had entered into two
contracts for the sale of' yarn. The purchaser cancelled the contracts and paid
pound 12,500 in settlement of the claims. The contention of the appellant was
that this payment was not a trading receipt or profit arising from his trade.
In rejecting this contention, Rowlatt, J. observed:
" It seems to me that there is no reason
why the sum received in that respect for breach of contract is not a sum which
is part of the receipts of the business for which that contract was made."
Examining the facts of the present case in the light of the above decisions,
the question to be considered is whether the contract dated May 9, 1940, was
entered into by the respondent in the usual course of his business. If it was,
then the amount paid for the termination of the contract must be held to be a
trading receipt. That the respondent has been carrying on business in the
production and supply of limestone is amply established. The record shows that
he had been supplying limestone and dolomite to the Bengal Iron Company, Ltd.,
from about the year 1920 and that the contracts of 1935 were entered into only
in the carrying on of that business. Vide para. 4 in the plaint in Suit No. 211
of 1940 already referred to. The contract of May 9, 1940, was made in
settlement of the rights under those contracts. It is to be noted that under
the agreement dated August 2, 1941, under which he received a sum of Rs. 2,50,000,
he also secured a contract for the supply of limestone for a period of 12
years. On these facts, it is impossible to (1) (1921) 12 Tax Cas. 266.
(2) (1929) 12 Tax Cas. 1241.
120 come to any conclusion other than that
the contract in question was entered into by the respondent in the ordinary
course of his business. The learned Judges in the-Court below observe that the
assessee was not a dealer in, though he was a supplier of, limestone. This
appears to us to be a distinction without a difference. Moreover, it would be
wholly immaterial for the present purpose whether the respondent was a dealer
in or supplier of limestone, as, in either view, he would be carrying on
business and the contract in question would be one entered into in the carrying
on of that business. We should also observe that the statement that the
respondent was only a supplier but not a dealer in limestone does riot appear
to be quite accurate on the facts. Under cl. 13 of the agreement dated May 9,
1940, the respondent had the right to work other quarries of his own, and the
evidence shows that he did supply limestone so quarried to other purchasers.
In support of the judgment of the Court
below, learned counsel for the respondent urged the following contentions :
(1) The contract dated May 9, 1940, was for a
period of 25 years of which more than 23 years had still to run at the time of
the settlement, and it was therefore an asset of an enduring character, capital
in character, and the compensation paid therefor was a capital receipt.
(2) The true character of the agreement was
that it brought into existence an arrangement which would enable the respondent
to carry on a business and was not itself any business and any payment made for
the termination of such an agreement is a capital receipt.
(3) The business which was to be carried on
pursuant to the contract was of a specialised character, that there was no
general market for limestone and dolomite, that the contract in question formed
practically the entire business of the respondent and the compensation paid for
the closure of that business would not be a revenue receipt but a capital
receipt on account of sterilisation of a capital asset. It is argued by Dr.
Radha Binode Pal that the features 121 stated above were not present in the
contracts which came up for consideration in the decisions cited for the
appellant, and that they are therefore distinguishable, and he relied on other
authorities as applicable to the fact,,; of this case. These contentions and
the authorities cited in support thereof must now be considered.
(1) Is the receipt of Rs. 2,50,000 a capital
receipt for the reason that it was compensation for the settlement of a
contract which had a long life before it ? The argument of the respondent is
that there is in the Income-tax law a well-defined distinction between fixed
capital and circulating capital (Vide John Smith & Son v. Moore)(1), that
where there is a contract the performance of which is to be not once and for
all but spread over a period of years, it is in the nature of a fixed capital
and a payment on account of it must be held to be capital receipt.
Reliance is placed in support of this contention
on the decisions in Commissioner of Income-tax v. Shaw Wallace & Co. (2)
and Barr, Crombie & Co. Ltd. v. Commissioners of Inland Revenue (3) and
certain observations in Kelsall Parsons & Co. v. Commissioners of Inland
Revenue (4) and The Commissioner of Income-tax and Excess Profits Tax, Madras
v. The South India Pictures Ltd., Karaikudi (5).
In Income-tax Commissioner v. Shaw Wallace.
& Co. (2), the respondent Company had been acting for several years as the
distributing agents of two oil Companies. In 1927-28, these Companies decided
to make their own distribution arrangements and accordingly terminated the
agency of the respondent and paid compensation therefor. The question was
whether this amount was a revenue receipt in the hands of the respondent. It
was held by the Privy Council that it was a capital receipt, because it
represented compensation paid for cessation of business, not profits earned in
the carrying on of it. In Barr, Crombie & Co. Ltd. v. Commissioners of
Inland Revenue (3), the facts were that (1) (1921) 12 Tax Cas. 266.
(3) (1945) 26 Tax Cas. 4o6.
(5)  S.C.R. 223.
(2) (1932) L.R. 59 I.A. 2o6.
(4) (1938) 21 Tax Cas. 608.
16 122 under an agreement dated May 25, 1937,
the appel]ant had been appointed manager of a shipping company for a period of
15 years, and one of the terms of the agreement was that if the company went
into liquidation, the entire remuneration for the remaining period -was payable
forthwith. On November 5, 1942, the company went into liquidation, and a sum of
pound 16,306 16s. 11d. was paid to the appellant as its remuneration for the
period of about 8 years which was still to run. On a question as to whether
this was taxable as a revenue receipt, it was held that as virtually the whole
of the asets of the appellant company consisted of the managing agency
agreement, a payment for its extinction was a capital receipt and was therefore
not taxable. Distinguishing the decision in Kelsall's case (1) where
compensation paid for the termination of an agency agreement was held to be a
revenue receipt, the Lord President Normand observed: (at page 411).
" Here we are not dealing with a single
payment in return for the surrender of the prospect of making profits in the
final year of the agreement, but with a payment for the surrender of an
agreement while there was still a substantial period-indeed, more than half of
the period of the agreement-to run ".
Lord Moncrieff agreeing with this conclusion
observed that " so far from this being a prepayment of future remuneration
for services, this was, if regard be had to 'the substance of the matter a
price paid upon the purchase and sale of the main asset of a business." In
Kelsall's case (1), the assessee carried on business as commission agents and
acquired a number of agencies in the course of that business. One of these
agencies which was for a period of three years was cancelled at the end of the
second year on payment of pound 1,500 as compensation. The question was whether
this was a capital or a revenue receipt. In holding that it was the latter, the
Lord President, Normand observed that the business of the appellant was to
acquire as many agencies as it could, that it was incidental to that agency
that it should be modified, altered or discharged (1) (1938) 21 Tax Cas. 6o8.
123 and that as the period outstanding was
one year, it could not be said that the appellant was parting with an enduring
asset of the business. Lord Fleming in agreeing with this conclusion stated
that he attached importance to the fact that the agreement had Only one year to
run and that different considerations might &rise if the outstanding period
" A different case would have arisen for
decision he observed, (at p. 622) " if the agreement had been terminated
when it had still, say, a period of 10 years to run. A payment made in respect
of a loss to be sustained over a period of years may well have a different
character from a payment made in respect of a loss to be sustained in the year
in which the payment is received." All these cases were considered by this
Court in The Commissioner of Income-tax and Excess Profits Tax, Madras v.
The South India Pictures Ltd., Karaikudi (1).
There, the assessee was carrying on business in the distribution of films, and
in the course of such business entered into three contracts dated September 17,
1941, July 16, 1942, and May 5, 1945, with a company called the Jupiter
Pictures, Ltd., for the production and distribution of three films for a period
of 5 years. On October 31, 1945, the assessee and the Jupiter Pictures, Ltd.,
entered into an agreement terminating the contracts in consideration of a
payment of Rs. 26,000 as compensation to the assessee. The question having been
raised whether this was a capital or revenue receipt, this Court held that it
was the latter and was liable to be taxed, and the decision in Barr, Crombie
& Co. Ltd. v. Commissioners of Inland Revenue (2) was distinguished on the
ground that there the whole trade of the assessee was built on the agreement
dated May 25, 1937, that it was a fundamental asset of the assessee's business,
and that the payment on account of it was a capital receipt.
Now, it is the contention of the respondent
that the present case is governed by the principles laid down in the above decisions
and not those enunciated in the authorities cited for the appellant, and that
the (1)  S.C.R. 223.
(2) (1945) 26 Tax Cas. 406.
124 payment of Rs. 2,50,000 as compensation
on account of the agreement dated May 9, 1940, falls within Income-tax Commissioner
v. Shaw Wallace & Co. (1) and Barr, Crombie & Co. Ltd. V. Commissioners
of Inland Revenue (2 ) rather than Kelsall's case (3) and The Commissioner of
Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd.,
Karaikudi (4) because the contract dated May 9, 1940, formed practically the
only business of the respondent and the contract had at the time of the
settlement still a period of 23 years to run. It will be seen that the
receipts, the chargeability of which was in question in the decisions cited for
the respondent, were all payments made as compensation for the termination of
agency contracts, whereas we are concerned with an amount paid as solatium for
the cancellation of a contract entered into by a businessman in the ordinary
course of his business, and that, in our judgment, makes all the difference in
the character of the receipt. In an agency contract, the actual business
consists in the dealings between the principal and his customers, and the work
of the agent is only to bring about that business. In other words, what he does
is not the business itself but something which is intimately and directly
linked up with it. It is therefore possible to view the agency as the apparatus
which leads to business rather than as the business itself on the analogy of
the agreements in Van Den Berghs Ltd. v. Clark (5). Considered in this light,
the agency right can be held to be of the nature of a capital asset invested in
business. But this cannot be said of a contract entered into in the ordinary
course of business. Such a contract is part of the business itself, not
anything outside it as is the agency, and any receipt on account of such a
contract can only be a trading receipt.
That there is a distinction between an agency
agreement and a contract made in the usual course of business will further be
clear, if we have regard to one (1) (1932) L.R. 59 I.A. 206. (2) (1945) 26 Tax
(3) (1938) 21 Tax Cas. 608. (4)  S.C.R.
(5)  A. C. 431.
125 of the reasons on which the conclusion
that compensation paid for cancellation of agency rights is a capital receipt
is sometimes rested. It is that, in substance, the agent assigns the agreement
to the principal and the compensation is price paid there for. Vide the observations
of Lord Moncrieff in Barr, Crombie & Co. Ltd. v. Commissioners of Inland
Revenue (1) at page 413 already quoted. It no doubt sounds somewhat strange
that an arrangement between parties to a contract settling claims there under
should be regarded as an assignment of the rights of one of them to the other,
but it at least emphasises that the agreement is to be regarded as a capital
asset of the agent, which is saleable.
Such a concept will be out of place with
reference to a contract entered into in the course of business. Any payment
made for the non-performance or cancellation of such a contract can only be
damages or compensation and cannot, in law or fact, be regarded as an
assignment of the rights under the contract. A claim for damages is, in law,
incapable of being transferred, though the benefit of a contract could be
assigned while it is subsisting, and such assignment can only be in favour of
third persons, not in favour of the other party to the contract, in which case
it will be a new contract. Reference may in this connection be made to the
observations of Rowlatt, J., in The Commissioners of Inland Revenue v. The
Northfleet Coal and Ballast Co., Ltd. (2) already quoted, that such contracts
were not sold.
If, then, contracts entered into in the
course of business cannot, unlike agency contracts, be regarded as ,capital
assets of the business, would it make any difference in their character that
they are to be in operation for a period ? On principle, it is difficult to see
why it should.
If under the terms of a contract a
businessman A is to supply goods, let us say, 100 bales of yarn, on a
particular day and he does that, the price received by him therefor will be a
revenue receipt. And in the above case if the purchaser cancels the contract
and pays damages to the seller, that would also be a revenue receipt. If under
the same (1) (1945) 26 Tax Cas. 406 (2) (1927) 12 Tax Cas. 1102.
126 contract A is to deliver the bales in
four quarterly installments, and he does so and receives the price in four installments,
all the receipts would be revenue receipts.
And if after one installment is delivered,
the purchaser cancels the contract as regards future installments and pays
compensation there for to the seller, such payment will undoubtedly be a revenue
receipt. If the contract is that A is to supply whatever goods are ordered by
the purchaser during a certain period, let us say, 10 years, the price received
for the goods ordered and delivered will be revenue receipt. Now, if the
purchaser under this contract puts an end to the contract after some time, say,
at the end of two years and pays compensation for the breach of the contract as
regards the remaining period, does the receipt thereof become a capital receipt
? It sounds illogical so to hold.
How does it affect the true position, whether
the contracting parties agree to carry on business in the sale and purchase of
goods for a stated period on terms settled between them, or whether they enter
into a succession of contracts for that purpose ? Two decisions have been
quoted before us as showing that payments under a contract entered into in the
ordinary course of business would be revenue receipts, even though the
agreement may be for a period. In The Commissioner of Inland Revenue v. The
Northfleet Coal and Ballst Co., Ltd.
(1) cited above, the contract was for the
supply of chalk for a period of ten years, and the compensation paid was for
the cancellation of the contract for the unexpired period of four years, and it
was held to be a trading receipt. In Shove (H. M. Inspector of Taxes) v. Dura
Ltd. (2), the respondent company had
introdticed company A to company B, as the result of which the former obtained
a remunerative business with the latter. In return for this service, A agreed
to pay the respondent a commission on the business so obtained. Later on, this
agreement was terminated on payment of a sum of pound 1,500 by A to the,
respondent. The question was whether this was a revenue (1) (1927) 12 Tax Cas.
1102. (2) (1941) 23 Tax Cas. 779, 783.
127 receipt. In answering it in the
affirmative, Lawrence, J., observed:
" Reliance was also placed on certain
dicta in the Court of Session in Kelsall Parsons & Co. v. Commissioners of
Inland Revenue, at pages 620, 622 and 624, which suggest that if the contract
cancelled has more than one year to run, the sum received for its cancellation
way be capital. The learned Judges who expressed this view did not say that
such sum must be capital. They were dealing with a contract different from the
present, namely, an agency contract, which constituted a very large part of the
taxpayer's business ".
" In view of the decision in Short
Bros., Ltd. v. Commissioners of Inland Revenue and in Commissioners of Inland
Revenue v. Northfleet Coal and Ballast Co. Ltd. and the differences of facts, I
do not feel that those dicta ought to be applied to the present case." In
our opinion, therefore, when once it is found that a contract was entered into
in the ordinary course of business, any compensation received for its
termination would be a revenue receipt, irrespective of whether its performance
was to consist of a single act or a series of acts spread over a period, and in
this respect, it differs from an agency agreement.
In holding that compensation paid on the
cancellation of a trading contract differs in character from compensation paid
for cancellation of an agency contract, we should not be understood as deciding
that the latter must always, and as a matter of law be held to be a capital
receipt' Such a conclusion will be directly opposed to the decisions in
Kelsall's case (1) and The Commissioner of Income-tax and Excess Profits Tax,
Madras v. The South India Pictures Ltd., Karatkudi (2). The fact is that an
agency contract which has the character of a capital asset in the hands of one
person may assume the character of a trading receipt in the hands of another,
as, for example, when the agent is found to make a trade of acquiring agencies
and dealing with them.
The principle was (1) (1938) 21 Tax Cas. 608.
(2)  S.C.R. 223.
128 thus stated by Romer, L. J., in Golden
Horse Shoe, (New) Ltd. v. Thurgood (1):
" The determining factor must be the
nature of the trade in which the asset is employed. The land upon which a
manufacturer carries on his business is part of his fixed capital.. The land
with which a dealer in real estate carries OD. his business is part of his
The machinery with which a manufacturer makes
the articles that he sells is part of his fixed capital. The machinery that a
dealer in machinery buys and sells is part of his circulating capital, as is
the coal that a coal merchant buys and sells in the course of his trade. So,
too, is the coal that a manufacturer of gas buys and from which he extracts his
gas." Therefore, when a question arises whether a payment of compensation
for termination of an agency is a capital or a revenue receipt, it would have
to be considered whether the agency was in the nature of capital asset in the
hands of the assessee, or whether it was only part of his stock-in trade. Thus,
in Barr, Crombie & Son Ltd. v. Commissioners of Inland Revenue (2), the
agency was found to be practically the sole business of the assessee, and the
receipt of compensation on account of it was accordingly held to be a capital
receipt, while in Kelsall's case (3) the agency which was terminated was one of
several agencies held by the assessee and the compensation amount received
therefor was hold to be a revenue receipt, and that was also the case in The Commissioner
of Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd.,
Karaikudi (4). It is, however, unnecessary to further elaborate this point, as
we are concerned in this appeal, not with an agency agreement but with a
contract entered into in the ordinary course of business, and, in our judgment,
compensation received on account of such a contract must be held to be a
(2) The above discussion answers to a large
extent the contention of the respondent that the contract (1) (1933) 18 Tax
Cas. 280, 300.
(3) (1938) 21 Tax Cas. 6o8.
(2) (1945) 26 Tax Cas. 4o6.
(4)  S.C.R. 223.
129 dated 'May 9, 1940' was merely a
framework of his business and not the business itself, and that a receipt on
account of it must be treated as a capital receipt. The decision relied on in
support of this contention is Van Den Berghs Ltd. v. Clark (1). There, two
companies, one English and the other Dutch, which were engaged in the
manufacture and sale of margarine entered into certain agreements, the object
of which was to avoid competition and to augment their profits. An elaborate
scheme was devised under which the two companies were to carry on their
business independently but "in friendly alliance" and in accordance
with the scheme; and the profits were to be shared between the two companies in
certain proportions. The agreements were to be in operation till 1940, but
differences arose between the parties in the working of the scheme and the
"alliance " was terminated in 1927, the Dutch company paying to the
English company a sum of pound 4,50,000 as compensation. The question was as to
the character of this receipt, whether it was a capital or a revenue receipt,
and it was held by the House of Lords that it was a capital receipt and not
Now, it will be seen that the contracts which
were the source of the receipt in question did not in themselves constitute the
business which yielded the profits to the two companies. Those profits were
derived by them from the manufacture and sale of margarine, and there was
nothing in the agreements providing that the companies were to join in the
manufacture and sale of the margarine. The position under the agreement is thus
stated by Lord Macmillan, who delivered the leading judgment:
" The three agreements which the
appellants consented to cancel were not ordinary commercial contracts made in
the course of carrying on their trade; they were not contracts for the disposal
of their products, or for the engagement of agents or other employees necessary
for the conduct of their business; nor were they merely agreements as to how
their (1) (1935) A.C. 431.
17 130 trading profits when earned should be
distributed as between the contracting parties. On the contrary the cancelled
agreements related to the whole structure of the appellants' profit-making
apparatus. They regulated the appellants' activities, defined what they might
and what they might not do, and affected the whole conduct of their
business." Thus, the agreements in question were intended to ensure that
the business in margarine was carried on to the best advantage, but did not, in
themselves, form part of the business. They were merely collateral to it. For
the reasons given in discussing the nature of agency agreements, the agreements
between the two companies must be regarded as not pertaining to the trading
activities, which yielded profits, and the payment on account of those
agreements must be held to be a capital receipt. But these considerations would
be inapplicable to the agreement, with which we are concerned. The business
which the respondent was to carry on and which was to yield profits to him was
the very business to which the agreement relates. It is under this very
agreement that he was to be paid Rs. 2-9-0 per ton of limestone loaded by him,
and the business which he had to do to earn the amount was to raise and supply
limestone as provided in the agreement. There is here no profit-making
apparatus set up by the agreement &part from the business which is to be carried
on under it. We are accordingly unable to agree that the present case is
governed' 'by the decision in Van Den Berghs Ltd. v. Clark (3) It remains to
deal with the contention of the respondent that the business which he was to
have carried on under the contract dated May 9, 1950, was practically the
entirety of his trading activities, and that the termination of such a contract
is tantamount to stopping his doing business and the compensation paid there for
is a capital receipt. Reliance is placed in support of this argument on the
decision in The Glenboig Union Fireclay Co. Ltd. v. The Commissioners of Inland
Revenue (2). Now, to appreciate the (1) (1935) A.C. 431.
(2) (1922) 12 Tax Cas. 427.
131 truer position, it is necessary to bear
in mind the distinction between compensation on account of business carried on
under an agreement with a third party when that is terminated, and compensation
which is received on account of a business which the assessee is prevented from
carrying on by a third person in exercise of an overriding power. In the former
case, the payment would in general be a trading receipt referable to the
business activities carried on or to be carried on under the agreement and
would be taxable as a revenue receipt. There may be exceptions to this. A
familiar instance is when the parties agree, as part of the contract to do
business, that one of them shall not carry on similar business for a stated
period after the termination of the contract, and a compensation is paid
therefor. That has been held to be a capital receipt. Vide Beak v. Robson (1).
The reason is that it is a payment made not on account of profits which might
have been earned in the carrying on of the business but as solatium for not
carrying on the business. A payment made in a similar covenant to operate
during the period of the contract, however, has been held to be a revenue
receipt, because it arises out of the carrying on of the business. Vide
Thompson v. Magnesium Elektron, Ltd. (2). It might also happen that one of the
parties to the contract might have, in the carrying out -thereof, incurred
expenses of a capital character and as a result of the cancellation of the
contract, those expenses would have been thrown away. A payment made on account
of those expenses would bear the character of a capital receipt. But apart from
these and similar in-stances, it might, in general, be stated that payments
made in settlement of rights under a trading contract are trading receipts and
are assessable to revenue. But where a person who is carrying on business is
prevented from doing so by an external authority in exercise of a paramount
power and is awarded compensation therefor, whether that receipt is a capital
receipt or a revenue receipt will depend upon whether it is compensation for
injury inflicted on a capital asset or on a (1) (1942) 25 Tax Cas. 33.
(2) (1943) 26 Tax Cas. 1.
132 stock-in-trade. The decision in The
Glenboig Union Fireclay Co. Ltd. v. The Commissioners Of Inland Revenue (1)
applies to this category of cases. There, ,he assessee was carrying on business
in the manufacture of fire clay goods and had, for the performance of that
business, acquired a fire clay field on lease. The Caledonian Railway which
passed over the field prohibited the assessee from excavating the field within
a, certain distance of the rails, and paid compensation therefor in accordance
with the provisions of a statute. It was held by the House of Lords that this
was a capital receipt and was not taxable on the ground that the compensation was
really the price paid " for sterilising the asset from which otherwise
profit might have been obtained ". That is say, the fire clay field was a
capital asset which was to be utilised for the carrying on of the business of
manufacturing fire clay goods and when the assessee was prohibited from
exploiting the field, it was an injury inflicted on his capital asset. Where,
however, the compensation is referable to injury inflicted on the stockin-trade,
it would be a revenue receipt. Vide The Commissioners of Inland Revenue v.
Newcastle Breweries Ltd.
(2). The principle of these decisions has no
application where the compensation paid is in respect of rights arising under a
trading contract. A payment made in settlement of that contract is an
adjustment of the rights under that contract, and must be referred to the
profits which could be made in the carrying out of that contract.
In the present case, the contract dated May
9, 1940, was simply an agreement to carry on business. In settlement of that
contract, Rs. 2,50,000 was paid to the respondent.
That was not a payment on account of any
capital expenditure incurred by him in the execution of the contract. That
indeed was the point sought to be raised by the respondent, but therein he has
failed. It is also to be noted that at no time was he prevented from carrying
on business. Clause 6 of the agreement dated May 9, 1940, contemplates that the
respondent was to carry on generally the business (1) (1922) 12 Tax Cas. 427.
(2) (1927) 12 Tax Cas. 927.
133 of supply of limestone even apart from
his work in the Gangapur quarry, and the agreement dated August 2, 1941,
provides for his supplying limestone for the furnaces at Kulti for a period of
12 years and for loading iron at Monoharpore for a like period. There was
therefore at no time any agreement which operated as a bar to the carrying on
of business by the respondent.
On a consideration of all the facts
established, we are of opinion that the receipt of Rs. 2,50,000 by the
respondent is a revenue receipt. and is chargeable to tax.
In the result, the appeal is allowed, the
judgment of the High Court set aside and the order of the Tribunal restored.
The respondent will pay the costs of the