Commissioner of Income Tax, Madras Vs.
Messrs. Best & Co  INSC 235 (2 November 1965)
02/11/1965 SUBBARAO, K.
CITATION: 1966 AIR 1325 1966 SCR (2) 430
R 1971 SC1590 (9) RF 1980 SC 793 (4,8) R 1986
SC1821 (32) D 1992 SC 959 (17)
Income-tax Act (11 of 1922), s. 10--Assessee
a multi-agency concern-One of the agencies terminated with a restrictive
covenant not to carry on business--compensation, whether capital or revenue
The respondent was a multi-agency concern.
The principal of one of the agencies terminated that agency and paid the
respondent certain amounts. When the amounts were sought to be assessed to
Income-tax, the respondent objected on the ground that the amounts represented
only compensation received for termination of the agency business and as
consideration for the restrictive covenant not to do business in the same line
for a prescribed period. The Income-tax Officer, the Appellate Assistant
and the Appellate Tribunal held against the
respondent, but the High Court on a reference, held that by the termination of
the agency, the respondent lost an earning asset and that the compensation paid
for the destruction of such an asset was a capital receipt not liable to tax.
In appeal to this Court,
HELD : While the income-tax authorities have
to gather the relevant material to establish that the compensation given for
the loss of the agency was a taxable income, an adverse inference could be
drawn against the assessee if he had not produced evidence which was in his
exclusive knowledge and keeping. The 'respondent gave up one of its innumerable
agencies in different lines without any protest presumably because it was in
the normal course of its business, and continued to do business without any
mishap. it did not place any material before the Department to establish the
relative importance of the said agency in the frame work of the earning
apparatus of its business. The loss of the agency would therefore only be -a
normal trading loss, and the amount of compensation attributable to it would be
a revenue receipt assessable under S. 10 of the Income-tax Act, 1922. [486 H;
487 A, C; 488 B-C] The restrictive covenant was one of the terms of the
agreement relating to consideration, and therefore the compensation paid was
not only in lieu of the giving up of the agency but also for the respondent
accepting a restrictive covenant for a specific period. Since the covenant was
an independent obligation which came into operation only after the agency was
terminated and was wholly unconnected with it, that part of the compensation
attributable to the restrictive covenant was a capital receipt not assessable,
to tax. [491 B, C, H; 492 A] Gillandars Arbuthnot & Co. Ltd. v.
Commissioner of Incometax, Calcutta,  8 S.C.R. 121 and Commissioner of
Income-tax, Madras v. Chari and Chari  3 S.C.R.
The apportionment of the compensation has to
be made on a reasonable basis between the loss of the agency in the usual
course of business and the restrictive covenant by the assessing authority. The
compensation was severable and any difficulty in apportionment cannot be a 481
ground for rejecting the claim by the revenue and the assessee for apportionment.
[492 B-D] Wales (H. M. Inspector of Taxes) v. Tilley, (1942) 25 T.C.
136 Carter v. Wadman (H. M. Inspector of
Taxes) (1946) 28 T.C. 41 and T. Sadasivam v. Commissioner of Income-tax, (1954)
28 I.T.R. 435, referred to.
CIVIL APPELLATE JURISDICTION : Civil Appeals
Nos. 682 and 683 of 1964.
Appeals from the judgment and order dated
July 24, 1961 of the Madras High Court in Case Referred No. 29 of 1957.
A. V. Viswanatha Sastri, R. Ganapathy lyer,
R. H. Dhebar and R. N. Sachthey, for the appellant.
K. N. Rajagopala Sastri, G. C. Sanghi, B. R.
Narwala and H. K. Puri, for the respondent.
The Judgment of the Court was delivered by
Subba Rao, J. Messrs. Best & Co., Ltd., Madras, the respondent herein,
hereinafter called the Agency Company, is a private limited company carrying
-on business in innumerable lines. It is doing the business of importers,
exporters, agents and subagents of various shipping, insurance, and
manufacturing companies, in the course of which it acquired numerous agencies
from manufacturers both in India and outside for sale in India of textiles,
dairy products, engineering equipments, soaps., paints, toilet goods, etc.
One of such agencies was from the Imperial
Chemical Industries (Exports) Limited, Glasgow, hereinafter called the "Principal",
for distribution and marketing in certain territories in South India of its
ammunition, blasting explosives and accessories. The said agency came into
existence in 1900. The terms of the agency were not reduced to writing. The
rates of commission were paid on terms agreed upon from time to time. The
agency was terminable at will; but, because of their mutual confidence, it
continued without break till the year 1947 when the Principal decided to
transfer all its agencies in India and Ceylon to Imperial Chemical Industries
(India) Limited. By its letter dated March 11, 1947, the Principal gave notice
to the Agency Company terminating its agency from April 1, 1948. After some
correspondence, the agency was terminated on March 31, 1948, and the Principal
paid certain amounts in three installments calculated on the basis of the
income earned by the Imperial Chemical Industries (India) Limited, which took
over the business from that date. Pursuant to that agreement, the Principal Sup.CI/66-18
482 paid on September 30, 1949, a sum of Rs. 34,100 as commission on sales
during the year ended March 31, 1949, on September 30, 1950, a commission of
Rs. 66,790 on sales during the year ended March 31, 1950, and on September' 30,
'1951, a commission of Rs. 3,35,371 on sales during the year, ended March 31,
1951. During the assessment year 1950-51, the first amount was brought to tax
and the assessment had become final and nothing turns upon it in these appeals.
But in respect of the other two assessment years, namely, 1951-52 and 1952-53,
the. Agency Company objected to the inclusion of the said amounts in its
taxable income on the ground that the said amounts represented only
compensation received for termination of the agency business and also as
consideration for the restrictive covenant not to do business in the same line
for a prescribed period.
The Income-tax Officer, in the first
instance, and, on appeals, the Appellate Assistant Commissioner held that the
termination of the said agency did not alter the structure of the respondent's
business and that they represented only remuneration paid voluntarily by the
Principal to the agent in appreciation of its past services. On further appeals
by the Agency Company, the Income-tax Appellate Tribunal held that, as the
three annual installments were based on future sales in the same territory as
before, they were of the same nature as the normal commission receipts of the
On that ground, both the appeals were
dismissed. At the instance of the assessee, the following question was referred
by the Tribunal to the High' Court of Judicature at Madras for its opinion
under s. 66(1) of the Indian Incometax Act, 1922, hereinafter called the Act
"Whether the aforesaid sum of Rs. 66,790 and Rs. 3 ' 35,371 are assessable
under Section 10 for the assessment years 1951-52and 1952-53." A Division
Bench of the said High Court, having regard to the circumstances of the case,
came to the conclusion that by the termination of the agency the assessee lost
an earning asset and the compensation paid for the destruction of such an asset
was a capital receipt and, therefore, not liable to tax. The Revenue, on
obtaining the necessary certificate from the High Court, has preferred the
present two appeals to this Court..
Mr. A. V. Viswanatha Sastri, learned counsel
for the Revenue, contended that the assessee had innumerable agencies, that it
was a normal incident in the course of its business to give up agencies and
acquire new ones, that the termination of the agency in question was a normal
occurrence in the course of its 483 business, that it had no impact on the
earning assets or the structure of the business, that the alleged restrictive
covenant was only an act of grace on the part of the agent in view of the long
standing relationship between the parties and that it did not enter into the
calculation of the, compensation paid to the assessee. In short, his argument
was that the said compensation only represented the taxable income of the
assessee should the Court hold that the compensation was in part capital and in
part revenue income, the argument proceeded, the said compensation would have
to be apportioned reasonably between the said parts.
Mr. Rajagopala Sastri, learned counsel for
the assessee, advanced the argument that on a true construction of the
agreement disclosed by the correspondence it should be held that the amount
received by the assessee was wholly as a consideration for. the restrictive
covenant and, therefore, was of a capital nature. Alternatively he contended
that even if the amount was wholly paid as compensation for the loss of the
agency, it was a capital receipt, as the assessee lost a substantial source of
income in relation to the totality of its business. On the assumption that the
payment partook of a composite character, the learned counsel would say that an
appointment should be made in proportion of the value to the assessee of the
loss incurred under both the heads, namely, the loss of the agency and the
restrictive covenant not to do business for a specified period in the same
These appeals raise the familiar question,
namely, whether a particular income arising from the termination of one of the
agencies of a multi-agency concern is a capital receipt or a revenue receipt.
The decisions on this question are legion.
Eminent judges in India as well as in England
expressed their inability to lay down a precise principle of universal
application but were able to evolve some workable rules of guidance. The
difficulty is inherent in the problem itself.
This Court in a recent decision has surveyed
the entire field and, therefore, no useful purpose will be served to cover the
ground over again. That case is Kettlewell Bullen & Co. Ltd. v.
Commissioner of Income-tax, Calcutta(1).
There, this Court, speaking through Shah, J.,
expressed its conclusion thus:
"'Where, on a consideration of the
circumstances, payment is made to compensate a person for cancel(1)  8
S.C.R. 93 484 lation of a contract which does not affect the trading structure
of his business, nor deprive him of what in substance is his source of income,
termination of the contract being a normal incident of the business, and such
cancellation leaves him free to carry on his trade (freed from the contract
terminated) the receipt is revenue: where by the cancellation of an agency the
trading structure of the assessee is impaired, or such cancellation results in
loss of what may be regarded as the source of the assessee's income, the
payment made to compensate for cancellation of the agency agreement is normally
a capital receipt." But the difficulty still remains in the application of
the said principle to the facts of each case. In Gillanders Arbuthnot and Co.
Ltd. v. Commissioner of income-tax, Calcutta(1) this Court applied the said
rules to the facts of that case, which, by and large, are similar to, the facts
in the present case. It would, therefore, be useful to notice briefly the facts
of that case. There, the appellant company carried an business in diverse lines
: acting as managing agents, shipping agents, purchasing agents, and
secretaries, the company also acted as importers and distributors on behalf of
foreign principals and bought and sold on its own account. Under an unwritten
agreement which was terminable at will the appellant acted as sole agents and
distributors of explosives manufactured by the Imperical Chemical Industries
(Export) Ltd. That agency was terminated and by way of compensation the
Imperial Chemical Industries (Export) Ltd. paid for the first three years after
the termination of the agency two-fifths of the commission accrued on its sales
in the territory of the appellant's agency computed at the rates at which the
appellant had formerly been paid and in addition in the third year full
commission for the sales effected in that year at the same rates. The Imperial
Chemical Industries (Exports) Ltd. had intended to take a formal undertaking
from the appellant to refrain from selling or accepting any agency for
explosives or other competitive commodities, but no such agreement in writing
was taken or insisted upon.
The question was whether the amounts received
by the appellant for those three years were of the nature of capital or
revenue. This Court held that the amounts paid were of the nature of income
and, therefore, assessable to tax. The reason given for that conclusion was
that, having regard to the vast array of business done (1)  8 S.C.R. 121
485 by the appellant as agents, the acquisition of agencies was in the normal
course of business and determination of individual agencies a normal incident
not affecting or impairing its trading structure. The material facts of that
case are on all fours with the present case. Indeed, the Principal in both the
cases was the same and the agency terminated was also a similar one. The
compensation given was worked out on the same lines. The only difference is
that in that case it was not found that the restrictive covenant entered into
This Court again reiterated the same
principle in Commissioner of Income-tax, Madras v. Chari & Chari Ltd.(1).
But, on the facts of that case, it came to the conclusion that the compensation
paid for the loss of agency was. a capital asset. There, Shah, J., speaking for
the Court, said "In Kettlewell Bullen and Co.'s case(1) this Court pointed
out that ordinarily compensation for loss of office or agency is regarded as a
capital receipt, but the rule is subject to an exception that payment received
even for termination of an agency agreement, where the agency is one of many
which the assessee holds, and the termination of the agency does not impair the
profit making structure of the assessee, but is within the framework of the
business, it being a necessary incident of the business that existing agencies
may be terminated, and fresh agencies may be taken, is revenue and not capital,
Kelsall Parson and Co.'s case(8) falls within the exception to the ordinary
rule, and circumstances which brought the case of the respondent within the
exception must be clearly established." As we have observed earlier, in
view of the judgments of this Court, no further citation is called for. Whether
the compensation received by an assessee for the loss of agency is a capital
receipt or a revenue receipt depends upon the circumstances of each case.
Before coming to a conclusion one way or the other, many questions have to be
asked and answered: what was the scope of the earning apparatus or structure,
from physical, financial, commercial and administrative standpoints ? If it was
a business of taking agencies, how many agencies it had, what was their nature
and variety ? How were they acquired, how one or some of them were lost and
what was the total income they were (1)  3 S.C.R. 692 (2)  8 S.C.R.
93 (3)  21 T.C. 608 C.I./66-19 486 yielding ? If one of them was given up
what was the average income of the agency lost ? What was its proportion in
relation to the total income of the company ? What was the impact of giving it
up on the structure of the entire business ? Did it amount to a loss of
enduring asset causing an unabsorbed shock dislocating the entire or a part of
the earning apparatus or structure ? or was it a loss due to an ordinary
incident in the course of the business ? The answers to these questions would
enable one to come to a conclusion whether the loss of a particular agency was
incidental to the business or whether it amounted to a loss of an enduring
asset. If it was the former, the compensation paid would be a revenue receipt;
if it was the latter, it would be a capital receipt. But these questions can
only be answered satisfactorily if the relevant material is available to the
income-tax authorities. The evidence, of witnesses in charge of the business,
the relevant accounts and balance sheets of the assessee before and after the
loss, other evidence disclosing the previous history of the total business and
the relative importance of the agency lost and the present position of the
business after the loss of the said agency have to be scrutinized by the
At this stage the question of burden of proof
raised at the Bar may be noted. In Commissioner of Income-tax v. Chari &
Chari Ltd.(1), this Court observed :
it must in the first instance be observed
that it is for the revenue to establish that a particular receipt is income
liable to tax................ ".
We may point out, as some argument was
advanced on the question of burden of proof, that this Court did not lay down
that the burden to establish that an income was taxable was on the Revenue was
immutable in the sense that it never shifted to the assessee. The expression
"in the first instance" clearly indicates that it did not say so.
When sufficient evidence, either direct or circumstantial, in respect of its
contention was disclosed by the Revenue, adverse inference could be drawn
against the assessee if he failed to put before the Department material which
was in his exclusive possession. The process is described in the law of
evidence as shifting of the onus in the course of a proceeding from one party
to the other. There is no reason why the said doctrine is not applicable to
income-tax proceedings. While the Income-tax authorities have to gather the
relevant material to establish that the compensation given for the loss of agency
was (1)  3 S.C.R. 692 487 a taxable income, adverse inference could be
drawn against the assessee if he had suppressed documents and evidence, which
were exclusively within his knowledge and keeping.
With this background let us scrutinize the
evidence in the present case. As we have stated earlier, the assessee is a well
established and long standing company in South India.
It has taken innumerable agencies in
different lines. One of such agencies was the agency it had taken from the
Imperial Chemical Industries (Exports) Limited, Glasgow.
Though the said agency had been with the
assessee for over 47 years, it was an agency terminable at will. The assessee
did not place any material before the Department to establish the relative
importance of the said agency in the framework of the earning apparatus of its
business; it did not adduce any evidence to prove that the said agency was a
pivot of its structure and that it had closed any branch or part of the
establishment in consequence of the said loss.
It could have placed material before the
Department to show that the average income from the said agency compared with
the total income from all the agencies was so large that by this loss the
entire business was dislocated. But it did not do so. The only evidence on
which the High Court relied and on which the learned counsel for the assessee
laid emphasis was the fact that the income returned by the assessee for the
year 1952-53 was very nearly the same as that it received by way of
compensation from the Principal during the accounting year corresponding to the
said assessment year. On that basis the High Court held that the income from
the source which had been taken away from the assessee by reason of the
termination of the agency would be very nearly half of its total income and,
therefore, it lost an enduring asset. This reasoning does not appeal to us.
Firstly, the compensation paid for the third
year did not represent only the commission on the sales effected in respect of
that agency during that year, but it represented not only the commission on the
said sales but also in addition two-fifths of that commission; secondly, the
figures for the earlier two years show that during (he year ending March 31,
1949, if the whole commission had, been paid, the figures would have been Rs.
85,250 for the first year and Rs. 1,66,975 for the second year. The second
year's figures were about one-fourth of the total income and the first year's
would be one-eighth of it. There is another fallacy in this line of reasoning.
The sales effected during the said three years were the sales effected by the
agency. It is not possible to predicate that the assessee would have effected
the same sales during that period if it had continued the agency. The real
facts 488 could have been brought out if only the average total commission
earned by the assessee for a reasonable period of time before the transfer was
disclosed. In the absence of such material it is not possible to arrive at any
conclusion one way or the other, on the line of enquiry pursued by the High
Court. What remains, therefore, is only the fact that the assessee had
innumerable agencies in different lines and that it only gave up one of them
and continued to do business without any apparent mishap. The correspondence
between the parties shows that the assessee gave up the agency without any
protest presumably because such termination of agencies was part of the normal
course of its business. We, therefore, hold on the facts of the present case
that the loss of the said agency by the assessee was only a normal trading loss
and that the income it received was a revenue receipt.
Mr. Rajagopala Sastri's next contention is
that on a fair reading of the correspondence that passed between the parties it
should be held that the compensation given to the assessee was only in lieu of
a restrictive covenant and, therefore, it was a capital receipt.
To appreciate this contention it is necessary
to read the relevant correspondence. On March 11, 1947, the Principal wrote a
letter to the assessee. As the argument mainly turned upon the contents of this
letter, it is necessary to extract it in full. It reads :
IMPERIAL CHEMICAL INDUSTRIES (EXPORT) LIMITED
Explosives Branch, Nobel House, 25, Bothwell Street, Glasgow C-2.
lath March 1947.
Our Ref. : Export sales Section GIL/NR.
Messrs. Best and Company Limited, P.O. Box
63, Madras, India.
Dear Sirs, Agency arrangements.
We refer to the interview which Mr. J. W.
Donaldon had with your Mr. Ruddle in May 1945, when it 489 was intimated that
as a matter of long term policy, our agencies in India and Ceylon would
ultimately be taken over by Imperial Chemical Industries (India), Limited. It
was indicated at that time that a period of two to three years might elapse
before any steps were taken as regards this transfer. We now have to advise you
that the matter has been receiving further consideration, and Imperial Chemical
Industries (India), Limited desire to take over the various agencies as from
the first April 1948.
It is with regret, therefore, that we have to
intimate our intention of transferring your agency, as from the above date, to
Imperial Chemical Industries (India), Limited, and would take this opportunity
of expressing to you our sincere appreciation of the valuable services you have
rendered to us over a period of many years.
As a result of the transfer of your agency to
Imperial Chemical Industries (India) Limited, we propose that compensation
should be paid to you on the following basis :(1) For the first three post-transfer
years, we shall pay you two-fifths of the commission accruing on annual sales
in the territory of your Agency taken over by, Imperial Chemical Industries
(India)Limited, such commission to be computed at the commission rates formerly
paid to you.
(2)In the third post-transfer year we shall
pay you, in addition, a sum equivalent to the full commission on sales for that
year effected by Imperial Chemical Industries (India) Limited in your
territory, calculated at the same rates.
(3) Payment will be made to you after the end
of each year as soon as the amount is ascertained.
For the purposes of calculating the
commission due to you, the post-transfer years will be deemed to run as from
the date of the transfer of your agency to Imperial Chemical Industries (India)
Limited. We trust that you will find these proposals acceptable.
As a condition of our paying compensation on
the basis outlined above, we would request you to be good enough to give us a
formal undertaking to refrain from 4 90 selling or accepting any agency for
explosives or other commodities competitive with those covered by the agency
agreement now being terminated.
In this connection, we are asking our legal
department to prepare a formal agreement which we will submit to you for your
signature as soon as possible.
Yours faithfully, for Imperial Chemical
Industries (Export) Limited.
Mr. Rajagopala Sastri contended that for the
past valuable services the Principal expressed only sincere appreciation and
for the termination of the agency and thus putting an end to the assessee's
future benefits it proposed to give the assessee compensation measured by the
sales effected by the new agent. But his main argument is that whatever
terminology was used, commission or compensation, the amount agreed to be paid
was wholly as compensation for the assessee agreeing to refrain from selling or
accepting any agency for selling explosives. That conclusion was sought to be
arrived at on the ground that the said restrictive covenant was a condition for
the payment of compensation.
We find it difficult to accept this
construction of the document. The scope of this document cannot be appreciated
ignoring the circumstances under which it came into existence. As we have
stated earlier, the agency, which is the subject-matter of this agreement, was
only one of many other agencies the assessee had.
We cannot agree with the learned counsel that
the compensation was given wholly for the restrictive covenant. Indeed, the
compensation was given expressly for giving up the agency. In the last
paragraph of the letter a request was made to the assessee to agree to a
restrictive covenant as a condition for paying compensation. The letter dated
April 8, 1947, written by the Principal to the Agency Company makes the
position clear. Therein it was stated "With regard to the point you raise
concerning the period during which you would undertake not to take any
competitive agency, we would like you to understand that it was never our
intention that you should be tied down on this Point for all time. We had felt
that the, limiting period should be one of five years and we are pleased to
note, from your letter that this appa491 rently is in accordance with your own
It is suggested that the five years should
date from the termination of the agency, namely, 1st April, 1948." The
letter written by the assessee to the Principal is not on the file. But it is
clear from this letter that the restrictive covenant was one of the terms of
the agreement relating to consideration. It was a part of the consideration
that passed from the assessee for receiving the compensation. We cannot also
agree with Mr. Viswanatha Sastri, who went to the other extreme and contended
that the restrictive covenant was only an act of grace on the part of the Agent
and that it did not enter into the bargain. We, therefore, hold that the
compensation agreed to be paid was not only in lieu of the giving up of the
agency but also for the assessee accepting a restrictive covenant for a
The next question is whether that part of the
compensation attributable to the restrictive covenant is a capital receipt or a
The House of Lords in Beak (H.M. Inspector of
Taxes) v. Robson(1), had to consider, whether compensation paid for a
restrictive covenant was a capital receipt or a revenue receipt. Under a
service agreement the respondent therein covenanted in consideration of the
payment to him of &-7,000 on the execution of the agreement, that if the
agreement were determined by notice given by him or by his breach of its
Provisions he would not compete directly or indirectly with the company within
a radius of fifty miles of its place of business untill the five years had
expired. The House of Lords held that the said amount was a payment for giving
up a right wholly unconnected with his office and operative only after he
ceased to hold that office and, therefore, it was not taxable under Schedule E
of the Income-tax Acts.
This Court in Gillanders Arbuthnot and Co.
Ltd. v. Commissioner of Income-tax, Calcutta(1) accepted the said principle and
held that the compensation paid for agreeing to refrain from carrying on
competitive business in the commodities in respect of the agency terminated or
for loss of goodwill was prima facie of the nature of a capital receipt.
In the present case, the covenant was an
independent obligation undertaken by the assessee not to compete with the new
agents in the same field for a specified period. It came into operation only
after the agency was terminated. It was wholly un(1)  25 T.C. 33.
(2)  8 S.C.R. 121 4 9 2 connected with
the assessee's agency terminated. We, therefore, hold that that part of the
compensation attributable to the restrictive covenant was a capital receipt and
hence not assessable to tax.
The next question is whether the compensation
paid is severable. If the compensation paid was in respect of two distinct
matters, one taking the character of a capital receipt and the other of a
revenue receipt, we do not see any principle which prevents the apportionment
of the income between the two matters. The difficulty in apportionment cannot
be a ground for rejecting the claim either of the Revenue or of the assessee.
Such an apportionment was sanctioned by courts in Wales (H.M. Inspector of,
Taxes v. Tilley(1), Carter v. Wadman (H.M. Inspector of Taxes (2 ) , and T.
Sadasivam v. Commissioner of Income-tax, Madras(1).
In the present case apportionment of the
compensation has to be made on a reasonable basis between the loss of the
agency in the usual course of business and the restrictive covenant. The manner
of such apportionment has perforce to be left to the assessing authorities.
The answer to the question referred to the,
High Court is that only such part of the sums of Rs. 66,790 and Rs. 3,35,371 as
is attributable to the loss of the agency is assessable under S. 10 of the Act
for the assessment years 1951-52 and 1952-53. We accordingly modify the answer
given by the High Court in that regard.
In the result, the appeals are partly
allowed. As both the parties failed in part and succeeded in part, they will
bear their respective costs here and in the High Court.
Appeals allowed in part.