P. H. Divecha & ANR Vs.
Commissioner of Income-Tax, Bombay I [1962] INSC 358 (11 December 1962)
HIDAYATULLAH, M.
DAS, S.K.
KAPUR, J.L.
SARKAR, A.K.
DAYAL, RAGHUBAR
CITATION: 1964 AIR 758 1963 SCR Supl. (2) 949
CITATOR INFO :
R 1971 SC1590 (9) R 1973 SC 524 (4) E 1992
SC1495 (14,31)
ACT:
Income Tax-Firm of three partners-Agreement
with a company--creates monopoly to sell and deliver company's bulbs in favour
of the firm-Undertaking by firm-To sell only company's bulbs-Agreement operates
16 years-Failure of negotiations for reneuul-Transition agreement-Company
agrees to pay Rs. 40,000/per annum to each partner during 3 years-Assessment
year-Each partner receives Rs. 10,000/-Whether trading asset or Capital
assets-Compensation or ex gratia payment.
HEADNOTE:
The two appellants along with another were
carrying on business in Electrical goods under the firm name Precious Electric
Co. In 1938 this firm entered into an agreement with M/s. Phillips Electric Co.
(India) Ltd. The material terms of the agreement were the following. The firm
was to have an exclusive territory for sale of Phillips bulbs and undertook to
sell only Phillips bulbs in the territory. The agreement allowed the firm
compensation if Phillips bulbs were sold in the territory by the company. The
agreement was terminable by a three months notice on either side.
There was no stipulation in the agreement as
to the quantity or quality of bulbs to be bought by the firm, neither was it
agreed that the firm was to act as an agent of the company.
The agreement continued for 16 years. In 1954
negotiations for a fresh agreement were conducted but they were not successful.
Since the company was taking over the business of selling the bulbs in the
territory a working scheme for the transition period following the termination
of the agreement was reached. The most material term of the scheme was that the
company would pay Rs. 40,000/per annum as a gesture of goodwill in quarterly installments
to each of the partners during a period of three years from the date of the
expiry of the existing agreement. In the assessment year each of the partners
received two quarterly payments of Rs. 10,000/each. This amount was taxed by
the Income Tax Officer in respect of the two appellants under s. 10 (5A) of the
Indian Income Tax Act, 1922. The appellants appealed without success to. the
Assistant Commissioner. Thereupon 950 they appealed to the Tribunal contending
that the amount assessed was compensation paid for the termination of the
agreement or it was an ex gratia payment. It was further contended that the
payment made to the individual partners did not constitute a receipt of the
firm's business.
Alternatively it was argued that the said
receipt was not liable to be included in the total income of the recipients by
reason, of s. 4 (3) (VI I) of the Income Tax Act. The Tribunal did not accept
any of these contentions but it referred three questions for the decision of
the High Court.
These questions were whether the receipt in question
was a taxable receipt, if so whether it was liable to be not 'included in the
total income under s. 4 (3) (VII) and whether the said receipt fell within s,
10 (5A) (d). The High Court answered that the receipt was a taxable receipt and
s. 4(3)VII did not exempt it from liability. The third question was left
unanswered. The present appeal has arisen byway of a certificate granted by the
High Court.
The contentions were that the agreement was
not a trading agreement; it constituted an asset on the termination of which
compensation was paid to make up for the loss of this capital asset; in the
alternative that even if it was not compensation for loss of capital it was an
ad hoc ex gratia payment in the nature of `solatium' as described by the Privy
Council in Income-tax Commissioner v. Shaw Wallace & Co. (1932) L. R. 59 1.
A. 206. For the respondent it was contended that since there was no premature
termination of the agreement even if it is treated as capital, it has exhausted
itself and therefore must be treated as revenue from other sources' under s. 12
of the Act.
Held, that in determining whether a payment
amounts to a return for loss of a capital asset or is income, profit or gain
liable to income-tax, one must have regard to the nature and quality of the
payment. If the payment was not received to compensate for loss of profits of
business the receipt cannot properly be described as income, profit or gains.
The size of the amount paid or the periodicity of the payments have no decisive
bearing on the matter.
The Commissioner of Incone-tax v. Vazir
Sultan & Sons., [1959] Supp. 2 S. C. R. 375, Godrej & Co. v.
Commissioner of Income-tax.-[1960] I S. C. R. 572, Commissioner of Income-Tax
v. Jairam Yalji, [1959] 36 I.T.R. 148 and Senainam Doongar Mal v. Commissioner
of Income-tax, [ 1 961] 42 I.T.R. 392, referred to.
The payment cannot be connected with
estimated loss of profits since, the terms of the agreement show that the firm
951 was not entitled to be compensated for temporary suspension of the benefits
or a complete termination of those benefits.
Glenboig Union Fireclay Co. Ltd. v.
Commissioner of Inland Revenue, (1922) T.C. 472, referred to.
In the absence of any proof that the amount
paid was the likely profit it is difficult to say that the payment replaced
those profits.
The agreement in the present case was not an
agreement for the purchase of bulbs. It mentioned no quantity or quality or
price. It only secured to the firm a right to exclusive purchase of bulbs for
sale in an exclusive territory. The agreement can only be described as an
agreement which constituted a source and a monopoly and which gave an enduring
advantage to a trader in his trade. The loss of such an agreement must be
regarded as falling on the capital side and not in the course of his ordinary
trading. If the agreement had been breached prematurely the damages would not
have been calculated on the basis of outstanding contracts only but on the
basis of an a vantage lost.
Bush Beach & Gent Ltd. v. Road. (1939) 22
T.C. 519 Short Bros. Ltd. v. Commissioner of Inland Revenue, (1927) 12 T.C.
955, Commissioner of Inland Revenue v. North Fleet Coal and Ballast Co. Ltd.,
[1927] 12 T.C. 1302 and Yen Den Berghs Ltd. v. Clark, (1935) 19 T. C. 390,
referred to.
Even if the payment cannot be considered as a
payment for loss of capital it cannot be regarded as payment for any services
rendered or likely to be rendered. It was an ad hoc payment out of gratitude
and in appreciation of the personal qualities of the assessees.
Chibbett v. Joseph Robinson & Sons,
(1924) 9 T.C. 49, referred to.
The receipt not being income profit or gain
s. 4 (3) (VII) had no application.
CIVIL APPELLATE JURISDICTION : Civil Appeal
No. 332 of 1961.
Appeal from the judgment and ordered dated
June 23, 1959, of the Bombay High Court in Income-tax Reference No. 51 of 1958.
952 A. V. Viswanatha Sastri, S. P. Mehta, J.
B. Dodachanji, O.C. Mathur and Ravinder Narain, for the appellants.
K. N. Rajagopal Sastri and R. N. Sachthey,
for the respondent.
1962. December, 11. The judgment of the Court
was delivered byHIDAYATULLAH, I.-This is an appeal on a certificate granted by
the High Court of Bombay against the judgment and order of the High Court dated
June 23, 1959. The appellants are two assesses whose cases were consolidated
before the Tribunal and hence a single appeal. The facts of the case are as
follows :
Before the year 1938, the two appellants and
one Jehangir Irani were carrying on business in electric goods including
electric bulbs under two firm names. One of the firms was called the Precious
Electric Co. and the other was named J.
Pirojsha & Co. In June, 1938, Precious
Electric Co. entered into an agreement with M/s. Philips Electrical Co. (India)
Ltd. by which the Company demarcated a territory for the Firm, undertaking to
sell and deliver electric bulbs therein exclusively to the Firm. By a letter
which formed an annexure to the agreement the Company agreed to sell electric
bulbs to the Firm at ex-warehouse prices subject to a commission of 12-21 %on
the gross invoice amount and the Firm was allowed a further discount of 2% on
the net invoice prices to cover breakage or fault in manufacture. It was
further agreed that if the Company sold any goods directly to the buyers in the
territory the Company would pay to the Firm compensation amounting to 5% of the
net amount of invoices covering such sales. The Firm on its part undertook to
sell only Philips bulbs in the territory and to 953 prevent re-exportation of
the bulbs by third parties. In addition to other conditions to which we need
not refer at this stage there was a clause for termination of the agreement.
The clause provided that the agreement would be deemed to have been made as
from July 1, 1938, and would continue unless determined by either party by
giving to the other party three months' prior notice by registered letter of
such party's intention to determine the agreement on the June 30, 1939 or any
subsequent June 30. This agreement continued for a period of sixteen years.
On March 8, 1954, the Company sent a letter
to the Firm informing the Firm that the agreement would come to an end from
June 30, 1954. The Company sent a draft of a new agreement which was intended
to take the place of the earlier agreement. Some negotiations between the parties
followed but no fresh agreement was signed . On May 28, 1954, the two assessees
and the Manager of the Firm met the representatives of the Company to discuss
the new agreement.
Nothing much came of the discussion and since
the Bombay branch of the Company was taking over the business of selling bulbs
in the territory, a working scheme for the period immediately' following the
termination of the existing agreement was reached. This was recorded in the
shape of minutes which were signed by the representatives of the Company and by
the two partners of the Firm. The minutes covered arrangements for the period
of transition, the stocks and the staff of the firm. Of these the important
provisions are as follows :(a) PERIOD OF TRANSITION:
Philips Bombay Branch will continue the
distribution of lamps, etc. to dealers and in this respect Messrs. Precious
promised to furnish their name list of dealers and their 954 supplies over the
past six months. It was concluded that the execution of orders of locally available
goods might be terminated in two months' time, whereas this matter as far as
orders placed with overseas suppliers are concerned might take about five
months.
During this period Messrs. Precious will
receive all co-operation from Messrs. Philips to ensure a smooth winding up of
the business.
Furthermore, particular attention will be
given to the I. S. D. contracts and transactions in connection with public
bodies. Messrs. Precious will inform these bodies that the supplies will be
effected through their intermediary by Philips Bombay, Branch which refers in
particular to those cases where close personal contact between Messrs. Precious
and the parties exists. The commission related to the above special cases,executed
after the termination of the existing agreement will be due to Messrs. Precious
if no technical objection emanating from ELA'S agreement will come
forward." "'(b) STOCKS Messrs. Philips, Bombay will take care that
the stocks of Messrs. Precious will be disposed of in one way or the other as
soon as possible in order to avoid that Messrs.
'Precious' capital might unnecessarily be
tied up.
In order to achieve this, the available goods
will be classified in three categories, viz (i) Easily saleable goods.
(ii) Goods which require some sales efforts,
which means that they might -be disposed of in a period of four to six weeks.
955(iii) Slow moving items which will be
taken over by Bombay Branch.
The goods mentioned under (iii) above will be
taken over by Messrs. Philips at the original invoice price if not otherwise
decided due to deterioration of the goods whilst a deduction is valid for cost
incurred for transfer." The following minutes, headed
"Miscellaneous", were at the end and read :"MISCELLANEOUS:As a
gesture of goodwill, Messrs. Philips are prepared to pay in quarterly installments
to each of the three partners' during a period of three years, Rs. 40,000/per
annum from the date of the expiry of the existing contract. The three partners
referred to above as far as Messrs. Philips Electrical Co., understand are Mr.
Pirojsha H. Devecha
2. Mr. Khurshedji A. Irani
3. Mr. Noshir J. Irani Finally, Mr. Van Rhijn
stated that Messrs. Philips are quite willing to continue Messrs. Precious as
regular lamp dealers and the profit they realise the from will be in addition
to the three years' remuneration referred to above." In the account year
ended December 31, 1954 relative to the assessment year 1955-56, each of the
three partners received two quarterly payments of Rs. 10,000 each. This amount
was taxed by the Income-tax Officer in respect of the two appellants as
compensation under s. 10 (5A) of the incometax Act. An assessment was also made
on the third 956 partner but we are not concerned with that assessment.
The appellate Assistant Commissioner to whom
the assessee appealed held that provisions of s. 10 (5A) did not apply to the
facts of the case on the ground that the appellants were not agents of the
Company from which payment had been received and the amount received was not
compensation as no legal damage had been caused to them by the Company. He,
however, held that the sum of Rs. 20,000 in respect of each of the appellants
was a taxable receipt. The -assessees appealed to the Tribunal and four
contentions were raised by them. They were "(i) it was compensation paid
for termination of agreement which constituted the frame work of the Firm's
business.
(ii) the amount was an ex-gratia payment made
by way of testimonial.
(iii) the payment is made to individual
partners and not to the firm as such and does not represent a receipt in the
course of firm's business.
(iv) alternatively, the said receipt was not
liable to be included in the total income of the recipient by reasons of
Section 4 (3) (vii)." The Tribunal did not accept these contentions but at
the request of the firm referred three questions for the decision of the High
Court. Those questions were as follows :whether the receipt of Rs. 20,000/is a
taxable receipt for the purpose of the Indian Income-tax Act, 1922 ? 957 (ii)
If so, is it liable to be not included in the total income of the recipient by
reason of Section 4 (3) (vii) ? (iii) Does the said receipt fall within the
mischief of Section 10 (5A) (d) and as such liable to tax accordingly ?"
The reference was heard by the High Court and the learned judges answered the
-first question as follows :"The receipt of Rs. 20,000/is a taxable
receipt for the purpose of the Indian Income-tax Act, 1922." In view of
the answer the High Court observed as follows :"As we have already held
that the amount is taxable receipt, being receipt arising from business,
Section 4 (3) (vii) does not exempt it from liability to tax. We are in the
view we have taken not called upon to consider whether even if the receipt of
Rs. 20,000/is a capital receipt, by operation of Section 10 (5A) (d) the amount
can be regarded as a revenue receipt. We answer the second question as follows
:
It is liable to be included in the total
income notwithstanding Section 4 because it arose from business." The
third question was left unanswered. The High Court certified the case as fit
for appeal and hence this appeal.
The High Court in reaching its conclusion
examined the agreement of 1938 and come to the conclusion that though it
involved a ""monopoly purchase" and gave to the Firm an
exclusive right to 958 sell Philips bulbs in the assigned territory, it was no
more than a trading agreement which did not constitute a trading asset. By the
loss of this monopoly right, the High Court went on to say, the business of the
firm was not destroyed because even after the termination of the agreement the
firm was entitled to carry on the business of selling electric bulbs as a
,-,regular lamp dealer". According to the High Court the agreement while
it lasted only conferred on the Firm the right to obtain Philips bulbs on
favourable terms as their stock-in-trade. By the termination of the agreement
this right to acquire the stock-in-trade on favourable terms was lost but there
was no capital loss as the business of selling bulbs continued. The High Court
also referred to the minutes where the payment of Rs. 40,000 per annum to each
of the partners for a period of three years was "expressly
designated" 'three years remuneration'.
They referred to numerous cases in which
distinction has been made in India and in England between capital and revenue
receipts. The learned judges, distinguished those in which receipts were
described as on the capital side. In particular they relied on the case in
Bush, Beach & Gent.
Ltd. v. Road (1). They distinguished between
those cases in which the cancellation of the contract affected the structure of
the assessee's business and those in which it did not, and held that this was a
case in which the structure of the business of the Firm was not affected and
the payment made must be treated as on the revenue side particularly because it
was described as remuneration and was payable yearly for a period of three
years.
In the appeal before us Mr. Vishwanath Sastri
has put the case of the appellants from two angles. He contends that the
agreement was not a trading agreement but constituted an asset on the
termination of which compensation was paid to make up for the loss of this
capital asset. He contends that the (1) (1939) 22 Tax Cases 519.
959 agreement, though it could be terminated
on the June 30 in any year with three months' notice, had run for sixteen years
to the advantage of both the Company and the Firm and thus was always likely to
run unless terminated. He points out that it involved a monopoly right to sell
Philips bulbs exclusively in the territory assigned and also conferred other
rights like favourable terms of purchase of bulbs, compensation for invasion of
territory and a right to discount in case of breakage or faulty manufacture. In
other words, the agreement was not an ordinary trading agreement by which the
stock-in-trade was secured but involved something more than the purchase of
stock-in-trade.
It constituted the means of earning profits
or as it is commonly described ,,,the money-making apparatus" of the
appellants. When this agreement was terminated, he continued, it was not a
premature termination but the expectancy was that it was to run unless
terminated and the compensation which was paid though described as remuneration
was, in a business sense, merely compensation for the loss of those rights
which the Firm had enjoyed and which it expected to enjoy in the future if the
agreement was not terminated.
In the alternative, Mr. Vishwanatha Sastri
contends that even if the amount could not be referable to a loss of a capital
asset it was not referable to any future service to be rendered by the
assessees who had by the termination of the agreement become ordinary dealers
in bulbs like any other dealer in the same territory. Nor was it referable to
any past service but was a payment ex-gratia out of appreciation of the
personal qualities of the partners whose services in the past were fully
remunerated. In other words, this was an ad hoc payment in the nature of a
'testimonial' as it is sometimes described or as a "solatium', by which
term the Privy Council described the payment in Income-tax Commissioner v. Shaw
Wallace & Co. (1) (1) (1932) L.R. 59 I.A. 206.
960 Mr. K. N. Rajagopal Sastri on behalf of
the Commissioner of Income-tax contends that the business of selling bulbs was
only a part of the business activities of Precious Electric Co. and that Firm
was one of the two firms carrying on the same or similar businesses. The
agreement conferred the benefit of a favourable mode of acquiring
stock-in-trade only and its termination did not lead to any loss of capital
because it was not a capital asset in the hands of the Firm but was only a
trading agreement, entered into in the ordinary course of business. Mr. Raiagopal
Sastri contends that the monoply involved in the agreement was merely
incidental to such a trading agreement and was not an asset which could be said
to have been lost on the termination of the agreement. He contends that there
was no premature termination as the agreement had worked itself out and even if
treated as capital it had exhausted itself. An amount paid after capital has
exhausted itself must be treated as revenue from 'other sources' within s. 12
of the Income-tax Act. He contends that even if the entire business activities
of the assessees were confined to implementing the agreement it cannot be
considered as capital because it had a very minor place in the entire business
of the two firms which continued unaffected by the termination of the
agreement. In reply to the argument that this was a "testimonial' or
`solatium' Mr. Rajagopal Sastri contends that the minutes did not describe it
as such but on the other hand stated that the payment was made to supplement
the business receipt of the partners in the next three years. He accordingly
contends that the judgment under appeal is right and this payment cannot be
regarded either as a capital receipt or as an exgratia payment.
Before we consider these questions and refer
to the authorities which were cited at the bar we shall refer in some detail to
the terms of the agreement of 1938 to find out its true nature so as to be able
to 961 decide whether it can be regarded as a trading agreement entered into
for the purpose of obtaining the stock-in-trade for the business or it can be
regarded as an asset. The agreement consisted of 13 clauses but all of them
were not equally important. The first clause provided for two matters : (a) it
fixed a territory and (b) it defined the scope of the agreement. In the first
part were mentioned the Bombay Presidency, Rajputana, Central Provinces and
Berar, and in the second part "all lamps for electrical lighting
purposes"' of certain kinds (compendiously called 'Philips lamps') were
said to be covered by -the agreement.
Clause 2 was also divided into two parts. The
first part said that the Company undertook to sell and/or to deliver Philips
lamps exclusively to the Firm in the territory, the second part provided that
should any buyer refuse to purchase from the Firm, the Company would make the
supply direct but '.pay five per cent. compensation over the net amount of
invoice covered in such orders ,to the Firm.
Clause 3 recited the terms accepted by the
Firm. This clause was also divided into two parts. The first part bound
territory only such Philips lamps it by the Company.
prevent re-export of the lamps the Firm to
sell in the as were supplied to The second part bound it to by third parties as
far as possible. By clause 4 the Firm bound itself to observe clause 3 in
respect of such lamps as might remain undisposed of with the Firm after the
termination of the agreement. Clause 5 reserved to the Company the right to
alter the prices rate of discount and conditions of sale without notice to the
Firm even in respect of unexecuted contracts. Clause 6 reserved to the Company
the right to refuse orders and/or to cancel or to suspend deliveries for any
reason, whatever, including the reason that the prices obtaining had become
unprofitable.
That clause also provided that in case of
such cancellation, cessation or suspension of deliveries the Firm would not be
entitled to receive -compensation. By clause 7 the Firm bound 962 itself to
push the sale of the Philips lamps according to the directions of the Company and
not to sell lamps other than Philips lamps and not to support any firm
competing with the Company in any way and to keep secret methods of work etc.
Clause 8 then provided that the Firm would buy and sell Philip lamps on its own
account and at its own risk. The rest of the terms need not be referred to. The
gist of the agreement, therefore, was that the Firm was to have an exclusive
territory for sale of Philips lamps and undertook to sell only Philips lamps in
that territory. The agreement allowed the Finn compensation if Philips lamps
were sold in the territory by the Company. There was no provision in the
agreement how many lamps the Firm was to buy from the Company in a particular
period and there was no condition that the Firm -would be required to buy any
specified quantity and/or quality. There was no agreement that the Firm was to
act as the agent of the Company. This was an agreement between principal and
principal, the measure of the business depending upon how far the Firm wag able
to push the sales of Philips lamps in its own interest and in the interest of
the Company. The agreement was to commence on July 1, 1938, and was termi.
nable by a three months notice on either side on June 30, of any year. It is
fair to in force that as long as the Company and the Firm found the arrangement
profitable the agreement would have continued. By an annexure to the agreement,
which was in the form of a letter, the terms of business between the Firm and
the Company were laid down. This letter stated the commission payable to the
Firm and the manner in which payments were to be made by the Firm. Sufficient
reference to these terms has already been made by us in an earlier part of this
judgment. This annexure was to be read as a part of the agreement. It was probably
kept separate so that in case of need only the annexure might be altered
without the trouble of executing a fresh agreement.
063 In determining whether this payment
amounts to a return for loss of a capital asset or is income, profits or gains
liable to income-tax, one must have regard to the nature and quality of the
payment. If the payment was not received to compensate for a loss of profits of
business the receipt in the hands of the appellant cannot properly be described
as income, profits or gains as commonly understood. To constitute income,
profits or gains, there must be a source from which the particular receipt has
arisen, and a connection must exist between the quality of the receipt and the
source. If the payment is by another person it must be found out why that
payment has been made. It is not the motive of the person who pays that is
relevant. More relevance attaches to the nature of the receipt in the hands of
the person who receives it though in trying to find' out the quality of the receipt
one may have to examine the motive out of which the payment was made. It may
also be stated as a general rule that the fact that the amount involved was
large or that it was periodic in character have no decisive bearing upon the
matter. A payment may even be described as 'pay', 'remuneration' etc. but that
does not determine its quality, though the name by which it has been called may
be relevant in determining its true nature, because this gives an indication of
how the person who paid the money and the person who received it viewed it in
the first instance. The periodicity of the payment does not make the payment a
recurring income because periodicity may be the result of convenience and not
necessarily the result of the establishment of a source expected to be
productive over a certain period. These general principles have been settled
firmly by this Court in a large number of ,cases.
See for example : The Commissioner of
Income-tax v. Vazir Sultan, & Sons (1), Oodrej & Co, v. Commissioner of
Income tax (2), Commissioner of Income-tax v. Jairam Valji (3), Senairam
Doongarmall v. Commissioner of Income-tax (4).
(1) [1959] Sapp. 2 S.C.R. 375. (2) 11960] 1
S.C.R. 527.
(3) [1959] 35 I.T.R. 148. (4) (1961] 42
I.T.R, 392.
964 We shall begin by considering whether the
payment made in this case can be related to the termination of the agreement of
1938 and can be said to arise from that termination in the shape of
compensation in lieu of profits. The agreement of 1938 did not state that on
the termination of the agreement in the way provided there compensation was
payable to the Firm. For temporary suspension of supplies no compensation was
payable. These terms of the agreement show that though the agreement was to run
its course as long as it proved profitable to the parties, at least the Firm
was not entitled to be compensated either for a temporary suspension of the
benefits under the agreement or a complete termination of those benefits. The
payment cannot, therefore, on the terms of the agreement be connected with loss
of estimated profits. It was said, a long time ago in the well-known case of
Glenboig Union Fireclay Co. Ltd. v. Commissioner of Inland Revenue (1) that
there is no relation between the measure that is used for the purpose of calculating
a particular result and the quality of the figure that is arrived at by means
of application of that test. Here, the amount is large but there is nothing to
show that it was ever) an adequate measure of the profits that were expected to
be made during the three years in which the amount was to be paid. Even if it
had been there would have been no inference in law. But in the absence of any
proof that this was the likely profit it is difficult to say that the payment
replaced those profits.
Another way of looking at the matter is to
consider whether the agreement was a trading agreement or something which was
in the nature of an asset in the hands of the firm. In this connection the
Department relies strongly upon the case of Bush Beach & Gent. Ltd. v. Road
(2). In that case ,the agreement was different. No doubt by that agreement also
a territory was reserved (1) (1922) Tax Cas 427. (2) (1939) 2 Tax Cases 519.
965 and a monopoly was created but that
agreement was to last for four years and was prematurely terminated at the end
of two years. Under that agreement a minimum quantity of chemicals had to be
bought and if the buyers failed to exercise their option to take up the minimum
quantity in any one year, the contract itself was to be considered as terminated
without any further option. The assessees in that case were industrial chemists
till 1933 and by the agreement had offered to buy agricultural chemicals and
had set-up, is a result of the agreement, a special organisation for selling
agricultural chemicals. The amount of compensation on the premature termination
of the agreement was arrived at after negotiations and the sum represented
profits of the lost business and not the price for the purchase of the
contract. It was observed by Lawrence, J., that the business of the assessee
continued unaffected and that if a trading contract made in the ordinary course
of business, though covering a new field, was prematurely -terminated and
compensation was paid for that premature termination, it must be considered to
be in replacement of profits and not capital. In reaching this conclusion the
learned judge pointed out that the case resembled Short Bros. Ltd. v.
Commissioners of Inland Revenue (1) and Commissioner of Inland Revenue v. North
fleet Coal and Ballast Co. Ltd. () but was distinguishable from Ven den
Berghts' case (3). In Short Brother's case (1) a trading contract was
terminated and compensation was paid towards loss of profits in respect of that
contract. Lord Haworth M. R. observed that the payment was not compensation for
not carrying on of the business but was a sum paid in the ordinary course in
order to adjust the relation between the shipyard and its customers. In the
same case Lawrence, L.
J. observed that the payment was in the
nature of an ordinary trading receipt on the termination of a trading agreement
which might or might not have been profitable but on the termination of which
the (1) (1927 ) 12 Tax Cas. 955. (2) (1927) 12 Tax Cas. 1102 (3) (1935) 19 Tax
Cas. 390.
966 payment was made on the expectation that
it would have been profitable. In North fleet's case (1) compensation was paid
to get rid of a contract under which supplies of chalk from a quarry had to be
made. The purchaser received a payment of pound 900 a year and in return released
the supplier from liability under the contract. Later a lumpsum of E. 3000 was
accepted and this amount was held to be a trading profit. It was observed by
Rowlatt, J.
"'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
notionally have earned or are going to earn a profit.
Those profits are relating to this sum. The
profits are not destroyed. It is the profits which we are concerned with, not
the contract itself" On the other side there is the leading case of Ven
den Berghs Ltd. v. Clark (2) where mutual trading agreements between two
companies were rescin. ded and one of the companies was paid lb. 450,000 as
"'damages". This was treated as a capital receipt and not an income
receipt to be included in computing the profits of the trade under Schedule D,
Case 1, of the Income-tax Act 1918. Lord Macmillan described the payments as
follows "On the contrary the cancelled agreements related to the whole
structures of the appellants' profit-making apparatus.
They, resulted the Appellants' activities,
defined what they might and what they might not do, and affected the whole
conduct of their business. I have difficulty in seeing how money laid out to
secure, (1) (1927) 12 Tax Cas. I 10?.
(2) (1935) 19 Tax Cas. 390.
967 or money received for the cancellation
of, so fundamental an Organisation of a trader's activities can be regarded as
an income disbursement or an income receipt." The agreement in our case
was not an agreement for the purchase of bulbs or lamps. It mentioned no
quantity or quality or price. It only secured to the firm a right to exclusive
purchase for sale in an exclusive territory. In other words, it created a
monopoly right of purchase for and a monopoly right of sale in a certain
territory. The agreement secured to the firm an advantage of an enduring
nature. No doubt, the agreement was terminable in anyyear on three months'
notice but it would have lastedas long as it was profitable to the contracting
parties and the indications were that it was to subsist for some time. It was
an agreement which need not have continued but which was likely to continue.
The question, therefore, is whether by termination of the agreement the firm
lost an advantage or merely lost the right to obtain certain stock in-trade for
which they had bargained. If it was first then the receipt, if connected with
that loss, was a capital receipt and if the latter it was a replacement of the
profits which were likely to ensue from the trading agreement. In our opinion,
it is impossible to describe this agreement as a trading agreement. It can only
be described as an agreement which constituted a source and a monopoly, and
which gave an enduring advantage to a trader in his trade. The loss of such an
agreement must be regarded as falling on the capital asset of the person
affected and not in the course of his ordinary trading. If the agreement had
been breached prematurely the damages would not have been calculated on the
basis of outstanding contracts only but on the basis of an advantage lost.
Indeed, the agreement itself contemplated in some of its terms other contracts
under which the supplies were to be made and refers in 968 terms to the
cancellation of "'orders" and "contracts This shows that in
addition to this agreement there were to be trading contracts in the shape of
orders for bulbs which the Firm would have placed with the Company in the
ordinary course of their business. The agreement said that even on the
termination of those contracts and orders no compensation was payable. It is
difficult to see how this payment can be related to profits or how it can be
called income, profits or gains or even income from "'other sources."
The payments can be regarded only as ad hoc payments.
Even if it be not regarded as a payment for
loss of capital it cannot be regarded as payment for any services rendered or
likely to be rendered. The services in the past were amply remunerated. The
payment does not contemplate that the agreement in the past had not been
sufficiently remunerative to the Firm. It does not pretend to pay them for past
services. The minutes do not show that any service in the future was expected
from these appellants. What remained to be done was to wind up the business
with regard to the agreement of 1938 itself. For this purpose, the Company
agreed to give all facilities to the Firm in respect of easily saleable
articles and to take over those which required a longer duration to sell. The
only service, if service it can be called, was that the Firm was to hand over
to the Company a list of customers and the supplies made to them during the
past six months. It cannot be said that for this service the payment was made.
The payment was thus not related to any service either in the past or in the
future.
Both sides have relied upon cases in which
certain payments were held to be taxable or not taxable according as the facts
in those cases suggested that the payment was for some services in the past or
future or was entirely gratuitous.
No useful purpose will be served by going
over such cases because the facts of 969two very dissimilar cases lead to
different principles. We do not, therefore, refer to the cases of professional
cricketers for whom benefit matches are held or who receive payments for
outstanding performance with the bat or ball or cases of persons working in
honorary capacity or in little paid jobs who on retirement receive some payment
in token of their worth. Those cases stand on their own facts. The safest
method is to take the facts of the case in hand and to consider for what was
the payment received and incidentally for what was the payment made. judged
from this angle it is quite clear that the payment here was not made for any
service. In fact it was not made to the firm but to the three partners
individually. It was not related to any service that was likely to be performed
in the future even though it -A as described as remuneration additional to the
ordinary profits of trading. It was in no sense a remuneration. It was in fact
a payment made out of regard for the qualities of the three partners of the
firm who were'long associated with -the Company to its profit and who had built
up a vast network of sales Organisation of which the Company would have
obtained benefit when it entered on the business of selling for itself. This
payment need not be given a particular name. It need not be called a
'testimonial' as to which Rowlatt, J, said in Chibbett v. Joseph Robinson &
Sons (1) that there is no magic in that name. It need not be called a
"solatium', a term devised by Rowlatt J, in the same case and applied by
the Privy Council in Shaw Wallace's case (2) but which this Court did not adopt
in Senairam Doongarmall's case (3) without attempting to give it a name we are
satisfied that the payment was in token of appreciation and was not related to
any business done or to loss of profits and it was not recompense for services
past or future. It was a payment out of gratitude and must be regarded as a
payment which does not bear the character of income, profits or gains which
alone are taxable under the Income-tax Act. In our, opinion, the (1) [l924) 9
T.C. 49. (2) (1932) L.R. 59 I.A. 206 (3) [1959) 35 148 970 High Court, with all
due respect, was in error in holding that this amount was taxable. The answer
to the first question must therefore be against the Department.
The next question is whether the receipt can
be described under s. 4 (3) (vii) as of a casual and nonrecurring nature and
not by way of addition to the remuneration of an employee. The assessees were
not "employees" of the Company and were not in receipt of
remuneration. After the termination of the agreement they were to work as
regular leap dealers if they cared. There was, no compulsion that they must
sell electric lamps whether made by the Company or by other manufacturers. If
they did, they were to receive commission at any other regular dealer. It is
thus obvious that the latter part of s. 4 (3) (vii) does not apply. The receipt
may only be described as a receipt of a casual and non-recurring nature if it
were income, profits or gains.
We have already said that the fact that
payment was spaced over three years did not make this a recurring receipt. In
our judgment the receipt would be saved by s. 4 (3) (vii) from being included
in the total income in any event. But we are of opinion that not being income,
profits or gains s. 4 (3) (vii) has no application. Our answer to the second
question is that s. 4 (3) (vii) does not apply.
The third question need hardly detain us. it
was not answered by the High Court. 'Section 10 (5A) of the Act deals with four
categories of persons. The first three categories exfacie do not apply. The
fourth category also does not apply as the appellants in their individual
capacity were not holding "an agency" and the Firm -of which they
were partners was also not an agent of the Company.
The answer to that question must be against
the Department.
In view of what we have said above this
appeal must succeed.
It is allowed with costs on the respondent in
this Court and in the High Court.
Appeal allowed.
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