Kettlewell Bullen and Co. Vs.
Commissioner of Income-Tax, Calcutta [1964] INSC 149 (1 May 1964)
01/05/1964 SHAH, J.C.
SHAH, J.C.
SUBBARAO, K.
SIKRI, S.M.
CITATION: 1965 AIR 65 1964 SCR (8) 97
CITATOR INFO:
APL 1965 SC 452 (11,15) R 1966 SC 54 (11) R
1966 SC1325 (4,5) R 1970 SC1811 (6) F 1971 SC1590 (9,10) R 1972 SC 386 (18) RF
1973 SC1011 (25)
ACT:
Income-tax-Compensation received for
surrendering managing agency-If capital or revenue-Test--Income-tax Act, 1922
(11 of 1922), ss. 2(6c), 10, 12.
HEADNOTE:
By an agreement with the Fort William Jute
Company in 1925 the appellant company became its Managing Agent. The terms,
inter alia, were that the appellant or its successors, unless they chose to
resign, were to continue as Managing Agent until they ceased to hold certain
shares in the capital of the company and were on that account removed by a
resolution of the company or their tenure of office was determined by the
winding up of the company. On termination of the agency, the Managing Agent was
to get such reasonable compensation as was agreed upon between the Managing
Agent and the company. Besides this managing agency the appellant held five
other managing agencies. In 1952, the appellant by in agreement with M/s.
Mugneeram Bangur & Co., agreed to relinquished the managing agency of the
Fort William Jute Co., Ltd., in their favour in consideration of M/s. Mugneeram
Bangur and Co. taking over the shares held by the appellant, procuring
repayment of loans advanced by the appellant to the Fort William Jute Company
and further procuring that the Fort William Jute Company. will pay compensation
to the appellant. The appellant intimated the members of the latter company
that it would be in the best interest of the share-holders to terminate the
appellant's agency which would otherwise continue till 1957 and that M/S.
Mugneeram Bengur & Co. had agreed to reimburse the Fort William Jute Co.
Ltd. for payment of Rs. 3,50,000 as compensation to the appellant. The
arrangement with M/s. Mugneeram Bangur & Co. was accepted by the Fort
William Jute Co. and the appellant tendered resignation. M/s. Mugneeram Bangur
and Co. 94 became the Managing agent. The appellant received the sum of Rs.
3,50,000 and credited the sum in its profit and loss account as having been
received from the Fort William Jute Co. Ltd. on account of compensation for
loss of office and in calculating the net profit for the purpose of incometax
for the year 1953-54 did not include this amount in the return. The Income-tax
Officer in assessment included the amount in the appellant's taxable income.
The Assistant Appellate Commissioner on appeal modified the assessment holding
that the sum received by the appellant as compensation for surrendering the
managing agency, which was to enure for five years more and might have
continued for another twenty years, was a capital receipt. The Appellate
Tribunal confirmed the order of the Appellate Assistant Commissioner. At the
instance of the Commissioner of Income-tax the following question was referred
to the High Court:
Whether on the facts and circumstances of the
case the sum of Rs. 3,50,000 received by the assessee to relinquish the
managing agency was a revenue receipt assessable under the Indian Income-tax
Act?.
The High Court answered the question in the
affirmative.
HELD: that the answer should be in the
negative. The transaction in question was not a trading transaction, but one in
which the assessee parted with an asset of enduring value. The compensation
received was compensation for loss of capital. It was inconsequential whether
the appellant conducted the remaining agencies after the determination of the
one in question.
Where payment is made as compensation for
cancellation of a contract which does not affect the trading structure of the
business, nor causes 'deprivation of what in substance is source of income, and
is a normal incident of the business, the compensation is revenue. But where
the cancellation impairs the trading structure or results in loss of the source
of income, the compensation paid for the cancellation of the agreement is
normally capital receipt.
Commissioner of Income-tax Nagpur v. Rai
Bahadur Jairam Yalji, 35 I.T.R. 148, referred to.
Commissioner of Income-tax v. Shaw Wallace
and Co. L.R. 59 I.A. 206, explained.
Raja Bahadur Kamakshaya Narain Singh of
Ramgarh v.
Commissioner of Income-tax, Bihar and Orissa,
L.R. 70 I.A.
180, Commissioner of Income-tax and Excess
Profits Tax Madras v. South India Pictures, 29 I.T.R. 910, Peirce Leslie and
Co. Ltd. v. Commissioner of Income-tax, Madras, 38 I.T.R. 356, Commissioner of
Income-tax, Hyderabad-Deccan v. Vazir Sultan and Sons. 36 I.T.R. 175 and Godrej
& Co. v. Commissioner of Income-tax, Bombay City, 37 I.T.R. 381, discussed.
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 226 of 1963.
95 Appeal from the judgment and order dated
August 1, 1961, of the Calcutta High Court in Income-tax Reference No. 75 of
1956.
S. Chaudhuri, D. N. Mukherjee and D. N.
Gupta, for the appellant.
K. N. Rajagopal Sastri and R. N. Sachthey,
for the respondent.
May 1, 1964. The Judgment of the Court was
delivered by SHAH J.-The appellant is a public limited company. and has its
registered office at Calcutta. By an agreement dated May 1, 1925, the Fort
William Jute Company Ltd. appointed the appellant its managing agent upon
certain terms and conditions set out therein. Under the agreement the appellant
was to receive as managing agent remuneration at the rate of Rs. 3,000 per
month, commission at the rate of ten per cent on the profits of the company's
working, additional commission at three per cent on the cost price of all new
machinery and stores purchased by the managing agent outside India on account
of the company, and interest on all advances made by the managing agent to the
company on the security of the company's stocks, raw materials and manufactured
goods. The appellant and its successors in business, whether under the same or
any other style or firm, unless they resigned their office were entitled to
continue as managing agent until they ceased to hold shares in the capital of
the company of the aggregate nominal value of Rs.
1,00,000 and were on that account removed by
a special resolution of the company passed at an Extraordinary meeting of the
company, or until the managing agent's tenure was determined by the winding up
of the company. In the event of termination of agency in the contingencies
specified, the managing agent was to receive such reasonable compensation for
deprivation of office, as may be agreed upon between the managing agent and the
company and in case of dispute, as may be determined by two arbitrators. By cl.
8, the managing agent was at liberty at any time to resign the office of
managing agent by leaving at the registered office of the company previous notice
in writing of its intention in that behalf. The agreement did not specify any
period for which the managing agency was to enure. Since the successors of the
appellant were also to continue as agents, unless they resigned or became
disqualified, the duration was in a sense unlimited. But by virtue of s.
87-A(2) of the Indian Companies Act, 1913, the appointment of the appellant as
managing agent would expire on January 14, 1957, i.e. on the expiry of twenty
years from the date on which the Indian Companies (Amendment) Act, 1956, was
brought into operation. Section 87-A(2), however, did not prevent the managing
agent from being re-appointed after the expiry of that period.
Beside the managing agency of the Fort
William Jute Co. Ltd.
the appellant held at all material time
managing agencies of five other limited companies, viz., Fort Closter Jute
Manufacturing Co. Ltd., Bowreach Cotton Mills Co. Ltd., Dunbar Mills Ltd.,
Mothola Co. Ltd and Joonktollee Tea Co.
Ltd. The appellant had advanced Rs. 12,50,000
to the Fort William Jute Co. Ltd. on the security of the stocks, raw materials
and manufactured goods of that company. The appellant held in 1952, 600 out of
14,000 ordinary shares of the face value of Rs. 100 each. and 6,920 out of
10,000 preference shares also of the face value of Rs. 100 each.
On May 21, 1952, the appellant entered into
an agreement with M/s Mugneeram Bangur & Co., the principal conditions of
which were:
(i) M/s Mugneeram Bangur & Co. to
purchase the entire holding of shares of the appellant in the Fort William Jute
Co. Ltd.-ordinary shares at Rs. 400 each and preference -,hares at Rs. 185
each, and to make an offer to all holders of the company's shares-preference
and ordinary-to purchase their holdings at the same rates;
(ii) M/s Mugneeram Bangur & Co. to
procure repayment on or before June 30, 1952 of all loans 97 made by the
appellant to the principal company;
(iii) M/s Mugneeram Bangur & Co. to
procure that the principal company will compensate the appellant for loss of
office in the sum of Rs. 3,50,000, such sum being payable to the appellant
after it submitted its resignation as managing agent; and (iv) M/s Mugneeram
Bangur & Co. to reimburse the company the amount payable to the appellant.
The reasons for which the appellant agreed to
relinquish the managing agency were set out in a letter dated May 28, 1952,
addressed by the appellant to the members of the company intimating that M/s
Mugneeram Bangur & Co. were willing to purchase the shares at the same
rates at which they had agreed to purchase the share-holding of the appellant.
It was recited in the letter that the installation of modern machinery in the
company's factory entailed heavy capital expenditure and it was necessary to
obtain a loan secured by debentures charged on the company's property; that
large sums were required for renewals and replacements of machinery and it was
not possible to obtain additional bank accommodation; that the appellant had
maade large advances to the company exceeding Rs. 12,50,000 and, having regard
to its other commitments, it was doubtful if it would be able to make available
to the company addiional finance; that the arrangement with M/s Mugneeram
Bangur & Co., by acceptance of the terms offered by them, was the most
satisfactory method of solving the company's difficulties; that it was in the
best interests of the shareholders to terminate the appointment of the
appellant which in the normal course would not fall due for renewal until
January 14, 1957; that M/s Mugneeram Bangur & Co. had agreed to procure
that the Fort William Jute Co. Ltd. will pay to the appellant Rs.
3,50,000 and that M/s Mugneeram Bangur &
Co. will reimburse the company for the payment, it being anticipated that they
will in Line course be appointed managing agents of the company.
98 The arrangement with M/s Mugneeram Bangur
& Co. was carried out. The appellant tendered its resignation with effect
from July 1, 1952, in pursuance of the terms of the agreement and M/s
Mungneeram Bangur & Co. were appointed as managing agent of the company.
The sum of Rs. 3,50,000 received by the appellant from the company which it is
common ground was provided by M/s Mugneeram Bangur & Co.-was credited in
the profit and loss account of the appellant as received from the Fort William Jute
Co. Ltd. on account of compensation for loss of office. But in arriving at the
net profit in the return for income-tax for the year 1953-54 this amount was
deleted. In the proceedings for assessment for the year 1953-54 the Incometax
Officer, Companies District 1V, Calcutta, included this amount in the
appellant's taxable income. In appeal the Appellate Assistant Commissioner
modified the assessment holding that the sum of Rs. 3,50,000 received by the
appellant as compensation for surrendering the managing agency, which was to
enure for five years more, and which in normal course might have continued for
another term of twenty years, was a capital receipt. The Appellate Tribunal
confirmed the order of the Appellate Assistant Commissioner, observing that compensation
received tinder an agreement for "an outright sale of such an agency to a
third party", not being one which a businessman enters in the normal
course of business, nor being one which amounts to modification, alteration or
discharge of normal incidents of such a business, was not assessable to
income-tax as a revenue receipt.
At the instance of the Commissioner of
Income-tax, the Tribunal referred under s. 66(1) of the Income-tax Act, 1922,
the following question to the High Court of Judicature at Calcutta:
"Whether on the facts and in the
circumstances of the case the sum of Rs. 3,50,000 received by the assessee to
relinquish the managing agency was a revenue receipt assessable under the
Indian Income-tax Act?" 99 The High Court, for reasons which we will
presently set out, answered the question in the affirmative. With certificate
granted by the High Court, this appeal is preferred by the appellant.
This case raises once again the question
whether compensation received by an agent for premature determination of the
contract of agency is a capital or a revenue receipt.
The question is not capable of solution by
the application of any single test: its solution must depend on a correct
appraisal in their true perspective of all the relevant facts. As observed in
Commissioner of Income-tax Nagpur v.
Rai Bahadur Jairam Valji(1) by Venkatarama
Aiyar, J.,:
"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 Jay 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 [(1935) 3 I.T.R. (Engl. Cas.) 17]. That, however is
not to say that the question is one of fact, for as observed in Davies (H. M.
Inspector of Taxes) v. Shell Company of China Ltd. (1952) 22 I.T.R. (Suppl.) 1)
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'." (1) [1959] SUPP. 1 S.C.R. 110, 113.
100 The interrelation of facts which have a
bearing on the question propounded must therefore first be determined. The
managing agency was not, except in the circumstances set out in cl. 2 of the
agreement, liable to be determined at the instance of the company before
January 14, 1957, unless the appellant by giving notice of three weeks
voluntarily resigned the agency. At the date of termination the agency had five
more years to run, and the Companies Act did not prohibit renewal of the agency
in favour of the appellant, after the expiry of the initial period of twenty
years. The appellant company was formed for the object, amongst others, (vide
cl. 3(2) of the Memorandum of Association of the appellant) of carrying on the
business of managing agencies.
The appellant was entitled under the terms of
the agreement to receive so long as the agency enured 'Len per cent of the
profits of the company's working, three per cent on all purchases of stores and
machinery abroad, and a monthly remuneration of Rs. 3,000. The appellant
submitted its resignation in exercise of the power reserved under cl. 8 of the
managing agency agreement, but that resignation was it is common ground part of
the arrangement with M/s Mugneeram Bangur & Co. dated May 21, 1952. Under
the terms of the managing agency agreement, the principal company was not
obliged to pay any compensation to the appellant for voluntary resignation of
the agency, but in consideration of the appellant parting with its shareholding
and submitting resignation of the managing agency so as to facilitate the
appointment of M/s Mugneeram Bangur & Co. as managing agent, the latter
purchased the shareholding of the appellant, undertook to make available Rs.
3,50,000 for payment to the appellant and to discharge the debt due by the
company to the appellant. Payment of Rs. 3,50,000 was therefore an integral
part of an arrangement for transfer of the managing agency. A managing agency
of a company is in the nature of a capital asset: that is not denied. It is
true that it is not like an ordinary asset capable of being transferred from
one person to another. Theoretically the power to appoint or dismiss the
managing agent may lie with the directors of the company, but in practice the
power lies with the person or per101 sons having a controlling interest in the
share-holding of the company. M/s Mugneeram Bangur & Co. were anxious to be
appointed managing agents of the principal company, and for the purpose the
appellant had to be persuaded to agree to a premature termination of its
agency. This was secured for a triple consideration; sale of shares held by the
appellant at an a-reed price, stipulation to discharge the liability of the
company to repay the loans due by the company, and payment of Rs. 3,50,000 as
compensation for termination of the appellant's agency.
The High Court summarised the effect of the
agreement between the appellant and M/s Mugneeram Bangur & Co. as follows:
The sum of Rs. 3,50,000 described as compensation for loss of office of the
managing agent was part of the whole scheme incorporated in the agreement. Each
clause of the agreement was a consideration of the other clauses and payment of
compensation for the alleged loss of office did not, being part of the total
scheme, stand by itself.
Determination of the managing agency of the
appellant was not compulsory cessation of business: it was a voluntary
resignation for which under the agency agreement the appellant was not entitled
to any compensation, but by the device of procuring a purchaser the appellant
was doing "business of selling the managing agency and getting a profit
and value for it which it otherwise could not have got". The High Court
stamped this transaction with the nature and character of a "trading or a
business deal", because in their view the managing agency of a company-an
institution peculiar to Indian business conditions--which creates a managing
agent as an alter ego. of the managed company with authority to utilise the
existing structure of the company's Organisation to carry on business, earn
profits, and in fact, virtually to trade in every possible sphere open to the
company, may. be regarded as circulating capital, where several managing
agencies are conducted by an assessee. Therefore in the view of the High Court
the compensation received for surrendering the agency was remuneration received
on account of conducting the business, and was income. The judgment of the High
Court proceeded substantially upon the following two grounds:
102 (1) that on the facts of the case, the
managing agency held by the appellant of the Fort William Jute Co. Ltd. was
stock-in-trade; and (2) that the appellant was formed with the object of
acquiring managing agencies, and in fact held managing agencies of as many as
six companies. Earning profits by conducting the management of companies, being
the business of the appellant, compensation received as consideration for
surrendering the managing agency was a revenue receipt.
We are unable to agree with the High Court
that the managing agency of the Fort William Jute Co. Ltd. was an asset of the
character of stock-in-trade of the company. The appellant was formed with the
object, among others, of acquiring managing agencies of companies and to carry
on the business and to take part in the management, supervision or control of the
business or operations of any other company, association, firm or person and to
make profit out of it.
That only authorised the appellant to acquire
as a fixed asset, if a managing agency may be so described, and to exploit it
for the purpose of profit. But there is no evidence that the company was formed
for the purpose of acquiring and selling managing agencies and making profit by
those transactions of sale and purchase. A managing agency is not an asset for
which there is a market, for it depends upon the personal qualifications of the
agent. Counsel appearing on behalf of the Commissioner concedes that the case
that the managing agency was of the nature of stock-intrade was not set up
before the Tribunal, and he does not rely upon this part of the reasoning of
the High Court in support of the plea that the compensation received by the
appellant is a revenue receipt. He relies upon the alternative ground, and
contends that the managing agency of the Fort William Jute Co. Ltd. was part of
the framework of the business of earning profit by working as managing agent of
different companies, and in the normal course, termination of employment by the
principal companies of the appellant as managing agent being a normal incident
of such business, compensation received by the appellant is 103 not for loss of
capital, but must be regarded as a trading receipt especially when the
termination of the agency does not impair the structure of the business of the
appellant.
In the present case there is a special circumstance
which must first be noticed. In truth the amount of Rs. 3,50,000 was received
by the appellant from M/s Mugneeram Bangur & Co. in consideration of the
former agreeing to forego the agency which it held and which M/s Mugneeram
Bangur & Co.
were anxious to obtain. It was in a business
sense a sale of such rights as the appellant possessed in the agency to M/s
Mugneeram Bangur & Co. This is supported by the recitals made in cl. 2 of
the agreement that if at any time within six months after the completion of
such sale, M/s Mugneeram Bangur & Co. were unable to exercise the voting
rights attached to the shares purchased by them the appellant will appoint any
person nominated by M/s Mugneeram Bangur & Co.
to attend and vote for them at any meeting of
the company or the holders of any class of shares to be held within such period
in such manner as M/s. Mugneeram Bangur & Co. may decide. The object
underlying the agreement was therefore to transfer he managing agency to M/s
Mugneeram Bangur & Co. or at least to effectuate their appointment in place
of the appelant as managing agent of the Fort William Jute Co. Ltd.
All the stipulations and the covenants of the
agreement, viewed in the light of the surrounding circumstances, do stamp the
transaction as one of surrender of the rights of the appellant in the managing
agency so that corresponding rights may arise in favour of M/s. Mugneeram
Bangur & Co.
It would be irrelevant in considering the
true nature of he transaction, to project the somewhat legalistic consideration
that a managing agency is not transferable. It is because it is not directly
transferable, that the arrangement incorporated in the agreement was effected.
It would be difficult to regard such a transaction relating to a managing
agency as a trading transaction.
Counsel for the assessee contended that even
assuming at the form of the transaction under which for loss of the managing
agency the appellant received compensation from the principal company is
decisive, or has even a dominant 104 impact, and the ultimate source from which
the compensation was provided is to be ignored, the compensation received for
loss of agency by the agent must always be regarded under the Indian Income-tax
Act as capital receipt. In support of that contention counsel placed strong
reliance upon the judgment of the Judicial Committee in Commissioner of
Income-tax v. Shaw Wallace and Co.('). In the alternative, counsel pleaded that
even if the extreme proposition was not found acceptable, the right of the
assessee in the managing agency of the principal company was to enure for
another five years and which in the normal course would have continued for
another twenty years was an enduring asset and consideration received by the
appellant for extinction of that asset was a capital receipt.
On behalf of the Income-tax Department it was
contended that Shaw Wallace & Co's case(') does not lay down any
proposition of general application to compensation paid for determination of
all agency contracts. It was further submitted that, having regard to the
nature of the agreement and the voluntary resignation submitted by the assessee
no enduring asset remained vested in the assessee, and none was attempted to be
transferred: the compensation directly paid by the principal company (which
compensation was under the terms of the contract not payable) was only a
"measure of profit" which the appellant would, but for the
resignation, have earned, and was therefore in the nature of revenue. It was
also urged that compensation was not payaable to the assessee when resignation
of the mainaging agency was tendered under cl. 8 of the agreement, and
therefore the amount sought to be brought to tax was received by the assesseein
the course of a normal trading transaction ofthe assessee.Finally, it was urged
that in any event, bythe loss ofthe agency the framework of the business ofthe
assessee was not at all impaired, and therefore also the compsensation received
must be regarded as revenue and no capital.
Whether a particular receipt is capital or
income from business, has frequently engaged the attention of the court It may
be broadly stated that what is received for loss of capital (1) L. R. 59 I. A.
206 105 is a capital receipt: what is received as profit in trading transaction
is taxable income. But the difficulty arises in ascertaining whether what is
received in a given case is compensation for loss of a source of income, or
profit in a trading transaction. Cases on the borderline give rise to vexing
problems. The Act contains no real definition of income; indeed it is a term
not capable of a definition in terms of a general formula. Section 2(6C)
catalogues broadly certain categories of receipts which are included in income.
It need hardly be said that the form in which the transaction which gives rise,
to income is clothed and the name which is given to it are irrelevant in
assessing the exigibility of receipt arising from a transaction to tax. It is
again not predicated that the income must necessarily have a recurrent quality.
We are not called upon to enter upon an extensive area of enquiry as to what
receipts may be regarded as income generally, but merely to consider in this
case whether receipt of compensation for surrendering the managing agency may
be regarded as capital or as revenue. In the absence of a statutory rule,
payment made by an employer in consideration of the employee releasing him from
his obligations under a service or agency agreement or a payment made
voluntarily as compensation for determination of right to office arises not out
of employment, but from cessation of employment and may not generally
constitute income chargeable under ss. 10 and
12. It may be mentioned that this rule has
been altered by the legislature by the enactment of s. 10(5A) by the Finance
Act of 1955, which provides that compensation or other payment due to or
received by a managing agent of an Indian company at or in connection with the
termination or modification of his managing agency agreement with the company,
or by a manager of an Indian company at or in connection with the termination
of his office or modification of the terms and conditions relating thereto, or
by any person managing the whole or substantially the whole affairs of any
other company in the taxable territories at or in connection with the
termination of his office or the modification of the terms and conditions
relating thereto, or by any person holding an agency in the taxable territories
for any part of the 106 activities relating to the business of any other person,
at or in connection with the termination of his agency or the modification of
the terms and conditions relating thereto, shall be deemed to be profits and
gains of a business carried on by the managing agent, manager or other person,
as the case may be, and shall be liable to tax accordingly.
But this amendment was made under the Finance
Act,, 1955, with effect from April 1, 1955, and has no application to the
present case.
The Indian Income-tax Act is not in pari
materia with the English Income-tax Statutes. But the authorities under the
English Law which deal not with the interpretation of any specific provision,
but on the concept of income, may not be regarded as proceeding upon any
special principles peculiar to the English Acts so as to render them inapplicable
in considering problems arising under the Indian Income-tax Act. It is
well-settled in England that money paid to compensate for loss caused to an
assessee's trade is nor income. In Short Bros. Ltd. v. The Commissioner of
Inland Revenue(l) a sum received as compensation for loss resulting from
cancellation of a contract was held to be revenue in the ordinary course of the
assessee's trade, and liable to excess profits duty. Similarly in The
Commissioners of Inland Revenue v. The North fleet Coal and Ballast Co.
Ltd.('), compensation paid by a person who had agreed to purchase a certain
quantity of chalk yearly for ten years, from a company which was the owner of a
quarry, in consideration of being relieved of his liability under the contract was
held chargeable to excess profits duty as trading profit in the hands of the
company.
In The Commissioners of Inland Revenue v.
Newcastle Breweries Ltd.(3) compensation received under an order of the War
Compensation Court, under the Indemnity Act, 1920, in addition to what was paid
by the Admiralty for rum taken over in exercise of the power under the Defence
of the Realm Regulations was held to be revenue.
(1) 12 T. C. 955 (3) 12 T. C. 927 (2) 12 T.
C. 1102 107 In Ensign Shipping Co. Ltd. v. The Commissioner of Inland
Revenue(') an amount paid by the Government to a ship-owner to compensate him
for loss resulting from detention of his ships during a coal-strike, and for
wages etc. was held liable to excess profits duty. Again as held in Burma Steam
Ship Co. Ltd. v. Commissioners of Inland Revenue(') money received by a
ship-owner from a firm of ship-builders to compensate for loss resulting from
the failure by the latter to complete repairs to a ship within the stipulated
period was regarded as revenue.
These cases illustrate the principle that
compensation for injury to trading operations, arising from breach of contract
or in consequence of exercise of sovereign rights, is revenue. These cases
must, however, be distinguished from another class of cases where compensation
is paid as a solatium for loss of office. Such compensation may be regarded as
capital or revenue: it would be regarded as capital, if it is for loss of an
asset of enduring value to the assessee, but not where payment is received in
settlement of loss in a trading transaction.
In Chibbet v. Joseph Robinson & Sons 3)
the assessees who were ship-managers employed by a steamship company under a
contract which provided that they should be paid a percentage of ,he company's
income, were paid compensation for loss of office in anticipation of
liquidation of the steamship company. It was held that payment to make up for
loss resulting from cessation of profits from employment was not itself an
annual profit, but was payment in respect of termination of employment and was
not assessable to tax.
In Du Cros v. Ryall (4) the assessee settled
a claim made by his employee for damages for wrongful dismissal and paid 57,250
as compensation for wrongful dimissal. It was held that no. part could be apportioned
to salary and commission and the whole escaped assessment.
In Duff v. Barlow(') the managing director of
the appellant company who was employed for a period of ten (1) i2 T. C. 1169.
(3) 9 T. C. 48.
(2) 16 T. C. 67.
(5) 23 T. C. 631. (4) 19 T. C444.
108 years was asked by it to manage the
business of one of its subsidiaries, and to receive a percentage of profits
made by the subsidiary. The employment was terminated by mutual agreement two
years after its commencement and 4,000 were paid as compensation to the
managing director for loss of his rights of future remuneration. This was held
not taxable. because it was a sum paid as compensation for loss of a source of
income and hence a capital asset. This case was followed in Henley v. Murray(')
where the appellant employed as a managing director of a property company under
a service agreement which was not determinable till March 31, 1944, was also
appointed a director of a subsidiary company. At the request of the Board of
directors of the property company the appellant resigned his office in the
property company as well as its subsidiary and received from the property
company an amount equal to the remuneration which he would, under the
agreement, have been entitled to, if his appointment had not been determined.
It was held by the Court of Appeal that the use of the expression
"compensation for loss of office"' was not the determining factor
when the bargain itself stood cancelled, and the sum paid was in consideration
of total abandonment of all contractual rights which the other party had. The
receipt was in the circumstances not taxable.
The payment was not voluntarily made; the
bargain was that the appellant should resign and in consideration thereof, In
Barr, Grombie and Co. Ltd. v. Commissioners of Inland Revenue(') the appellant
company managed the ships of another company under an agreement for a period of
fifteen years. The shipping company went into liquidation and a sum exceeding
pound 16,000 was paid to the appellant company for the eight years which were
still to run to the date of expiry of the agreement. Over a period upwards of
sixteen years only two per cent of the appellant company's income was derived
from other managements, and on the liquidation of the shipping company the
appellant company lost its entire business except for some abnormal and
temporary business. It was held by the Court of Session (1) 31 T. C. 351 (2) 26
T. C. 406 109 in Scotland that the sum in question was not a trading receipt of
the appellant company. Lord President Normand observed:
"In the present case virtually the whole
assets of the Appellant Company consisted in this agreement. When the agreement
was surrendered or abandoned practically nothing remained of the Company's
business. It was forced to reduce its staff and to transfer into other
premises, and it really started a new trading life. Its trading existence as
practised up to that time had ceased with the liquidation of the shipping
Company." These cases establish the distinction between compensation for
loss of a trading contract and solatium for loss of the source of income of the
assessee.
But payment of compensation for loss of
office is not always regarded as capital receipt. Where compensation is payable
under the terms of the contract, which is determined, payment is in the nature
of revenue and therefore taxable.
For instance in Henry v. Foster(') it was
held that when compensation stipulated under a contract is paid for loss of
office, it is taxable under Sch. 'E', and it was also held in Dale v. De
Soissons(2) that compensation paid under an agreement to an Assistant of the
managing director for premature termination of employment was held to be
income.
The principle on which these cases proceeded
was also applied by the Court of Session in Scotland in Kessal Parsons and Co.
v. Commissioners of Inland Revenue(3) to a case in which there was no express
term for payment of compensation on termination of employment. The appellants
in that case carried on business as agents on a commission basis for sale in
Scotland of the products of various manufacturers, and entered into agency
agreements for that purpose. At the instance of the manufacturer concerned, one
of the agreements which was for a period of three years was terminated at the end
of the (1) (1931) 145 L. T. R. 225 (3) 21 T. C. 608, 520 (2) [1950] 2 All E. R
460 110 second year in consideration of a payment of pouns_ 1,500.
It was held by the Court of Session that no
capital asset of the assessee was depreciated in value, or became of less use
for the purpose of the assessee's business. The sum paid was accordingly
included in the calculation of the taxable profits for the year in which it was
received. Lord President Normand Observed.
"We are not embarrassed here by the kind
of difficulties which arise when, by agreement, a benefit extending over a
tract of future years is renounced for a payment made once and for all. The sum
paid in this case is really and substantially a surrogatum for one year's
profits." The foundation of the distinction made in Kelsall Parsons and
Co.'s case('): Henry v. Foster('): and Dale v. De Soissons(3) is to be found in
the observations made by Lord Macmillan in Van Den Berchs Ltd. v. Clark('). In
that case two companies which were manufacturers of ,margarine an margarine and
similar products entered into an agreement with a view to end competition
between them and to work in friendly alliance and to share the profits and
losses in accordance with an elaborate scheme. This arrangement was terminated
by mutual agreement in consideration of the payment by the Dutch company pound
450,000 to the appellant company as damages. It was held by the House of Lords
that the amount was received by the appellant as payment for cancellation of
the appellant company's future rights under the agreements, which constituted a
capital asset of the company, and that it was a capital receipt. lord Macmillan
observed.
"Now what were the Appellants giving up?
They gave up their whole rights under the agreements for thirteen years ahead.
These agreements are called in the States
Case "pooling agreements", but that is a very inadequate description
of them, for they did much more than (1) 21 T.C. 608,620 (2) [1931] 145 L.T.R.
225 (3) [I950] 2 All E.R. 460 (4) 19 T. C.
390, 431 111 merely embody a system of pooling and sharing profits. If the
Appellants were merely. receiving in one sum down the aggregate of profits
which they would otherwise have received over a series of years, the lump sum
might be regarded as of the same nature as the ingredients of which it was
composed. But even if a payment is measured by annual receipt, it is not
necessarily in itself an item of income." Cases which have lately arisen
before the Courts in the United Kingdom have elaborated this distinction. In
Commissioner of Inland Revenue v. Fleming and Co.(') the Court, of Session held
following Kelsall Parsons & Cos' case('), that compensation paid to the
assessee who carried on business as manufacturers' agent and general merchants
and had acted as the sole agents since 1903 for certain products of the
manufacturers for termination in 1948 of the agency at the instance of the
manufacturers was regarded as revenue. In the view of Lord President Cooper the
cases relating to determination of agencies, broadly speaking, fell on two
sides of the line drawn in the light of the varying circumstances:
(a) "the cancellation of a contract
which affects the profit-making sructure of the recipient of compensation and
involves the loss of an enduring trading asset"; and (b) "the
cancellation of a contract which does not affect the recipient's trading
structure nor deprive him of any enduring trading asset, but leaves him free to
devote his energies and Organisation released by the cancellation of the contract
to replacing the contract which has been lost by other like contracts",
and held that the case fell within the second class, and not the first.
In Wiseburgh v. Domville(3) the appellant had
entered into an agreement in 1942 under which he acted (1) 33 T. C. 57 (3) 36
T. C. .527 (2) 21 T.C. 608, (20 112 as sole agent for the manufacturer. In 1948
when this agreement could have been determined by notice expiring in October
1949, the manufacturer dismissed him. The appellant received pound 4,000 as
damages for breach of agreement.
The appellant had several agencies from time
to time as agents and it was one of the incidents of agency business that one
agency may be stopped and another may come and it being a normal incident of
the kind of business that the appellant was doing, that an agency should come
to an end, compensation paid was regarded as income on the principle laid down
in Kelsall Parsons and Co.'s case(').
In another case which soon followed-Anglo
French Exploration Co. Ltd. v. Clayson(2)-the appellant company carried on
business, among others, is secretary and agent for a number of other companies.
A South African Company appointed the appellant company as its secretary and
agent at a remuneration of pound 1,500 per annum tinder a contract terminable at
six months' notice. Under an arrangement with the purchaser of the controlling
interest of the shareholders under which the appellant company was to resign
its office as secretary and agent of the South African Company, an amount of
pound 20,000 received by the appellant company was held by the Court of Appeal
in the nature of a trading receipt.
In Blackburn v. Close Bros. Ltd.(') the
respondent company carried on business of merchant bankers and of a finance and
issuing house and derived income in the form of allowances for performing
managerial and secretarial services.
Following a dispute with one 'S' for which
the respondent company had agreed to provide secretarial services for three
years at a remuneration of pound 8,000 per annum, the agreement was terminated
within about 2-1/2 months from the date of its commencement. pound 15,000
received by the respondent company as compensation for termination of the
agreement was held to be a trading receipt. Pennycuick J., held that the
contract was one of a number of ordinary commercial contracts for rendering (2)
36 T. C. 545 (1) 21 T.C. 608, 620 39 T.C. 164 113 services by the assessee in
the course of carrying on its trade, and therefore the sum received on the
cancellation of the agreement was a receipt of a revenue nature.
It is manifest that the principle broadly
stated in the earlier cases, that compensation for loss of office, or agency,
must be regarded as a capital receipt, has not been approved in later cases. An
exception has been engrafted upon that principle that where payment even if
received for termination of an agency agreement, the agency is one of many
which the assessee holds, and the termination of the agency does not impair the
profit making structure, but is within the framework of the assessee's
business, it being a necessary incident of the business that existing agencies
may be terminated and fresh agencies may be taken, the receipt is revenue and
not capital.
A case on the other side of the line may be
noticed: Sabine v. Lookers Ltd.('). Under agreements, annually renewed with the
manufacturers, the respondent company had acted for many years as their main
distributors in the Manchester area of the manufacturers' products, which it
bought for resale.
The respondent had sunk considerable sums in
fixtures and equipment specially designed for the trade of wholesale dealers
and carried a large stock of spare parts mainly for wholesale sale. The whole
of the trade of the respondent was geared to the display, sale, service and
repairs of the manufacturers' products. Upto 1952 inclusive,, the manufacturers
had included in its agreements with distributors a standard "continuity
clause, giving the distributors, on certain conditions, the option of renewal
for a further year. But in 1953, the manufacturers adopted a new standard
agreement, containing a new continuity clause which the respondent company
regarded as giving it less security than before. As compensation for loss
resulting from the alterations, the manufacturers paid to the respondent
company, a sum calculated on sales to the trade during the contract period. It
was held that this was a capital receipt, because, by the, modification the
framework of the respondent's business was impaired.
(1) 38 T. C. 120 114 Elaborate arguments were
presented before us on the decision of the Judicial Committee in Shaw Wallace
& Co.'s Case(').
The appellant contended that Shaw, Wallace's
Case(') laid down a principle of general application applicable to all cases of
compensation received from the principal as solatium for determination of the
contract of agency.
Counsel for the Revenue contended that the
principle should be restricted to its special facts, and cannot be extended in
view of the later decisions. It is necessary to closely examine the facts which
gave rise to that case. Shaw Wallace & Company carried on business as
merchants and agents of various companies and had branch offices in different
paris of India. For a number of years they acted as distributing agents in
India for the Burma Oil Company and the Anglo-Persian Oil Company, but without
a formal agreement with either company. The two Oil Companies having combined
decided to make other arrangements for distributing their products. Each
Company terminated its contract with Shaw Wallace & Company and paid
compensation to it, which aggregated to Rs. 15,25,000. This amount, subject to
certain allowances, was sought to he assessed to income-tax under ss. 10 and
12. The High Court of Calcutta held that the compensation received by the assessee
was a capital receipt. In appeal to His Majesty in Council the decision of the
High Court was affirmed.
The Judicial Committee declined to seek
inspiration from the English decisions cited at the Bar. The Board observed
that the expression "income" which is not defined in the Act connotes
a periodical monetary return coming in with some sort of regularity, or
expected regularity, from definite sources: the source is not necessarily one
which is expected to be continuously productive, but it must be one whose
object is the production of a definite return, excluding anything in the nature
of a mere windfall. They further observed that the income chargeable under head
(iv) of s. 6 business" read with s. 10 is to be in respect of the profits
and gains of any business carried on by the assessee, and therefore the sums
which the Income-tax Department sought to charge could only be taxable if they
were the pro(1) L.R. 59 I.A. 2o6.
115 duce or the result of-carrying on the
agencies of the Oil Companies in the year in which they were received by the
assessee. But when once it was admitted that they were sums received, not for
carrying on this business, but as some sort of solatium for its compulsory
cessation, the answer seemed fairly plain. The Board observed that if compensation
received for sale of the business or its goodwill was capital, the same
reasoning ought to apply when the sum received was in the nature of a solatium
for cessation of a part of the business, and it was a matter of no consequence
that the assessee continued to pursue its other independent commercial
interests, and profits from which were taxed in the ordinary course, for the
sums sought to be taxed had no connection with the continuance of the
assessee's other business: the profits earned by the assessee, it was observed,
were "the fruit of a different tree, the crop of a different field",
and if under s. 10 the compensation was not taxable, it was not taxable under
s. 12 under the head " other sources" as well.
The judgment of the Board proceeds upon the
ground that compensation received not for carrying on the business, but as
solatium for its compulsory cessation, would be regarded as capital receipt,
and for the application of this principle, existence of other independent commercial
interests out of which profits were earned by the assessee was irrelevant. Two
comments may be made at this stage. It cannot be said as a general rule, that
what is determinative of the nature of the receipt is extinction or compulsory
cessation of an agency or office. Nor can it be said that compensation received
for extinction of an agency may always be equated with price received on sale
of goodwill of a business. The test, applicable to contracts for termination of
agencies is: what has the assessee parted with in lieu of money or money's
worth received by him which is sought to be taxed? If compensation is paid for
cancellation of a contract of agency, which does not affect the trading
structure of the business of the recipient, or involve loss of an enduring
asset, leaving the tax-payer free to carry on his trade released from the
contract which is cancelled, the receipt will be a trading receipt: where the
cancellation 116 of a contract of agency impairs the trading structure, or
involves loss of an enduring asset, the amount paid for compensating the loss
is capital.
The view expressed by the Judicial Committee
has not met with unqualified approval in later cases, Lord Wright in Raja
Bahadur Kamakshya Narain Singh of Ramgarh v. Commissioner of Income-tax. Bihar
and Orissa(') observed that it is incorrect to limit the true character of
income, by such picturesque similies like "fruit of a different tree, or
crop of a different field". Again it cannot be said generally that
compensation for every transfer or determination of a contract of agency is
capital receipt:
Kelsall Parsons & Co. v. Commissioner of
Inland Revenue('):
Commissioners of Inland Revenue v. Fleming
& Co. (3): Wiseburgh v. Domville(4) and Commisiosner of Income-tax and
Excess Profits Tax, Madras v. South India Pictures Ltd.(').
Nor is it true to say that where an assessee
holds several agency contracts, each agency contract cannot without more be
regarded as independent of the other contracts, and income received from each
contract cannot always be regarded as unrelated to the rest of the business
continued by the assessee. The decision in Shaw Wallace Co.'s case(') cannot
therefore be read to yield the principle that compensation for loss of an
agency may in all cases be regarded as capital receipt. Nor does it lay down
that where the assessee has several lines of business each line must in
ascertaining the character of compensation for loss of a line of business be
deemed an independent source. This view is exemplied by decisions of this Court
and a decision of the Madras High Court. In the South India Pictures Ltd.'s
case(5) compensation received for determination of the distribution rights of
films was held taxable. After the assessee had exploited partially its right of
distribution of cinematographic films to which it was entitled under the terms
of agreement under which he had advanced money to the producers, the agreements
were cancelled and the producers paid an aggregate sum of Rs. 26,000 to the
assessee towards commission. It was held by Das C. J., (1) L. R, 70 1. A. 180
(2) 21 T.C. 608, 620 (3) 33 T.C. 57 (4) 36 T.C. 527 (5) 29 1. T. R. 910 (6)
L.R. 59 I.A. 2o6 117 and Venkaterama Aiyar, J., (Bhagwati J., dissenting) that
the sum paid to the assessee was not compensation for not carrying on its
business, but was a sum paid in the ordinary course of business to adjust the
relations between the assessee and the producers, and was taxable. Similarly in
Rai Bahadur Jairam Valji's cave(') a contract for the supply of limestone and
dolomite was terminated when the purchaser the Bengal Iron Company Ltd. found
the rates uneconomical.
A suit was then filed by the respondent for
specific performance of the contract and for an injunction restraining the
company from purchasing limestone and dolomite from any other person. A fresh
agreement made between the respondent and the company fell through because of
circumstances over which the parties to the agreement had no control. The
company then agreed to pay Rs. 2,50,000 to the respondent as solatium, besides
the monthly instalments of Rs. 4,000 remaining unpaid under the contract of
1940.
The Income-tax Department sought to bring to
tax the amount of Rs. 2,50,000 and the balance due towards the monthly
instalments of Rs. 4,000. It was held by this Court that the sum of Rs.
2,50,000 was not paid to the respondent as compensation for expenses laid out
for works at the quarry of a capital nature and could not be held to be a
capital receipt on that account, the agreements were merely adjustments made in
the ordinary course of business. There was in the view of the Court no
profit-making apparatus set up by the agreement of 1941, apart from the
business which was to be carried on under it and there was at no time any
agreement which operated as a bar to the carrying of the business of the
respondent and therefore the receipt of Rs.
2,50,000 was chargeable to tax. Venkatarama
Aiyar, J., observed, in at,agency contract the actual business consists of
dealings between the principal and his customers, and the work of the agent is
only to bring about the business: what he does is not the business itself, but
something which is intimately and directly linked up with it. The agency may,
therefore, be viewed as the apparatus which leads to the business rather than
the business itself. Considered in this light the (1) [1959] Supp. 1 S.C.R. 110
118 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 something outside it, and any receipt on account of such a contract
can only be a trading receipt. Because compensation paid on the cancellation of
a trading contract differs in character from compensation paid for cancellation
of an agency contract, it should not be understood that the latter is always,
and as a matter of law, to be held to be a capital receipt. 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 asset in the hands of another, as
for example, when the agent is found to make a trade of acquiring agencies and
dealing with them." Therefore, when the question arises whether the
payment of compensation for termination of an agency is a capital or a revenue
receipt, it must be considered whether the agency was in the nature of a
capital asset in the hands of the agent, or whether it was only part of his
stock-in-trade.
The learned Judge also observed that payments
made in settlement of rights under a trading contract are trading receipts and
are assessable to revenue, but where a trader is prevented from doing so by
external authority in exercise of a paramount power and is awarded compensation
therefor, whether the 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 stock-in-trade.
In Pairce Leslie and Co. Ltd. v. Commissioner
of Income-tax, Madras(') the assessee company took up managing agencies of
several plantation companies. The managing agencies were liable to termination,
but the assessee was entitled to compensation by the terms of the agreement.
The Talliar Estates Ltd. was one of the companies managed by the assessee. The
agreement was a composite agreement about the managing agency rights and
certain other rights. When the Talliar Estates Ltd. went into liquidation the
assessee received Rs. 60,000 by way of compensation for loss of office and the question
arose (1) 38 I. T. R. 356 119 whether that amount was income in the hands of
the assessee.
The Madras High Court held that the loss of
one of several managing agencies had little effect on the structure of the
assessee's business even in tea or on its profit earning apparatus as a whole
and the termination of the agreement with the Talhar Estates could well be said
to have been brought about in the ordinary course of business of the assessee
and therefore the amount received was a trading receipt.
In the South India Picture Ltd.'s case(): Rai
Bahadur Jairam Valji's case(') and Peirce Leslia Company's case(') it was held
that the receipt of compensation for loss of agency was in the nature of
revenue. In the South India Pictures Ltd.'s case(') the amount received was not
compensation for not carrying on its business, but was a sum paid in the
ordinary course of business to adjust the relations between the assessee and
the producers; the termination of the agreements did not radically or at all
affect or alter the structure of the assessee's business, and the amount
received by the assessee was only so received towards commission i.e. as
compensation for the loss of commission which it would have earned, had the
agreements not been terminated. Therefore, the amount was not received by the
assessee as the price of any capital assets sold or surrendered or destroyed,
but the amount was simply received by the assessee in the course of its going
distributing agency business and therefore it was an income receipt. In that
case the majority of the Court held on three distinct grounds, viz., (i) that
the assessee did not part with any capital asset; (ii) that the amount was
received in the course of the distributing agency business which was continued,
and (iii) that the termination of the agreements did not radically or at all
affect or alter the structure of the assessee's business, that the sum received
was revenue.
Rai Bahadur Jairam Valji's case(') was one of
compensation received for termination of a trading contract. In Peirce Leslie
and Company's case(') there was termination of office, but it was held to be
brought about in the ordinary course of the trading operations of the assessee.
(i) 29 I.T.R. 910 (2) [1959] Supp. I S.C.R.
iio (338 I.T.R. 356 120 On the other side of the line are cases of Commissioner
of Income-tax, Hyderabad-Deccan v. Vazir Sultan and Sons(') and Godrej and Co.
v. Commissioner of Incometax, Bombay City (2). In Vazir Sultan and Son's
case(') the majority of the Court held that compensation paid for restricting
the area in which a previous agency agreement operated was a capital receipt,
not assessable to incometax. It was held that the agency agreements were not
entered into by the assessee in the carrying on of their business, but formed
the capital asset of the assessee's business which was exploited 'by the
assessee by entering into contracts with various customers and dealers in the
respective territories; it formed part of the fixed capital of the assesssee's
business and was not circulating capital or stockin-trade of their business and
therefore payment made by the company for determination of the contract or
cancellation of the agreement was a capital receipt in the hands of the
assessee.
In Godrej and Co.'s case(') the managing
agency agreement in favour of the assessee of a limited company which was
originally for a period of thirty years and under which the assessee was
entitled to a commission at certain rates was modified and remuneration payable
to the managing agents was reduced. As compensation for agreeing to this
reduction, the assessee received Rs. 7,50,000 which was sought to be taxed as
income in the hands of the assessee. This Court held, having regard to all the
attending circumstances, that the amount was paid not to make up the difference
between the higher remuneration and the reduced remuneration, but in truth as
compensation for releasing the company from the onerous terms as to
remuneration as it was in terms expressed to be; so far as the assessee firm was
concerned it was received as compensation for the deterioration or injury to
the managing agency, by reason of the release of its rights to get higher
remuneration and, therefore, a capital receipts.
On an analysis of these cases which fall on
two sides of the dividing line, a satisfactory measure of consistency (1) 36 1.
T. R. 175 (3) 36 I.T.R. 175 (2) 37 r.T.R. 381 121 in principle is disclosed.
Where on a consideration of the -circumstances, payment is made to compensate a
person for cancellation 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.
In the present case, on a review of all the
circumstances, we have no doubt that what the assessee was paid was to
compensate him for loss of a capital asset. It matters little whether the
assessee did continue after the determination of its agency with the Fort
William Jute Co.
Ltd to conduct the remaining agencies. The
transaction was not in the nature of a trading transaction, but was one in
which the assessee parted with an asset of an enduring value. We are,
therefore, unable to agree with the High Court that the amount received by the
appellant was in the nature of a revenue receipt.
We accordingly record the answer on the
question submitted by the Tribunal in the negative. The appellant would be
entitled to its costs in this Court.
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