Commissioner of Income Tax Bombay City
Vs. Chunilal Vs. Mehta and Sons (P) Ltd.  INSC 188 (11 August 1971)
CITATION: 1972 AIR 268 1972 SCR (1) 117 1971
SCC (3) 587
CITATOR INFO :
RF 1991 SC 686 (16) RF 1991 SC 999 (14)
Income-tax Act, 1922, s. 10
(5-A)-Compensation received on termination of managing agency taxable under
section-Section enacted by Finance Act, 1955--Managing Agency terminated on
April 23, 1951-Suit for compensation under agreement filed by managing
agents-Compensation amount as determined by High Court received by managing
agents in December 1955-Managing agents maintaining accounts on mercantile
basis-Compensation amount when falls due? -Whether taxable in assessment year
The assessee held the managing agency of a
public limited company Under the agreement the assessee was to continue as
managing agents for a minimum period of 21 years. On April 23, 1951 the
Directors of the managed company passed a resolution terminating the services
of the assessee as managing agents. This resolution was affirmed by the
shareholders at their extraordinary general meeting held on May 23, 1951. There
was dispute about the compensation payable to the assessee. In a suit filed by
the latter the trial judge as well as the Appellate Bench of the Bombay High
Court held that under the terms of the agreement the assessee was only entitled
to liquidated damages at the rate of Rs. 6000 per month for the unexpired
period of the agency namely 3 years 2 months and 7 days. The suit was decreed
for Rs. 2,34,000 on November 17, 1955 and the assessee received the amount in
December 1955. The assessee contended before the Income-tax Officer that as it
maintained accounts on the mercantile system and the amount had become due in
1951 the same could not be taxed in the assessment year 1956-57 under s.
10,(5A) of the Income-tax Act, 1922. Before the said section was introduced
into the Act by the Finance Act, 1955 compensation received on termination of a
managing agency was treated as a capital receipt; after its enactment such
compensation became taxable as income. The section was not retrospective, so
that if the assessee's plea that the compensation amount accrued in 1951 was
accepted it could not be treated as income at all. The Income-tax Officer and
the Appellate Assistant Commissioner rejected the plea. The Tribunal however
held that on the facts and circumstances of the case the compensation became
due to the assessee on April 23, 1951 and therefore it could not be brought to
tax in the assessment year 1956-57. The High Court in reference held that the
amount was not taxable but the interest thereon could be taxed in 1956-57. The
HELD: (i) It was rightly held by the High
Court that the assessee was entitled under the agreement to liquidated damages
at the rate of Rs. 6,000 per month for the unexpired period of the managing
118 As such the assessee's right to get the
compensation arose on April 23, 1951 when the resolution terminating the
managing agency was passed. [123A-B] (ii) Section 10 (5A) refers to 'payment
due or received'.
The expression 'due to' refers to those
assessees who maintain their accounts according to the mercantile system of
accountancy and the expression received by' applies to those assessees who
adopt the cash system of accountancy.
Since the assessee in the present case
maintained the mercantile system of accounting the relevant assessment year for
the compensation accruing on April 23, 1951 was the succeeding assessment year.
[123 C-D, H] Commissioner of Income-tax, Madras V. A. Gajapathy Naidu, 53
I.T.R. 114, applied.
(iii) The plea on behalf of the Revenue that
the right to get the amount arose when the quantum of compensation was
determined by the High Court, could not be accepted. The fact that the assessee
was claiming an exorbitant sum to which it was not entitled would not convert
its right into a contingent right. [124 E-G] Thiagaraja Chettiar & Co. v.
Commissioner of Income-tax, Madras, 51 I.T.R. 393 and F. E. Hardosstle &
Co. (P) Ltd. v. Commissioner of Income-tax, Bombay City 1, 47 I.T.R. 394,
(iv) The plain and unambiguous words of s. 10
(5A) which had become an integral part of the Act, lent no support to the plea
that by a legal fiction the compensation must be deemed to have accrued to the
assessee in December 1955. The fact that the assessee included the receipt in
question in its profit and loss account in the year 1955 was a wholly
immaterial circumstances. That circumstance did not afford any basis for the
argument that for this particular receipt the assessee adopted a different
system of accountancy.
Obviously the entry was delayed because of
What is relevant is the method of accounting
and not the actual entries. [125E-G]
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 1535 of 1968.
Appeal by special leave from the judgment and
order dated March 1, 1967 of the Bombay High Court in Income-tax Reference No.
52 of 1962.
M. C. Chagla, A. K. Verma, J. B. Dadachanji,
O. C. Mathur and Ravinder Narain, for the respondent.
The Judgment of the Court was delivered by
Hegde, J. In this appeal by special leave, the questions that arise for
decision relate to the taxability under S. 10 119 (5A) of the Indian Income-tax
Act, 1922 (in brief 'the Act') of a certain amount received by the assessee
firm as compensation on the termination of its managing agency.
The assessee is a Private Limited Company and
at the relevant time,, it was under voluntary liquidation. It was incorporated
in June 1945 by converting an erstwhile partnership firm into a Private Limited
Company. The partnership firm had entered into a managing agency agreement on
June 15,1933 with a Public Limited Company called "The Century Spinning
and Manufacturing Co. Ltd." Under the said agreement, the assessee was to
continue as managing agents for a minimum period of 21 years and thereafter
until that firm chose to resign its office or is removed from office by the
managed company. During the period of 21 years stipulated in the agreement, the
managed company had no right to remove the managing firm from its office except
for reasons mentioned in the, agreement.
During the period the assessee continued to
act as the managing agents the agreement provided, that the managing agents
will get a minimum remuneration of Rs. 6,000/a month and if its remuneration is
found at the close of the year to be less than 10 per cent of the gross profit
of the company, the managing agents were to be paid a further additional sum to
make the aggregate remuneration received by it equal to 10 percent of the gross
profit of the company for that year. The Agreement further provided that if the
managing agents' services were terminated before the period of 21 years
stipulated in the agreement except for reasons mentioned in clause 15 of the
agreement the managing agents would be entitled to receive from the managed
company as compensation or liquidated damages for the loss of office the sum
mentioned in clause 14 of the agreement.
In about April 1951, a large holding of the
managed company was acquired by a group of shareholders who were hostile to the
managing agents. Thereafter the relationship between the managing agents and
the managed company became strained.
On April 23, 1951, the Directors of the
managed company passed a resolution terminating the services of the assessee
firm as managing agents. This resolution was affirmed by the shareholders at
their extraordinary general meeting held on May 23, 1951 In 9-M 1245 SupCI/71
120 pursuance of the resolution, the Board of Directors on April 23, 1951, a
notice of termination of the managing agency was issued to the managing agents.
In reply the assessee ,claimed compensation of Rs. 50 lacs for the unlawful
termination of its services. But the managed company was prepared to pay Rs.
2,34,000/as compensation calculating the compensation at Rs. 6,000/a month for
the unexpired period of the agency i. e. 3 years 2 months and 7 days and Rs.
4600/as remuneration for the 23 days of April 1951.
The assessee refused to accept that amount.
Thereafter the assessee sued the managed company on the original side of the
Bombay High Court claiming a sum of Rs. 28 lakhs as compensation for the
unlawful termination of its services.
The managed company resisted that suit. The
suit was decreed on November 17, 1955 in the sum of Rs. 2,34,000/and that
decree was affirmed in appeal. The trial judge as well as the appellate Bench
held that under the terms of the agreement the assessee was only entitled to
liquidated damages at the rate of Rs. 6,000/per month for the unexpired term of
its agency. The assessee received the amount decreed in December, 1955.
Till the insertion of S. 10 (5A) into the Act
by the Finance Act of 1955 (Act 15 of 1955), compensation received by a
managing agent for the termination of his agency was considered as a capital
receipt, but S. 10 (5A) provided that any 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 shall be deemed to be profits and gains of a business carried on by the
managing agent, and shall be liable to tax accordingly. This provision is not
retrospective in operation.
As seen earlier, the compensation with which
we are concerned in this case was received by assessee in December, In the
assessment year 1956-57, the Income-tax Officer overruling the objections of
the assessee included the said amount as the profits of the business of the
assessee during the previous year. Admittedly the assessee maintained its
accounts according to mercantile system of accountancy., The assessee's
contention before the Income-tax Officer that the receipt in question cannot be
brought 121 to tax in the assessment year 1956-57 as it became due in 1951 was
rejected by the Income-tax Officer. In appeal the Appellate Assistant
Commissioner agreed with the view taken by the Income-tax Officer. He opined
that the amount became due to the assessee only when it was decreed by the High
Court on November 17, 1955 and therefore it was assessable in the assessment
year 1956-57. But on a further appeal, the Tribunal held that on the facts and
in the circumstances of the case, the compensation in question became due to
the assessee on April 23, 1951 and therefore it could not be brought to tax in
the assessment year 1956-57. At the instance of the Commissioner, the Tribunal
submitted under s. 66 (1) of the Act, the following two questions of law for
the opinion of the High Court "1. Whether on the facts and in the
circumstances of this case the compensation for termination of the managing
agency accrued to the assessee on 23rd April 1951 ?
2. Whether on the facts and in the
circumstances of this case the compensation of Rs. 2,34,000/and interest
thereon was taxable under s. 10 (5A) of the Indian Income-tax Act, in the
assessment year 1956-57?" The High Court answered the first question in
the affirmative and the second question as follows :
The amount of compensation of Rs. 2,34,000/will
not be liable to tax, but the amount ofinterest thereon will be taxable under
s. 10,(5A) in the assessment year 1956-57 Aggrieved by that decision, the
Commissioner of Income-tax, Bombay City has brought this appeal.
We shall first address ourselves to the
question as to whether on the facts and in the circumstances of this case, the
compensation for termination of the managing agency accrued to the assessee on
April 23, 1951 ? The answer to this question depends upon the true effect of
the terms of the agreement between the managing agents and the managed company.
There is no dispute that the termination of the managing agency did not fall
within the scope of clause 15 of the agreement which provides that the managing
agent shall not be entitled to receive from the company 122 any compensation
for the loss of the office of Agents to the company if such loss arises from
any of the causes mentioned therein. It is clear-that was also the view taken
by the High Court in the suit filed by the assessee against the managed
company-that the, assessee was entitled to get compensation under clause 14 of
the agreement. That clause provides :
"In case the firm shall be deprived of
the office of Agents of the. company for any reason or cause other than or
except those reasons or causes specified in clause fifteen of these presents
the firm shall be entitled to receive from the Company as compensation or
liquidated 'damages for the loss of such appointment a sum equal to the
aggregate amount of the monthly salary of not less than Rupees six thousand,
which the Firm would have been entitled to receive from the company for and
during the whole of the then unexpired portion of the said period of twenty one
years if the said Agency of the Firm had not been determined." In the suit
filed by the assessee against the managed company, the only controversy between
the parties was whether that clause should be read alongwith clause 10 of the
agreement which provided for the payment of remuneration to the managing agents
during the continuance of the Managing agency agreement or whether the
compensation payable should be determined solely on the basis of clause
14. Replying on the expression "not less
than Rs. 6000/-" in clause 14, the assessee contended that Rs. 6,000/referred
to in the clause is merely the minimum but the actual compensation should be
determined in the manner provided in clause 10. The High Court rejected that
contention. According to the High Court clause 14 not only provided for the
payment of damages for improper termination of the services of the managing
agents but it also stipulated the damages to which they were entitled to. In
its opinion that clause had quantified the damages to which the managing agents
were entitled to. It opined that the damages payable to the assessee firm were
liquidated damages., The High Court further held that the 123 expression
"not less than Rs. 6,000/-" means a definite sum of Rs. 6,000/-,
neither more nor less. We are in entire agreement with the view taken by the
High Court in that suit. It is plain from the language of clause 14 of the
agreement that the assessee was entitled to a definite sum under that clause.
In other words it was entitled to liquidated damages. Hence we agree with the
answer given by the High Court to the first question referred to earlier.
Now coming to the second question, the answer
to the same depends upon the interpretation to be placed ,on s. 10 (5A).
Earlier we have set out that provision to the
extent necessary for our present purpose. That section takes in "Payment
due to or received". In the matter of payments, there are two aspects viz.
(1) payments due and (2) payments received. The mercantile system of
accountancy takes note of "payments due" whereas cash system of
accountancy recognises only payments received. Mercantile system of
accountancy, a double entry system is maintained on the basis of accrual of
rights to receive or liability to pay a certain sum of money, unlike is the
case of cash system of accountancy which merely takes note of actual receipts
We have earlier, come to the conclusion that
the compensation with which we are concerned in this case became due to the
assessee in April 1951 though it was actually received by the assessee in December
1955. Now arises the question to what circumstance the expression "due
to" in s.
10 (5A) applies and to what circumstance the
expression "received" therein is applicable? They do not mean the
same thing. Our income-tax law is familiar with these two expressions. That law
permits an assessee to adopt his own system of accountancy subject to certain
conditions and his tax liability is determined on the basis of the system of
accountancy adopted by him. In other words, the Act permits the assessee to adopt
either the mercantile system of accountancy or the cash system of the
accountancy and the system adopted by him would be the basis on which he should
be assessed. It is not necessary in this case to deal with the exceptions to
that rule. We have to read, s. 10 (5A) alongwith the other provisions in the
Act. If so read, it is clear that the expression "due to" in that
section refers to those assessees who maintain their accounts 124 according to
the mercantile system of accountancy and the expression "received by"
applies to those assessees who adopt the cash system of accountancy. As
observed by this Court in Commissioner of Income-tax, Madras v. A. Gajapathy
"When an Income-tax Officer proceeds to
include a particular income in the assessment, he should ask himself, inter
alia, two questions, namely: (1) what is the system of accountancy adopted by
the assessee, and (ii) if it is the mercantile system, subject 'to the deeming
provisions, when has the right to receive accrued. If he comes to the conclusion
that such a right accrued or arose to the assessee in a particular accounting
year, he should include the said income in the assessment of the succeeding
assessment year." Herein also we have to ask ourselves the question,
bearing in mind the fact that the system of accountancy adopted by the assessee
is the mercantile system, as to when the assessee's right to get the
compensation arose. We have already held that it arose in April 1951.
It was urged on behalf of the Department that
as the assessee disputed the quantum of compensation to which it was entitled,
we must hold that its right to get the amount arose when that dispute was
determined by the High Court.
We are unable to accede to this contention.
As mentioned earlier, the right of the assessee to get compensation for
unlawful termination of its services and the quantum of compensation to which
it was entitled were clearly prescribed in the agreement. It was also so held
by the High Court in the suit between the assessee and the managed company. The
fact that the assessee was claiming an exorbitant sum to, which it was not
entitled to will not convert its right into a contingent right. In Thiagaraja
Chettiar & Co. v. Commissioner of Income-tax, Madras(2) the High Court of
Madras held that where a managing agent is entitled under the terms of the
managing agency agreement to remuneration at a certain percentage on the annual
net profits of the company, the remuneration payable to the managing agent
accrued when the net pro-fits (1) 53 I.T.R. 114. (2) 51. I.T.R. 393, 125 of the
company for the year are ascertained. The mere fact that owing to disputes
between the company and the managing agent the company had not credited the
managing agent with the remuneration due to the latter in its accounts, would
not entitle the managing agent to claim that the remuneration due to him had
not accrued and should not be assessed to income-tax until the company had
credited him in its accounts with the amount of commission due to him. We are
in agreement with the ratio of that decision and that ratio governs the facts
of the president case.
The ratio of the decision of the Bombay High
Court in F. E. Hardosstle & Co. (Private) Ltd. v. Commissioner of Income
Tax, Bombay City-1(1), is also to the same effect.
It was next urged on behalf of the Department
that s. 10 (5A) is a code in itself and in applying the provisions therein, no
reliance should be placed on the system of accountancy which the assessee
generally adopts. It was further urged that as the liability under s. 10 (5A)
is a new liability and as the receipt with which we are concerned was received
in December, 1955, after s. 10 (5A) was incorporated into the Act, we must by a
legal fiction deem that the amount became due only in December, 1955. We see no
basis for this argument. The language of s.10 (5A) is plain and unambiguous.
That provision has now become an integral part of the Act. Therefore the deemed
payment under that provision stands on the same footing as any other payment.
The fact that the assesses included the receipt in question in its profit and
loss account in the year 1955 is a wholly immaterial circumstance. That
circumstance does not afford any basis for the argument that for this
'particular receipt, the assessee adopted a different system of accountancy.
Obviously because of the dispute between the assessee and the managed company,
the assessee did not enter the amount in question in the year in which it
became due. Method of maintaining accounts is one thing and the actual entries in
the accounts maintained is a different thing. What is relevant is the method of
accountancy and not the actual entries.
(1) 47 I.T.R. 394.
126 For the reasons mentioned above, we agree
with the answers given by the High Court to the questions of law referred to
it. This appeal is accordingly dismissed, with costs.
G.C. Appeal dismissed.