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1954 (9) TMI 30 - BOMBAY HIGH COURT

1954 (9) TMI 30 - BOMBAY HIGH COURT - [1955] 27 ITR 315 - Income-Tax Reference No. 16/X of 1954 - Dated:- 17-9-1954 - Chagla (CJ) And Tendolkar, JJ. For the Commissioner : G. N. Joshi with P. R. Sunkersett For the Assessee : N. A. Palkhivala with Dwarkadas JUDGMENT Chagla, CJ. The question that arises on this reference is whether a receipt of ₹ 25 lacs was a capital or a revenue receipt. This question has vexed and troubled many Judges and many Courts and in Barr, Crombie & Co. Ltd. v. .....

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y of the Court to consider them although the Court has to observe that each case must be decided on its own facts. Now, the facts here are an illustration of high finance, in this case at its highest, and one must confess that the manipulations which high finance requires leave one completely bewildered. The Moon Mills had appointed P.A. Hormarjee & Co. as its managing agents for several years, and on the 28th of June, 1943, a new managing agency agreement was entered into between the Mills .....

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of ₹ 25 lacs by the Moon Mills Ltd. for getting rid of its obligations under the agreement to pay the managing agents was an expenditure incurred wholly and exclusively for the purposes of the business of the Moon Mills. The department rejected the claim of the Moon Mills that the amount was a permissible deduction. That decision of the department was upheld by the Tribunal, but with regard to the decision of the department in the case of the assessee company that the sum of ₹ 25 la .....

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apital Gains" under section 12B of the Act? Now, in order to appreciate the contentions put forward both on behalf of the Commissioner and the assessee it is necessary to have a certain background and to look into the past history which ultimately resulted in the deed of transfer of the 3rd of April, 1946. In the first place it is necessary to look at the managing agency agreement itself of the 28th of June, 1943. Looking at this agreement it is clear that it is a composite agreement and it .....

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greement, the duration of the agreement is 20 years, and clause (2) provides for the remuneration of the managing agents on the terms laid down in that clause. Then clause (8) is important and that clause provides that "the company shall employ the managing agents as muccadums and brokers of the company for the said term of 20 years beginning as aforesaid or until the managing agents voluntarily give up the offices of muccadums and brokers of the company, or either of them and the company s .....

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rred upon the managing agents but upon Hormarjee & Co. personally. Mr. Palkhivala has drawn our attention to the definition of "managing agents" contained in clause (1). This is the usual definition of "managing agents" which includes not only the managing agents appointed by the agreement but also their successors or assignees. Therefore what clause (8) means is that whoever at a particular time happens to be the managing agents of the company shall have the right to act .....

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g agents to assign their managing agency agreement. It not only makes it obligatory upon the managing agents to assign the rights as managing agents but also at the same time to assign their rights as muccadums and brokers as also selling agents, the intention being clearly that if a person ceased to be the managing agent he could not continue to be a muccadum or a broker or a selling agent of the company. Clause (16) provides that in the event of the company being would up at any time for the p .....

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arjee & Co. are given further rights as muccadums and brokers and selling agents. It is not open to the mills to deprive the managing agents of the right as muccadums and brokers or selling agents, nor is it permissible to the managing agents to continue as muccadums and brokers and selling agents if they ceased to be managing agents. As we have already pointed out, the rights of Hormarjee & Co. were transferred to the assessee company on the 21st of July, 1944, and a deed of transfer wa .....

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that the unexpired portion of the agreement dated the 28th of June, 1943, so far as it relates to the appointment of the said company as the managing agents of this company be terminated as from the 31st March, 1946, on payment of reasonable compensation to them for loss of office and that Mr. Narayanlal Bansilal, a director of the company, be authorised to negotiate and finalize the question of compensation. On the 4th of March, 1946, there was a meeting of the board of directors of the assesse .....

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he board of directors of the Moon Mills Ltd. was held and Mr. Jalan was again in the chair, and Mr. Narayanlal Bansilal reported to this meeting that he had been carrying on negotiations with the assessee company. He informed the board that it was not prepared to accept the termination of the contract and claimed ₹ 25,00,000 as full compensation for loss of office as managing agents of the company in the event of such termination. The board resolved that the employment of the assessee comp .....

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ase was executed on the 3rd of April, 1946, and it is rather significant to note that the reason given for the termination of the managing agency was that disputes and differences having arisen between the parties the directors of the release company decided to terminate the said agreement so far as it related to the managing agents as from the 31st of March, 1946. Now, it has been found as a fact by the Tribunal that there were no disputes and differences between the two companies and this reci .....

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e 28th of June, 1943, but they retained to themselves the rights of selling agents and brokers and muccadums under that agreement. It is difficult to understand how, looking to the terms of that agreement to which we have drawn attention, it was possible for the assessee company to continue as brokers and muccadums and selling agents when they ceased to be managing agents, and it is also difficult to understand how there was any obligation upon the Moon Mills Ltd. to continue the assessee compan .....

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s reference is to consider the effect of this deed of release and to decide the rights of the parties according to the terms of this deed. Certain other facts which have been set out in the statement of the case should also be pointed out. The Tribunal points out that the resolution which was passed by the shareholders of the company with regard to the termination of the managing agency agreement and the payment of compensation of ₹ 25,00,000 could have been got passed by the directors of .....

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o the assessee company. The assessee company having received these ₹ 20,00,000 on that very day advanced a sum of ₹ 10,00,000 to the very Ganeshnarayan Onkarmal and the sum of ₹ 10,00,000 to the very Ganeshnarayan Mannalal. Therefore except for book entries the position remained identically the same as it was before the payment of ₹ 20,00,000 to the assessee company as it was afterwards. In other words, ₹ 20,00,000 remained with Ganeshnarayan Onkarmal and Ganeshnara .....

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r of attorney, and when the assessee company ceased to be the managing agents and the directors took over the management of the company a power of attorney was issued to these very three gentlemen and they continued to manage the mills as they had done before. On these facts the Income-tax Officer who assessed the assessee company came to the conclusion that the termination of the managing agency was a stage managed affair, and Mr. Joshi has strongly emphasised this aspect of the case and his co .....

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tions. It is only concerned with finding out what is the income of a person and subjecting that income to tax, and if the assessee much to our regret succeeds in satisfying us that this sum of ₹ 25,00,000 is not income, we must hold that the Tribunal was right in coming to the conclusion that is did that this amount is not liable to tax. Prima facie it would appear that this sum of ₹ 25 lacs is not an income receipt but a capital receipt. The amount has been paid by the Moon Mills Lt .....

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ference has just been made was laid down by the Privy Council in Shaw Wallace & Co. v. Commissioner of Income-tax, Bengal [1932] 59 I.A. 206, and it is rather necessary to consider that case in some detail because that case really constitutes the foundation of most of the arguments that have been advanced before us with regard to the taxability of this amount, and this case has also been looked upon as a locus classicus by Courts which had to consider similar questions from time to time afte .....

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mpanies was terminated and the assesses received a sum of ₹ 12,00,000 in respect of the agency of the Burma Oil Company and ₹ 3,25,000 in respect of the agency of the Anglo-Persian Oil Company. The Income-tax Department included these two receipts as income in computing the assessable income for the relevant year, and the question that arose before the Privy Council was whether these two amounts constituted "income" within the meaning of the Income-tax Act, and at page 212 .....

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is more a matter of words than of substance. Income, their Lordships think, in this 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. Thus income has been likened pictorially to the fruit of a tree, or t .....

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the produce or the result of carrying on the agencies of the oil companies in the year in which they were received by the respondents. But when once it is admitted that they were sums received, not for carrying on this business but as some sort of solatium for its compulsory cessation, the answer seems fairly plain." Then they further observe: If the business had been sold-even if that somewhat indeterminate asset known as the 'goodwill' had been assigned to the employing companies, .....

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received for putting an end to the business and being paid as solatium for its cessation. At page 214 the Privy Council is repelling an argument that was obviously advanced before them that the two receipts should be treated as income because the source of that income still continued, and the source that was suggested was the other business that the assessees were carrying on; and it is in the light of what we have just stated that the passage at page 214 should be viewed: "It is contended .....

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uit of a different tree, the crop of a different field." Therefore, what the Privy Council decided was that the source which produced income was the two agencies which the assessees had. Those sources were dried up or ceased to exist and therefore the amounts received could not be attributable to income from those sources, because the amounts were received not as the produce from those sources but for a diametrically opposed purpose of putting an end to them or preventing them from function .....

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d therefore the sum of ₹ 25,00,000 cannot represent the source. On the other hand, Mr. Palkhivala urges upon us to look upon the rights of the assessee company under the agreement as constituting three separate sources, one, income from the managing agency which is one source, a separate source, the second source is the income derived by the assessee company as muccadums and brokers, and the third source is the income derived by the assessee company as selling agents, and Mr. Palkhivala sa .....

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reason of the fact that the assessee company enjoys the status or office of the managing agents that these other rights are conferred upon it and we cannot look upon these rights as separate and distinct as constituting separate and distinct sources. But even accepting Mr. Joshi's contention, a serious difficulty still remains in the way of the Commissioner. Assuming that the sum of ₹ 25,00,000 is not referable to a separate source, it would still be incumbent upon the Commissioner to .....

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25,00,000 must be referable to a capital asset possessed by the managing agents; and the real question that we have to consider is whether, if that be the true position, could it be said in law that the sum of ₹ 25,00,000 constitutes a revenue receipt merely because it is referable to a part of the source or one of the many rights enjoyed by the assessee or one of the capital assets enjoyed by the assessee. Now, Mr. Joshi says that the sum of ₹ 25,00,000 should be looked upon as ref .....

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agents but is the services rendered by the assessee company as managing agents; and there can be no doubt in this case that the assessee has surrendered its rights to perform services as managing agents and its right to derive profit by rendering the services. Therefore this sum of ₹ 25,00,000 can only be referable to the services rendered by the assessee as managing agents. Can it then be said that although the services have been terminated, although the assessee has been prevented from .....

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ion, can it be said that because the business is carried on with the other activities, therefore the solatium paid to the assessee is not capital but income? Mr. Joshi says that the source of the assessee's income is the agreement, and so long as the agreement subsists and is operative, whatever amount the assessee receives which is referable to the agreement must be looked upon as income arising under the agreement. Now, that contention again is also untenable. It is clear that what produce .....

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id remuneration as laid down in the agreement. Mr. Joshi relies on the passage in the Privy Council judgment to which reference has already been made at page 214 for the purpose of urging that the Privy Council has clearly laid down that if the business of the assessee continues, then the mere fact that part of the business has come to an end and in respect of that part a compensation is paid to the assessee, then that compensation cannot be looked upon as capital. Now, in the first place it mus .....

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rivy Council was considering other independent business carried on by the assessee and the principle that the Privy Council laid down was that unless the sum in question had some connection with the continuance of the assessee's other business, the fact that the assessee carried on other business could not have any bearing on the question as to whether the sum received by the assessee was capital or income. Now, if we were to apply the same test here, we would have to be satisfied that ͅ .....

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have given up his right under the agreement as muccadums, brokers and selling agents. The position might have been different if the deed of surrender had provided that in consideration of the ₹ 25,00,000 received by the assessee he undertook an obligation to continue as selling agents and muccadums and brokers of the company ; then there would have been a clear connection between the receipt of ₹ 25,00,000 by the assessee and the continuance of the assessee as brokers, muccadums and .....

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5,00,000 was profit made by the assessee in the course of its business or profit earned out of its business. Surely when these ₹ 25,00,000 have been paid to the assessee for the cessation of its particular business, it could not be urged that this very sum of ₹ 25,00,000 were profits earned by the assessee in the course of its business. This is exactly what the Privy Council has emphasised at page 213 that once it is admitted that the sums were received not for carrying on the busine .....

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es cited by Mr. Joshi into certain categories and perhaps it would be convenient to follow that classification. The first are three cases dealing with the termination of appointment either as managing agents or director or any other office. The first is the Privy Council case which we have already referred to. The second is a case reported in Henley v. Murray (H.M. Inspector of Taxes) [1950] 31 Tax Cas. 351. That is a case of a director. What the Court of Appeal held in that case was that a cert .....

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e expected to do quite as much work', or he may even say 'I shall not be expected to do any work at all'. If that were the form of the arrangement in this case, I think it would be true to say that the lump sum which was paid was profits which became payable under his contract, and that it was paid to him by virtue of his office or employment of profit within the meaning of the schedule." Now, the case that the Master of the Rolls was contemplating was where a contract of servic .....

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the effect of the deed of surrender was that the status of the assessee continued as managing agents and the managed company, the Moon Mills Ltd., told the assessee not to render any service to them as managing agents. In our opinion that is not the real effect of the deed of surrender. The deed of surrender effectively puts an end to the relationship between the Moon Mills Ltd. and the assessee company as the managed company and the managing agents. The principle laid down by the Master of the .....

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ensation would be payable to the assessee company. The Special Commissioner held that the sum received by the assessee company on the shipping company going into liquidation was remuneration under a service agreement and was a trading receipt on revenue account. The Court of Session held that this sum was payable as compensation if the carrying out of the agreement became impossible by reason of the liquidation of the shipping company and that therefore the payment made to the appellant company .....

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was in return for the loss of a single agency out of about a dozen agencies carried on by the company, and the fact that the payment in that case did not represent the whole capital assets of the company was easily shown by the fact that in the year after the surrender of the single agency profits were no less than they had been the year before the surrender. With respect, we do not understand on principle why it should make any difference to the question that has got to be considered whether t .....

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he correct principle, because it will be remembered that in Shaw Wallace's case [1932] 59 I.A. 206 the assessee company had several agencies and yet the Privy Council came to the conclusion that the compensation paid for the loss of two agencies was a capital receipt and not an income or revenue receipt. Therefore, although on the facts of the case, with respect, the decision is correct, we find ourselves unable to agree with the observations made by the learned Lord President to which refer .....

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ted at the end of the second year in consideration of payment to the assessee of a certain sum as compensation and the question arose whether this receipt was capital or revenue receipt. The General Commissioners held that it was revenue receipt and that decision was confirmed by the Court of Session. Now, the learned Lord President Normand, with respect, came to the right conclusion in view of two important facts which were found in this case. One was that the contract which was terminated was .....

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hin one year; but at page 619 the learned Lord President refers to one fact which also seems to have weighed with him in coming to his decision and that fact is, as set out by the learned Lord President, that the assessee's business was entirely different from the business carried on by some one who under contract, acts exclusively as agent for a single principal. That this fact considerably weighed with the learned Lord President is clear from what we have pointed out in Barr Crombie's .....

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naging agency contract was incidental to the business carried on by the assessee nor can it be said that the variation or modification of the managing agency contract was incidental to the business of the assessee, nor can it be disputed that the managing agency was a valuable asset and at the date when it was surrendered the managing agency had still 13 years to run. The third category of cases is where an agent or an employee continues in service or employment, but he takes a reduced remunerat .....

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the assessee agreed to receive a lump sum of ₹ 7,50,000 from the managed company in consideration of the assessee agreeing to accept a flat rate of 10 per cent. on the annual net profits of the company for the remaining term of the managing agency. The question we had to consider was whether the sum of ₹ 7,50,000 received by the assessee was capital or income and we held it was income because we pointed out that there was an obligation upon the assessee to continue to render service .....

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ce to the managed company as managing agents. The crucial fact in the case before us is that there was complete cessation of this particular activity on the part of the assessee company. Then the next category of cases is where the agreement is entered into as an ordinary normal part of the assessee's business and compensation is received for the breach of that agreement. That type of case is to be found in Bush, Beach and Gent Ltd. v. Road [1940] 8 I.T.R. Suppl. 36. In this case the assesse .....

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ght have made under the contract, and not the purchase price of the contract itself". Obviously if an assessee is doing business in a commodity and in respect of that business various contracts have been entered into and some contracts are not carried out and compensation is paid to the assessee company, those amounts would represent income because the entering into of those contracts is incidental to the business and are entered into in the ordinary course of business. Now, the agreement t .....

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tion to certain decisions which clearly lay down that a sum received in consideration of immobilisation, assignment or surrender of a part of a capital asset or a part of a source is capital and not income. The first is a case reported in Glenboig Union Fireclay Co. Ltd. v. Commissioners of Inland Revenue [1922] 12 Tax Cas. 427. There the assessee company carried on business as manufacturers of fireclay goods, and it was the lessee of certain fireclay fields over part of which ran the lines of a .....

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nclusion can only be well founded if the sum be regarded as profits, or a sum in the nature of profits, earned in the course of their trade or business. I am quite unable to see that the sum represents anything of the kind. It is said, and it is not disputed, that the amount in fact was assessed by considering that the fireclay to which it related could only be worked for some two and a half years before it would be exhausted, and it is consequently urged that the amount therefore represents not .....

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profit that would otherwise be gained. In either case the capital asset of the company to that extent has been sterilised and destroyed, and it is in respect of that action that the sum was paid." Now, it would be noted that in this case this fireclay represented only a part of the assets of the assessee company. The assessee company was carrying on the business with regard to the other fireclay and it was in respect of only a part of the capital asset that compensation was paid and yet the .....

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of the assessee company. Therefore what one has to look at is the quality of the amount which is sought to be brought to tax. The mere fact that that amount has been arrived at by computing the profits which are lost to the assessee or which the assessee would have earned if its capital asset had not been sterilised or destroyed has no bearing whatever upon the quality of the amount actually paid. Then there are two cases, one dealing with copyright reported in Withers (Inspector of Taxes) v. N .....

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there was a partial assignment of a copyright and in Margerison (H.M. Inspector of Taxes) v. Tyresoles Ltd. [1942] 25 Tax Cas. 59 the assessee company had parted with its freedom of action, its rights arising under its ownership of the patented process, for a certain limited period, for a certain limited area, and for a certain limited type of customer, and at page 68 Mr. Justice Wrottesley says this: "I find some difficulty in saying that there is not here material upon which the Commissio .....

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d not necessarily the whole of it, the amount received by the sale of a part is capital receipt and not income receipt. Now, this is exactly what the assessee has done in this case. It is not exactly a case of sale, but it is a case of surrender of a part of its capital resources, the resources consisting of the managing agency, muccadumage, brokerage business and the selling agency business. The mere fact that the assessee company still retains the other two capital resources cannot possibly le .....

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the business and under the Defence of India Rules Government paid compensation to the assessee for injury to its business, and the question was whether this compensation was income or capital, and we held that it was capital because it was referable to a capital asset and it was paid for injury to a capital asset. At page 367 we point out that: "The department has attempted to tax this amount of compensation as income falling under section 10 of the Income-tax Act, and we have to be satisf .....

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tions would also apply to the facts of this case because the sum of ₹ 25,00,000 has not been received by the assessee in the course of its business nor does it represent the profits or gains of any business carried on by the assessee. Therefore, in our opinion, inasmuch as the sum of ₹ 25,00,000 was received by the assessee company in consideration of the termination of its managing agency, it was a solatium for the cessation of one of the several activities which the assessee compan .....

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