Rai Bahadur Jairam Valji v. Commissioner Of Income Tax

1. The questions referred to us for opinion are:

(1) Whether in the circumstances of this case the sum of Rs. 2,50,000 received by the assesses as damages or compensation for the premature termination of the contract of 9th May, 1940, is income assessable within the meaning of the Indian Income-tax Act.

(2) Whether in the event of the said sum being held to be assessable, the provisions of Rule 9 of Schedule 1 of the Excess Profits Tax Act should not be applied thereto and the profits of the chargeable accounting period determined according to law.

2. The first question arises out of the order in income-tax proceedings and the second question arises out of the consequential excess profits tax proceedings.

3. The assessee was supplying for a number of years dolomite and limestone to the Bengal Iron Company Limited for its work at Kulti. This supply was being made from the assessee's quarries at Paraghat which he had taken on lease from the Central Provinces Government. These quarries were worked till June, 1931, when they were discontinued as the company stopped taking supplies on account of she closing down of blast furnaces. On 5th January, 1935, there was a fresh agreement to supply dolomite and limestone to the company as it was about to start one blast furnace and intended to start a second one in the near future. The quarries were therefore reopened in March, 1935. In 1936 the Bengal Iron Company, Limited, went into liquidation and on 8th September, 1936, it was amalgamated with the Indian Iron and Steel Company, Limited, and the latter continued to take its supplies from the assessee under the said agreement.

4. In or about May, 1938, the company suddenly stopped taking supplies of dolomite and consequently the dolomite quarry was closed almost immediately thereafter. There was considerable correspondence between the. assessee and the company in which the former protested against this breach of agreement complaining that he had been put to a heavy loss as he made capital investment of more than 4 lakhs of rupees in developing the quarries. Thereafter by a notice dated 29th May, 1939, the company informed the assesses that it would not take supplies of limestone after 31st December, 1939. Consequently, the limestone quarry was closed sometime thereafter. The stoppage of work turned both the quarries into veritable lakes. There were only two customers for this material of Paraghat quarries, the Indian Iron and Steel Company Limited and the Tata Iron Works. The Tatas had their own arrangements and the Indian Iron and Steel Company refused to take supplies from the assessee on the grounds that it was losing Rs. 20,000 a month in freight and that it had arranged for another cheaper source of supply. No market was thus left to the assessee.

5. Some attempt was made in the year 1940 to prospect a new area with a view to secure a contract with the Tatas but the quality was not approved and the prospecting was therefore abandoned in or about August, 1941. Nothing was raised during the account year ending Diwali 1941.

6. On 31st January, 1940, the assessee instituted a suit for an injunction restraining the company from making its purchase of dolomite and limestone from any other person than the plaintiff and obtained a temporary injunction to this effect on 13th March, 1940. The suit was compromised on 3rd April, 1940, and a final agreement on the terms of which the suit was agreed to be withdrawn was executed on 9th May, 1940. The suit was accordingly dismissed as withdrawn.

7. Under this agreement the assessee was appointed a raising contractor for twenty-five years for working the quarries of the company at Grangapur and despatching limestone therefrom loaded in wagons at the railway siding to be provided by the company at its own cost. The assessee had to erect and keep in proper repairs at his own cost buildings and structures including stables, quarters, coolie lines etc., and he had also at his own cost to instal and maintain necessary machinery and appliances. It was provided that on the termination of the agreement the company would be entitled to take the buildings at a valuation not exceeding Rs. 15,000 and the machinery etc., was to be removed by the assessee at his own cost. The obligation of the company to receive the limestone and of the assessee to supply it was to come into existence on the completion of railway siding. There were other terms with which we are not directly concerned for the purpose of this reference. It was expected that it would take about 18 months for the completion of the railway siding and commencement of the supplies. It was also agreed that the company would get its supplies from other sources and. in the meanwhile pay Rs. 4,000 per month to the assessee till the commencement of his supply but for not more than 18 months. The agreement further provided that the assesses

"shall not at any time during its subsistence, directly or indirectly, or whether alone or jointly with another or others, undertake or be engaged or interested in any other contract, business or work for raising or working limestone or for managing or working any quarry or mines or in any business of work of a similar nature, within an area of 20 miles from Grangapur save with the previous written permission of the company."

8. This covenant in effect prohibited the assessee from carrying on any other business in limestone. The company was not able to secure the railway siding, with the result that the quarries at Gangapur could not be worked and the agreement dated 9th May, 1940, had to be abandoned.

9. It was therefore agreed between the parties that the assessee should surrender his rights under this agreement in consideration of a solatium of Rs. 2,50,000 and an agreement to supply limestone and another agreement for loading. Accordingly two agreements were executed on 2nd August, 1941, and a sum of Rs. 2,50,000 was paid to the assessee on 4th August, 1941.

10. Under the agreement for supply of limestone for 12 years from any source the price agreed was ex-factory at which the company was getting its supplies from Bisra Lime Company. At this time the assessee had no quarries from which he could make supplies and it was impossible to make supplies from Paraghat quarries as the cost ex-factory would have been more than the rate agreed. The other agreement was for loading iron ore. The supply of limestone commenced from 24th July, 1943, by working a new lease area of limestone in Grangapur State. The agreement dated 9th May, 1940, terminated with effect from 3rd August, 1941.

11. On these facts the Tribunal held that the agreement dated 9th May, 1940, was an ordinary commercial contract and that the sum of Rs. 2,50,000 and the two contracts for shorter periods were given as damages or compensation for breach of the agreement which was entered into during the course of his business. It also held that the receipt of this sum was a receipt of a casual and non-recurring nature but that it was not exempt under section 4 (3) (vii) as it arose from business. The question for determination therefore is whether this sum was a capital receipt or a casual, and non-recurring receipt not arising from business.

12. It may be noticed that during all these years from the commencement of the supplies from Paraghat quarries to their closure the assessee did not supply dolomite or limestone to any other person than the Bengal Iron Company and its successor. He had no other business of quarrying dolomite and limestone from any other quarry, nor was he buying and selling these articles. It may also he noted that the Paraghat quarries were abandoned finally in 1940 and the agreement dated 9th May, 1940, was a new venture.

13. The learned Counsel for the assessee submits that the amount of Rs. 2,50,000 is a capital receipt and relies on Commissioner of income-tax v. Shaw Wallace and Co. (1932) 59 I.A. 206 and Van Den Berghs Ltd. v. Clark [1935] A.C. 431 : I.T.R. Eng. Cas. 17. The facts in Commissioner of Income-tax v. Shaw Wallace and Co. (1932) 59 I.A. 206 are very similar to the facts here. Shaw Wallace and Co, were agents of various companies and for a number of years they acted as distributing agents of the Burma Oil Company and of the Anglo". Persian Oil Company. These two companies later on combined and decided to make their own arrangements for distribution of their products. Respondents' agencies were terminated. The Burma Oil Company paid 12 lakhs of rupees as ''full compensation for cessation of the agency" and the other company paid Rs. 3,25,000 as "compensation for loss of office as agents to the company". The question was whether these receipts were business receipts or capital receipts. In defining 'income' their Lordships observed:

The object of the Indian Act is to tax 'income', a term which it does not define. It is expanded, no doubt, into 'income, profits and gains', but the expansion 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 the crop of a field. It is essentially the produce of something which is often loosely spoken of as 'capital', But capital, though possibly the source in the case of income from," securities, is in most cases hardly more than an element in the process' of production.

14. Their Lordships further held that in the case of business the fundamental underlying idea is of continuous exercise of an activity. In their Lordships' opinion the sums received by Shaw Wallace and Co.,

"could only be taxable if they were 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 the sums received, not for carrying on this business, but as some sort of solatium for its compulsory cessation, the answer seemed fairly plain"

, namely that the sum could not be regarded as income, profit or gain from carrying on a business. Even if these sums were considered to be the price paid for sale of the agencies or for goodwill, their Lordships held that the price paid was not taxable on the same principle, namely that the amount was not received from carrying on any business.

15. The learned Counsel for the Commissioner contends that the definition of 'income' as given by their Lordships is not correct and has not been adhered to by their Lordships in subsequent decisions and he relies particularly on Kamakshya Narain Singh v. Commissioner of Income-tax, Bihar and Orissa (1943) 70 I.A. 180 : 11 I.T.R. 513, where their Lordships observed:

Income is not necessarily the recurrent return from a definite source, though it is generally of that character.... The multiplicity of forms which 'income' may assume is beyond enumeration.

16. In Maharaj Kumar Gopal Saran Narain Singh v. Commissioner of Income-tax, Bihar and Orissa (1935) 62 I.A. 207 : 3 I.T.R. 237, life annuities receivable under an indenture conveying the appellant's estate were held to be "income" within the meaning of that term in Shaw Wallace's case (1932) 59 I.A. 206. In Kamakshya Narain Singh's case (1943) 70 I.A. 180 : 11 I.T.R. 513, their Lordships were dealing with the contention that royalties were capital receipts. Under the lease payments were to be made to the assessee per ton of coal extracted with a minimum yearly royalty payable even if the per ton royalty was less than this minimum. The minimum royalty was payable even if the lessee did not work the mine and take any coal during the period of lease. The royalty was received every year. Their Lordships observed that: "this minimum royalty amounts to a species of annual guarantee ; it does not correspond to any coal in fact extracted and taken away ; it is simply 'income' flowing from the covenants in the lease."

17. The royalties were held assessable under Section 12 of the Act. In both these cases the definition of 'income' in Shaw Wallace's case (1932) 59 I.A. 206 was reproduced with approval though in the latter case their Lordships remarked that the picturesque simile of a tree was not quite appropriate in every case. The contention of the non-applicant has thus no force.

18. In Van Den Berghs Ltd. v. Clark [1935] A.C. 431 : 3 I.T.R. Eng. Cas. 17 the facts were that a Dutch company and an English company who were competitors in the manufacture and dealing in margarine, in order to end the competition, entered into an agreement under which they agreed to share their profits and loss in accordance with an elaborate scheme therein specified. The two companies were entirely independent of each other both as regards capital and management. A common policy was evolved under the agreement to be followed by them. Profits were not pooled but on an account being made a sum payable by one to the other was treated by the former as business expenditure and by the latter as business profit. During the World War I they could not make accounts and could not distribute the profits. After the War the English company claimed £450,000 as its share of profits during the war period which the other side disputed. The matter was referred to arbitration but nothing came out of it. Ultimately, both parties agreed to end the agreement for all time by payment of £450,000 to the English company. The question was whether this sum was a capital receipt or a business profit Lord Macmillan, who delivered the leading opinion, examined numerous decisions and observed:

The problem of discriminating between an income receipt and a capital receipt and between an income disbursement and a capital disbursement is one which in recent years has frequently engaged your. Lordships' attention. In general, the distinction is well recognized and easily applied, but from time to time cases arise where the item lies on the border-line and the task of assigning it to income or to capital becomes one of much refinement, as the decisions show.... 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 stated case 'pooling agreements', but that is a very inadequate description of them, for they did much more than merely embody a system of pooling and sharing profits.

19. Their Lordships further held that:

The agreements in question formed the fixed frame-work within which their circulating capital operated; they were not incidental to the working of their profit-making machine but were essential parts of the mechanism itself. They provided the means of making profits but they themselves did not yield profits. The profits of the appellants arose from manufacturing and dealing in margarine.

20. The Income-tax Act nowhere defines "income", "profits' or "gains" any more than "capital". Section 6 enumerates the heads of income, profits and gains and the succeeding sections prescribe the methods of computing income under each head. Even the definition of "business" in Section 2(4) exhibits a fine disregard of logic. "We have, therefore, to turn to decided cases in search of light. It is true that each case is found to turn on its own facts ; nevertheless, the decisions are useful as illustrations and as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem" : Van Den Berghs Ltd. v. Clark [1935] A.C. 431 : 3 I.T.R. Eng. Cas. 17.

21. The learned Counsel for the Department contended that the assessee was carrying on the business of supply of dolomite and limestone and the various agreements above referred to including that dated 9th May, 1940, were some of the several ordinary commercial contracts entered into during the course of his business and they were incidental to the working of the profit-making machine of the assessee and he relied on para. 1 of the plaint in the suit for injunction in which the assessee alleged that he was still carrying on business as a supplier of limestone and dolomite. This statement appears to be obviously erroneous and was evidently made to support the claim for temporary injunction. All the facts of the case have been enumerated in detail above. They clearly establish that the assessee was not a dealer in, though he was a supplier of, limestone. The agreement of 9th May, 1940, was not a contract of a trading nature and was not one of the several contracts entered in carrying on his business in limestone. It not only formed the bulk of its business but it was a business itself. This and the previous agreements for supply were each the fixed framework within which his circulating capital operated. The moment an agreement was broken by the company, his operations came to an end. They revived with the revival of the agreement or on making a new agreement. He was to work the covenants in the agreement dated 9th May, 1940, with his capital and labour. There was a restrictive covenant under which the assessee could not,

"at any time, during the subsistence of the agreement, directly or indirectly whether alone or jointly with another or others, undertake or be engaged or interested in any other contract, business or work for raising or working limestone or for managing or working any quarry or mine or in any business or work of a similar nature within an area of 20 miles from the company's quarries, save with the previously written sanction and permission."

Although this is not an absolutely restrictive covenant, its practical effect was that the assessee was prohibited from carrying on any business in limestone. It will thus be clear that the operations of the assessee were inseparable from the agreement with the company made on 9th May, 1940. His working stopped with the termination Of the agreement. It cannot therefore be said that this agreement was made in the course of carrying on the business of dealing in dolomite and limestone. As a matter of fact, the agreement brought into existence a business which, if carried on with the capital and labour of the assessee, might have yielded him profits. That business came to an end with the termination of the agreement, dated 9th May, 1940.

22. It is true, as the learned Counsel contends, that the assessee would have made profits if the agreement dated 9th May, 1940, had gone forward, but he would have made profits not by the existence of the agreement but by spending his labour and capital over working the Gangapur mine which was owned by the company. The framework of his business was the agreement and that agreement was put to an end by the parties in consideration of the solatium granted to the assessee. It was not certain that the assessee would have necessarily made profits. The profits depended on the variations in the cost of labour, depreciation of machinery, buildings etc. If the costs had gone up the estimated profits might have resulted in loss or otherwise. It is therefore not correct to call the disputed sum as the estimated profit for a period of 25 years. As stated in the statement of the case, " there is nothing to indicate the basis on which the solatium of Rs. 2,50,000 was fixed". In our opinion it is not pertinent for the decision of the nature of the receipt what measure was used for the purpose of calculating the amount: Glenboig Union Fireclay Go. Ltd. v. Commissioners of Inland Revenue (1932) 12 Tax Cas. 427, 464. We are concerned with the quality of the receipt and there appears to be no doubt that it is a solatium for the surrender of the rights under the agreement. As held by their Lordships of the Privy Council in Kamakshya Narain Singh v. Commissioner of Income-tax, Bihar and Orissa (1943) 70 I.A. 180 : 11 I.T.R. 513, the covenants in the agreement dated 9th May, 1940, if worked with the capital and labour of the assessee, would have yielded profit, but the destruction of covenants cannot be said to be the source from which the income is received.

23. The learned Counsel further urged that the assessee was a railway contractor and this contract was one of the series of contracts made by him during the course of his contract business. It must be observed-that this business was different from his business as a railway contractor ; and there is no material for holding that the assessee was making such contracts in the course of carrying on his business as a railway-contractor and was working them as part of that business. The Income-tax authorities have not proceeded on this footing. The Income-tax Officer held that the receipt in question was the result of carrying on the business of quarrying and raising limestone from the Gangapul quarry. The Appellate Assistant Commissioner held that this sum was received in course of the business of dealing in limestone and dolomite for a large number of years. The Tribunal merely stated that the contract was an ordinary commercial contract between the assessee and the company. No reference was made to the business of the assessee as a railway contractor. It will thus be seen that the view of the Tribunal is not borne out by the material on record. The learned Counsel for the Department further submits that the sum in question was a compensation for loss of future profits and was thus income from business receivable on breach of contract by the company and not for surrender of any contract or abandonment of any restrictive covenant therein. He relied on Burma Steamship Go. v. Commissioners of Inland Revenue (1930) 16 Tax Cas. 67 and Cossimbazar Raj Wards Estate v. Commissioner of Income-tax, Bengal [1916] 14 I.T.R. 377. In the former case the assessee who was carrying on business of a ship owner, including letting out ships on charter, received from the repairer of a ship compensation for delay in delivery of a repaired ship beyond the agreed time. The claim was for damages for loss of estimated profits for the period of delay. The assessee contended that it was a capital gain. This contention was negatived on the ground that the assessee's assets, namely, the ship, remained unaltered and the assessee received what he would have received as a revenue by letting out the ship for the disputed period. An injury caused by the breach of agreement by the repairer was inflicted on the assessee's trading and not on his capital assets. Though it is sometimes difficult to distinguish between a capital receipt and a revenue receipt, there can be no doubt that in that case the damages received would have been included in the trading account of the assessee. The case Cossimbazar Raj Wards Estate v. Commissioner of Income-tax, Bengal [1916] 14 I.T.R. 377, is easily distinguishable. It was the case of a lessor receiving a sum of Kg. one lakh in payment of royalty on the abandoned coal upon ceasing to work the mine. The payment was expressly provided for in the lease and therefore it was foreseen, known, anticipated, and provided for. It had its source in the agreement of lease itself where it was shown as royalty. It was therefore not a casual receipt and was an income from other sources taxable under Section 12.

24. We are therefore of the opinion that in the circumstances of this case the sum in question was received by the assessee as a solatium for the surrender of the agreement dated 9th May, 1940, and was a capital receipt and was not liable to assessment. We therefore answer the first, question in the negative.

25. In view of this answer it is not necessary for the purpose of this assessment to answer the second question. Unless the sum in question is an income from business, it is not liable to excess profits tax. I The assessee thus succeeds and is entitled to the costs of this reference from the Commissioner. We assess counsel's fee at Rs. 300 for the assessee and Rs. 100 for the Commissioner, who will pay all the costs of the reference to the assessee. A copy of this judgment be sent to the Appellate Tribunal under Section 66(5) of the Income-tax Act.