P.H Divecha And Another Assessees v. Commissioner Of Income-Tax, Bombay City, Bombay

Shah, J.:— This reference raises the vexed question whether certain amounts received by the assessee are capital receipts or revenue receipts. Elaborate arguments have been advanced before us by Mr. Palkhiwalla for the assessee in support of the plea that the amounts received by the assessee were capital receipts and not liable to tax and he has invited our attention to several decisions of the Supreme Court as well as of other courts. Before we refer to the arguments advanced at the Bar it is necessary to set out the facts which give rise to this Reference.

2. Prior to the year 1938, three persons, Jehangir A. Irani, Piroisha H. Divecha and Khurshed A. Irani were conducting in partnership a business in “electrical goods’ and as commission agents and merchants in the name and style of “Precious Electric Co”. The duration of the partnership was initially limited to a certain period but was from time to time renewed. Jehangir A. Irani died on 23-8-1942 and in his place his son Noshir J. Irani was admitted to the partnership. In June 1938, the three partners of Precious Electric Co. entered into an agreement with Philips Electrical Co. (India) Ltd. (which will hereafter be referred to as “the Philips”). Under that agreement, the Precious Electric Co. (which will be hereafter referred to as “the firm”) was given the monopoly rights to sell electric bulbs manufactured by the Philips in the Bombay Presidency, Rajputana, Central India, Central Provinces and the Berar. By clause 2 of the agreement, Philips undertook to deliver lamps of their manufacture, for sale in that territory exclusively to the firm. If any buyer refused to purchase lamps from the firm, Philips had the right to supply such buyers directly allowing compensation to the firm at the rate of 5 per cent on the net amount of invoices. By clause 8, the firm undertook only to sell lamps as were supplied to them by Philips and to sell the lamps supplied to them only in that territory and to do “everything possible to prevent their re-exportation by third parties”. By clause 7, the firm undertook to promote the sales of lamps in the territory always according to the directions given by Philips and in no way whatever to act against their interests and not to sell during the continuance of the agreement either directly or indirectly lamps other than Philips lamps and to refrain from doing any business, “either directly or indirectly, in articles competing with Philips articles and not to support and/or to participate in, either directly or indirectly, competing firms in any way”. By clause 4, the farm undertook in reselling lamps purchased from Philips, not to deviate under any circumstances, either directly or indirectly from the prices, rebates, selling terms and/or conditions as established by Philips. By clause 6 right was reserved to Philips to refuse orders and/or cancel or to suspend deliveries for any reason whatsoever and in case of such cancellation, cessation or suspension of deliveries the firm was not to receive any compensation. By clause 8, it was provided that the firm was to buy and sell Philips lamps on their own account and at their own risk and that the lamps were to be purchased by the firm at prices and on conditions which from time to time may be communicated to them by Philips. Authority was reserved to Philips to refuse delivery or to cancel orders in the event of the firm being in arrears. By clause 12, the agreement was deemed to have come in force from the 1st of July 1938 and was to “continue unless determined by either party giving to the other 3 months' prior notice x x x of such party's intention to determine the agreement on 30-6-1939 or any subsequent 30th of June”.

3. Under this agreement, till 21-8-1942 the three original partners carried on the business of the firm. After the death of Jehangir A. Irani, his son Noshir was admitted as a partner in the firm. Early in the year 1954, Philips decided to charge (sic) its selling organisation in India and to open a branch in Bombay with a view to taking over the distribution of lamps. On 8-3-1954, the Philips served a notice upon the firm terminating the agreement of 28-6-1938 as from 30-6-1954. By that notice, the firm was informed that it was intended to terminate the agreement as from 30-6-1954 and that the notice shall be considered as the official notice of termination of the existing agreement in accordance with Clause 12 thereof, and that it was intended to substitute a new agreement to be called the “New Lamp Agreement” a draft whereof was appended to the letter. After this notice was received by the firm, meetings were held on 28-5-1954 and 29-5-1954 between their representatives and the representatives of Philips. It was agreed at the meetings that after 28-6-1954 the date on which the existing agreement expired, — there will be no substitution of a new agreement about distribution of lamps and that with effect from that date, Philips Bombay Branch will take over the distribution of lamps. There were negotiations then for the period of transition and certain terms were agreed upon, which are not material. Arrangement was also made about the disposal of the stocks held by the firm. The question of compensation was then discussed and the terms finally agreed upon were recorded as follows:

“Miscellaneous: As a gesture of goodwill, Messrs Philips are prepared to pay in quarterly instalments to each of the three partners during a period of three years, Rs. 40,000/- per annum from the date of the expiry of the existing contract. The three partners referred to above as far as Messrs Philips Electrical Co. understand are:

1. Mr. Pirojsha H. Divecha.

2. Mr. Khurshedji A. Irani.

3. Mr. Noshir J. Irani.

Finally, Mr. Van Rhijn stated that Messrs Philips are quite willing to continue Messrs Precious as regular lamp dealers and the profit they realise therefrom will be in addition to the three years remuneration referred to above”.

4. The minutes of the meeting which recorded the terms of the settlement were signed on behalf of Philips and they were seen and approved on behalf of the firm.

5. In the account year 1954-1955 each partner received Rs. 20,000/- in two quarterly instalments, under the terms of the settlement whereby the original agreement of the year 1938 was terminated. The Income-tax Officer brought to tax the amounts of Rs. 20,000/- received by each of the three partners. Separate appeals were preferred by the three partners to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner confirmed the order passed by the Income-tax Officer. The order of assessment was then taken in appeal at the instance of two partners — P.M Divecha & K.A Irani — to the Income-tax Appellate Tribunal. The Tribunal held that the amount of Rs. 20,000/- received by each of the assessees was taxable as revenue receipt. The Tribunal negatived the contention raised for the assessees that the payment was compensation paid for termination of the agreement which constituted the “frame work of the company's business”. They observed that the payment was not an ex-gratia payment “by way of testimonial” and that it was unnecessary to express their opinion upon the question whether payments made to individual partners did not represent receipt in the course of the company's business.

6. In this Reference, the Tribunal have, at the instance of the assessees, referred the following three questions:

(i) Whether the receipt of Rs. 20,000/- is a taxable receipt for the purpose of the Indian Income-tax Act, 1922?

(ii) If so, is it liable to be not included in the total income of the recipient by reason of S. 4(3)(vii)?

(iii) Does the said receipt fall within the mischief of S. 10(5A)(d) and as such liable to tax accordingly?

7. The agreement of the year 1938 brought into existence what may loosely be called a right of monopoly purchase. Under this agreement, Philips undertook to sell to the firm (and to no other person) lamps for sale in the territory specified in the agreement and the firm in its turn undertook to advance the business of Philips in electric lamps and not to sell during the continuance of the agreement either directly or indirectly any lamps other than Philips lamps and not to sell those lamps outside the territory assigned. The relation between Philips and the company was evidently of principal and principal and not of principal and agent. The substance of the agreement, therefore, was that Philips agreed to sell their electric lamps only through the firm in the assigned territory and the firm in its turn undertook not to sell the lamps sold to them to any one outside the territory nor to deal in any competing business in electric lamps. This agreement was determined by notice served on the 8th March 1954. Even before the date of the agreement, the partners of the firm were carrying on business in electric lamps and other electric goods, and that business was continued after the agreement, but the firm acquired their stock-in-trade under a special agreement on favourable terms which ruled out competition in respect of one of the lines of their business. In the territory assigned to the firm, by the termination of the agreement in the year 1954, the business of the firm was not destroyed. The firm continued to carry on its original business in electric goods including electric lamps, and even Philips lamps could be sold by the firm as “regular lamp dealers”. In substance the alteration made by the agreement of the 29th of May 1954, was that the firm lost its rights as monopoly purchasers for the assigned territory and became regular dealers in lamps without any obligation not to deal in any other competing brand of lamps and “as a gesture of goodwill” Philips offered to compensate for the loss which it was apprehended may be caused to the firm, by agreeing to pay them Rs. 40,000/- per annum to each of the partners for a period of 2 years and this compensation was expressly designated “three years' remuneration”. It is urged by Mr. Palkhiwatla that this amount, which was agreed to be paid by Philips to the firm, was in the nature of a capital payment to the partners of the firm. It is urged that the monopoly rights conferred by the agreement of the year 1938 were, by the notice and the subsequent agreement of 29-5-1954, withdrawn. That is by the notice the very source of the business of the firm was extinguished, and that the profit making apparatus of the firm was destroyed and their assets became sterilised, and any payment made, to compensate for the loss of the rights, must be regarded as capital payment. We are unable, however, to agree with the contention raised by Mr. Palkhiwala that, by the service of the notice dated 8-3-1954 and the subsequent agreement between Philips and the firm on 29-5-1954, any attempt either to sterilise the assets of the firm or to destroy the profit making apparatus of the firm's business was intended. The firm's original business before the year 1938 was in electrical goods including electric lamps, and even after the agreement dated 28-6-1938 the same business was continued. There is also no doubt that after the 29th of May 1954 the same business and in the same line was carried on by the firm. Whereas under the agreement dated the 28th June 1938 the firm was obtaining a part of its stock-in-trade on specially favourable terms which simultaneously ruled out competition in the territory assigned by the agreement, after the 29th of May 1954, the favourable terms on which the lamps were obtained ceased to be available to the firm and the firm without any obligation not to carry on any competing line of business in lamps became a regular lamp dealer. By such an arrangement, we are unable to hold that the profit making apparatus of the assessee's business was destroyed. We are of the view that by the agreement which created monopoly rights a specially favourable method of acquiring stock-in-trade of the firm was denied and if that method was substituted by an agreement less favourable we do not think that thereby the compensation paid could be regarded as a capital asset.

8. Mr. Palkhiwalla has very strongly relied upon the judgment of their Lordshios of the Supreme Court in Commissioner of Income-tax, Hyderabad Deccan v. Vazir Sultan & Sons, (1959) 36 ITR 175 : (AIR 1959 SC 814). We may at once observe that we have carefully considered the facts of that case and the observations made by their Lordships of the Supreme Court and we have no doubt that the principle of that case has no application to the facts of the present case. In that case, originally the assessee company was appointed the sole selling agent and sole distributor of a brand of cigarettes for the Hyderabad State and was allowed a discount of 2 per cent on the gross selling price. In 1939 another arrangement was made between the assessee and the manufacturers whereby the assessee was allowed a discount of 2 per cent not only on the goods sold in the Hyderabad State but also on all goods sold outside the Hyderabad State. In 1950, the assessee and the company by mutual agreement reverted to the old arrangement in force prior to the year 1939 and the manufacturing company paid to the assessee a sum of Rs. 2,19,343/- “by way of compensation” for the loss of the agency for the territory outside the Hyderabad State. A question then arose whether the amount paid was a revenue receipt assessable to income-tax. In delivering his judgment Mr. Justice Bhagwati, (with whom Mr. Justice Sinha agreed) held that the agency agreement in respect of the territory outside the Hyderabad State was as much an asset of the assessee's business as the agency business within the Hyderabad State and though the expansion of the territory of the agency in 1939 and the restriction thereof in 1950 could be treated as grant of additional territory in 1939 and withdrawal thereof in 1950, both those agency agreements constituted but one employment of the assessee as the sole selling agent of the manufacturers and, therefore, the agency agreements were not in the conduct of their business by the assessees but formed the capital asset of the assessee's business which was exploited by entering into contracts with various customers and dealers in the respective territories. Therefore, in the view of their Lordships it formed part of the fixed capital of the assessee's business and was not the circulating capital or stock-in-trade of their business and payment made by the company as and by way of compensation for terminating or cancelling the agreement was a capital receipt. With this view Mr. Justice Kapoor disagreed. It is pertinent to note that, in the majority view the sole selling agents' rights before the year 1939 and after the year 1939 were an asset of the assessees, in the nature of a fixed capital of the assessee's business and for loss of a part thereof the amount received was a capital receipt. At p. 185 (of ITR): (at p. 821 of AIR) of the report, after considering cases cited at the bar, their Lordships observed:

“The position as it emerges on a consideration of these authorities may now be summarised. The first question to consider would be whether the agency agreement in question for cancellation of which the payment was received by the assessee was a capital asset of the assessee's business, constituted its profit-making apparatus and was in the nature of its fixed capital or was a trading asset or circulating capital or stock-in-trade of his business. If it was the former the payment received would be undoubtedly a capital receipt; if, however, the same was entered into by the assessee in the ordinary course of business and for the purpose of carrying on that business, it would fall into the latter category and the compensation or payment received for its cancellation would merely be an adjustment made in the ordinary course of business of the relation between the parties and would constitute a trading or a revenue receipt and not a capital receipt”.

9. Applying the test set out we have no doubt that on the facts of the present case the contract of the year 1938 between the firm and Philips and the modification thereof in the year 1954 were made in the ordinary course of business of the assessees as dealer in electric goods and for the purpose of carrying on their business: and compensation paid for withdrawing the benefit conferred by the agreement of the year 1938 will constitute a trading or revenue receipt and not a capital receipt. In truth the benefit conferred upon the firm by the agreement of the year 1938 did not constitute a trading asset and the modification thereof did not extinguish the whole of a part of the trading assets. The initial contract was one in the ordinary course of business and the modification of the same was also in the ordinary course of business of the firm as dealers in electric goods. The circumstance that the contract of the year 1938 was one which enabled the firm to purchase its requirements of electric lamps on favourable terms does not in our judgment, make that contract anytheless a contract made in the ordinary course of business nor does the modification of that contract amount to a contract otherwise than in the ordinary course of business.

10. We may refer to the cases cited at the Bar in which the courts were called upon to ascertain whether a certain payment made was in truth a capital receipt or a revenue receipt. We may at once observe that no definite tests of universal application can be evolved or have been attempted to be evolved nor any infallible criterion can be or has been laid down which can be helpful in indicating the considerations which may relevantly be borne in mind in approaching the problem. The cases, which we shall presently refer to, abundantly show that no criterion or test is of universal or general application.

11. In Bush, Beach and Gent, Ltd. v. Road, (1939) 22 Tax Cas 519, the assessee was an incorporated company which carried on its business in industrial chemicals. In 1933 the assessee Company entered into a contract for the purchase of certain agricultural chemicals. The contract whereby the right to deal in agricultural chemicals was acquired conferred monopoly rights, i.e the assessee was to sell the chemicals in certain specified areas and the suppliers undertook to debar their other customers from selling the same in those areas. For the purpose of these contracts, the assessee set up a new & independent sales organisation. Thereafter, the contract was terminated by agreement in the year 1935 and the assessee company received £4,750/- out of which £3,000/- were attributable to the year of assessment compensation for termination of the agreement. It was held that the cancellation of the contract did not affect the structure of the company's business of chemical merchants and that the contract was made in the ordinary course of business and that the payment was made in consideration of the loss of profits which would have been earned under the contract. It was observed in that case that the sum paid to the assessee represented not the purchase price of the contract itself, but profits which they might have made under the contract, and that the contract was made in the ordinary course of the company's business, although in a new field and the exclusion of competition was an ordinary incident of such contracts. The arrangement whereby the contract was terminated being in the ordinary course of the company's business, compensation paid as consideration for agreeing to that arrangement was revenue payment.

12. In John Smith and Son v. Moore, (1921) 12 fax Cas 266, the question which fell to be determined was whether the amount paid for purchasing the fights from the executors of the assessee's father's will under certain unexpired “coal contracts” was an admissible deduction in computing the profits for the purpose of Excess Profits Tax and it was held by the House of Lords (Viscount Finlay L.J dissenting) that the expenditure was a capital expenditure. In that case, the question was decided on the view that the contracts for purchasing coal were the assets of the estate of the deceased and the price paid for purchasing the unexpired contracts was capital expenditure. There is nothing in this judgment which supports the view that the contract of the year 1938 in this case between the firm and Philips could be regarded as asset, the consideration for extinguishing which may make the consideration a capital receipt.

13. Our attention was also invited to Commissioner of Income-tax, Bombay City v. Asiatic Textile Co. Ltd. Bombay, 1955-27 ITR 315 : ((S) AIR 1955 Bom 198) where to the assessee compensation was paid for termination of the managing agency agreement for a period of 20 years and it was held by this Court that the amount received by the managing agents as solatium for the termination of the managing agency could not be profits arising out of their business but constituted only a capital receipt. But even in that case, the court regarded the managing agency as an asset and the compensation paid for extinction of that asset a capital payment. Mr. Palkhiwalla placed great reliance upon the fact that beside being managing agents, the assessees were brokers, muccadams and selling agents of the company and by the termination of the managing agency agreement, their authority as brokers, muccadams and selling agents was not extinguished. We fail to see how that circumstance may alter the nature of the managing agency agreement. If the benefit of the managing agency was an asset, the mere circumstance that quae the company, of which the assessees were the managing agents, the assessees had certain other contractual rights which were not extinguished by the termination of managing agency will not make the benefit under the managing agency anytheless an asset.

14. The case in H.S Captain v. Commissioner Of Income-Tax, Bombay City, Bombay City, 1959-36 ITR 84 (Bom), on which reliance was also sought to be placed by Mr. Palkhiwalla, has in our judgment no application. The question in that case which fell to be determined was whether an amount of money paid to the assessee for termination of his employment was covered by the terms of S. 7(1) Explanation 2 of the Income-tax Act and the court held that the amount received by the assessee as compensation for loss of employment fell within Explanation 2 of S. 7(1) and was not, therefore, taxable.

15. Nor does the case of Van Den Berghs Ltd. v. Clerk. (1935) 19 Tax Cas 390, on which reliance was sought to be placed by Mr. Palkhiwalla affect our conclusion. That was a case in which two companies, which were competitors, entered into an arrangement for a certain number of years for pooling and sharing profits, under an elaborate scheme to promote their mutual commercial, pecuniary, and other interests. One of the companies then agreed to a premature termination of the agreement as desired by the other company on receiving a sum of £450,000 as compensation: and it was held that this sum was a capital receipt and not income. The agreement far from being one made in the ordinary course of business provided a fundamental organisation of the company's activities and affected the entire conduct of the assessee's business and therefore, the receipt under the agreement terminating the arrangement was a capital receipt. If, however, we are of the view that the monopoly rights under the agreement of the year 1938 do not constitute an asset, the extinction of those rights does not affect the conduct of the business of the assessee, or as it was called by Mr. Palkhiwalla, the “profit-making apparatus of the assessee's business” and if they are merely contracts entered into in the ordinary course of business, Van Den Berghs' case, (1935) 19 Tax Cas 390 will have no application.

16. On the view taken by us, the first question will be answered as follows:

“The receipt of Rs. 20,000/- is a taxable receipt for the purpose of the Indian Income-tax Act, 1922”.

17. As we have already held that the amount is taxable receipt, being receipt arising from business, S. 4(3)(vii) does not exempt it from liability to tax. We are in the view we have taken not called upon to consider whether even if the receipt of Rs. 20,000/- is a capital receipt, by operation of S. 10(5A)(d) the amount can be regarded as a revenue receipt. We answer the second question as follows:

“It is liable to be included in the total income notwithstanding S. 4 because it arose from business.”

18. The third question does not fall to be answered. The assessee to pay the costs of the Commissioner.

ED/D.H.Z

Answers accordingly.