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PETITIONER: COMMISSIONER OF INCOME TAX BOMBAYCITY

       Vs.

RESPONDENT: CHUNILAL V. MEHTA AND SONS (P) LTD.

DATE OF JUDGMENT11/08/1971

BENCH: HEGDE, K.S. BENCH: HEGDE, K.S. GROVER, A.N.

CITATION:  1972 AIR  268            1972 SCR  (1) 117  1971 SCC  (3) 587  CITATOR INFO :  RF         1991 SC 686  (16)  RF         1991 SC 999  (14)

ACT: 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 1956-57.

HEADNOTE: 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

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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 Revenue appealed. 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 agency. 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, approved. (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  the  dispute. What  is  relevant is the method of accounting and  not  the actual entries. [125E-G]

JUDGMENT: 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. appellant. 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

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(5A) of the Indian Income-tax Act, 1922 (in brief ’the Act’) of a certain amount received by the assessee firm as compen- sation 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

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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 of- interest 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

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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 liqui- dated 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  or disbursements. We  have  earlier,  come to the  conclusion  that  the  com- pensation  with which we are concerned in this  case  became due  to  the assessee in April 1951 though it  was  actually

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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 cleat 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 Naidu (1):               "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  pres- cribed  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  ex- orbitant  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

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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. 127