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PETITIONER: THE COMMISSIONER OF INCOME-TAX, MADRAS

       Vs.

RESPONDENT: CHARI AND CHARI LTD.

DATE OF JUDGMENT: 09/04/1965

BENCH: SHAH, J.C. BENCH: SHAH, J.C. SUBBARAO, K. SIKRI, S.M.

CITATION:  1966 AIR   54            1965 SCR  (3) 692  CITATOR INFO :  R          1966 SC1325  (5,6)  RF         1971 SC1590  (8)  RF         1975 SC1945  (14)

ACT:     Income  Tax Act, 1922, s.  10(2)(xv)--Deduction claimed by assessee of commission paid to  director for  special duties--Rate of commission  bona  fide determined by assessee--Whether open to revenue  to review such rate.

HEADNOTE: Managing   Agency--Compensation   for   termination of--Circumstances  in  which such  compensation  is revenue. The respondent, a private limited company,  carried on  business in tobacco and other  commodities  and also acted as managing agents for the N company and for  two other companies.  It had three  directors, all  of  whom were paid a  fixed  remuneration  for attending to the business of the company.  On June, 21,  1951, the respondent company was appointed  an agent   of  the  Central  Government  for   buying, checking, leaf drying, and retaining and  reselling tobacco  under, and in accordance with,  directions issued  from  time to time.  On June  22  1951  the respondent passed a resolution  placing one of  the directors,  A, in "special charge" of all the  work under the contract with the Central Government  and agreed  to pay him 30 per cent of the  net  profits from the contract. Under this arrangement, for  the year  ended 31st March 1952, commission at  30  per cent  was calculated and paid to A and was  claimed in  the  assessment year 1952-53 as  a  permissible deduction under s. 10(2)(xv) of the Income-tax Act, 1922.   The Income-tax Officer allowed only 10  per cent of the net profit for the services rendered by A and disallowed the balance :amount claimed by the respondent.  The  managing agency agreement of  the  respondent with  the  N Company was  terminated  in  September

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1’951,  when  the  State  Government  acquired  the undertaking of that company, and the respondent was paid  Rs.  17,346  as  compensation  for  premature termination  of its agency.  This amount was  taken into account by the Income-tax Officer in computing the  respondent’s income for the year  ended  March 31, 1952.    Appeals  against  the order  of  the  Income-tax Officer to the Appellate Assistant Commissioner and to  the  Tribunal challenging the  disallowance  of part  of  the  commission  and  inclusion  of   the compensation for termination of the managing agency were  unsuccessful.  On a reference on  both  these points,   the  High  Court  decided  them  in   the respondent’s favour.     HELD: (i) The contract with the Government was, for the respondent, an important contract requiring special attention by a person well acquainted  with the practical details of the business. If for  such special services the management as prudent business men  for advancing the interest of respondent  bona fide  regarded  30 per cent of the net  profits  as reasonable  remuneration, the  revenue  authorities were  not justified in reviewing that  opinion  and reducing the rate of remuneration. [697B, C] 693     Where,  on  a  consideration  of  the  relevant materials the Appellate Tribunal is of the  opinion that a particular remuneration is not bona fide, or is unreasonable, the High  Court, in exercising its advisory  jurisdiction, has no power  to  interfere with  that  opinion;  but  in  the  present   case, material  circumstances relating to the  nature  of the  contract  and  the  special  services  to   be performed were not at all taken into account by the revenue authorities. [697C-E]     (ii)  Ordinarily,   compensation  for  loss  of office or agency. is regarded as a capital receipt; but  this  rule  is subject to  an  exception  that payment received even for termination of an  agency agreement,  where the agency is one of  many  which the  assessee  bolds, and the  termination  of  the agency does not impair the profit-making  structure of  the assessee, but is within the  frame-work  of the business, it being a necessary incident of  the business  that existing agencies may be  terminated and fresh agencies may be taken, is revenue and not capital.  However, in the absence of evidence as to what  effect  the  determination  of  the  managing agency  of the N company had upon the  business  of the  respondent,  the mere  circumstance  that  the respondent  had  managing  agencies  of  two  other companies without more would not bring the  present case within the exception [698H; 699 A-c]     Kelsal Parsons & Co. v. Commissioners of Inland Revenue,   21T.C.  and  Kettlewell  Bullen  &   Co. v.C.I.T. Calcutta, [1964] 8 S.C.R. 93 explained and distinguished.

JUDGMENT:     CIVIL APPELLATE JURISDICTION: Civil Appeal  No. 215 of 1964.     Appeal from the judgment and order dated August

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24, 1961 of the Madras High Court in Case  referred No. 102 of 1957.     Niren  De,  Additional  Solicitor-General,   R. Ganapathy   Iyer   and  R.N.  Sachthey,   for   the appellant. R. Thiagarajan, for the respondent. The Judgment of the Court was delivered by     Shah,  J.  The respondent is a private  limited Company.   It  carried  on business  in  hides  and skins, minerals, tobacco and other commodities, and also acted as managing agents for the Nellor  Power and Light Company Ltd. and for two other Companies. T.M.   Ayyadurai,   T.M.   Rangachari   and    P.C. Chakrabarti  were directors of the  Company.   Each director  was  paid  a fixed  remuneration  of  Rs. 4,800/- per annum for attending to the business  of the  Company. On June 21, 1951 the  respondent  was appointed  by the Central Government as  its  agent for   buying,  checking,  weighing,  leaf   drying. storing.  transporting,  retaining  and   reselling tobacco under and in accordance with the directions issued  from time to time.  The Central  Government agreed  to  pay  to the  respondent  price  of  the tobacco  purchased, charge at the rate of one  anna per lb. for tobacco not redried, and at the rate of two   annas  per  lb.  for  tobacco  redried.   and commission on all purchases.  On June 22, 1951  the respondent   passed  a  resolution   placing   T.M. Ayyadurai   in  "special  charge"   for   arranging purchases of tobacco on credit, 694 inspecting  tobacco at Guntur and at  Madras  Port, and for supervising shipment of tobacco, and agreed to  pay  him  30  per cent of  the  net  profit  as remuneration.   Under  the   contract   with    the Government  of India Rs. 1,38,454/- became  due  to the respondent    as commission in the account year ending March 31. 1952. After providing Rs. 41,473/- for expenses, 30 per cent of the balance being  Rs. 29,094/-  was paid to T.M. Ayyadurai as  commission and was claimed in the assessment year 1952-53 as a permissible  deduction  under s. 10(2)(xv)  of  the Indian Income-tax Act, 1922. The Income-tax Officer allowed only 10 per cent of the net profit for  the services rendered by T.M. Ayyadurai in the contract for  tobacco purchase and sale. and disallowed  Rs. 19,796/-   out  of  the  amount  claimed   by   the respondent.     The managing agency agreement of the respondent with the Nellore Power and Light Company Ltd.,  was terminated with effect from September 28, 1951 when the  Government of the State of Madras in  exercise of the powers conferred  upon it by the  Electrical Undertakings Acquisition Act, 1949 compulsorily ac quired  the  undertaking of that Company,  and  the respondent  was paid Rs. 17,346/-  as  compensation for  premature  termination of  its  agency.   This amount  was  taken into account by  the  Income-tax Officer  in computing the income of the  respondent in the assessment year ending March 31. 1952.     Appeals against the order passed by the Income- tax Officer to the Appellate Assistant Commissioner and to the Tribunal challenging the disallowance of part   of   the   commission   and   inclusion   of compensation for termination of the managing agency

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agreement were unsuccessful.     The  Tribunal thereafter being directed by  the High Court of Judicature, Madras under s. 66(2)  of the  Indian Income-tax Act, drew up a statement  of the  case and referred the following two  questions to the High Court:-                  "(1) Whether on the facts and in the               circumstances    of   the   case    the               disallowance  of a sum of Rs.  19,796/-               out  of  the remuneration paid  to  Mr.               T.M. Ayyadurai is justifiable; and                   (2)  Whether a sum of Rs.  17,346/-               which represented compensation received               by  the  assessee for the loss  of  the               managing  agency of the  Nellore  Power               and Light Company Ltd. is income liable               to tax?" The  High Court answered both the questions in  the negative.     Allowance in respect of the  amount  covered by the  first  question was sought by  the  respondent under  s.  10(2)(xv) of the Income-tax  Act,  1922, which provided:                  "any   expenditure  not   being   an               allowance  of the nature  described  in               any   of  the  clauses  (i)  to   (xiv)               inclusive. and               695               not  being  in the  nature  of  capital               expenditure or personal expenses of the               assessee  laid out or  expended  wholly               and exclusively for the purpose of such               business, profession or vocation." The   question   whether  an  amount   claimed   as expenditure  was  laid out or expended  wholly  and exclusively  for  the  purpose  of  such  business, profession  or  vocation has to be decided  on  the facts  and  in the light of circumstances  of  each case.   But  as observed by this Court  in  Eastern Investments  Ltd.  v. Commissioner of  Income  tax, West   Bengal(1)  the  final  conclusion   on   the admissibility  of  an allowance claimed is  one  of law.  The  High Court had therefore power  to  call upon the Tribunal to submit a statement of the case under  s.  66(2) of the Indian Income-tax  Act.  In considering whether the expenditure to remunerate a person for services rendered is allowable under  s. 10(2)(xv)  the Income-tax Officer must have  regard to  all  the  circumstances, such  as,  nature  and special  character of the service, practice if  any in the trade for payment of a percentage of  profit to   an    employee   in   similar   circumstances, qualifications  of the employee for  rendering  the service,  amount  if any paid by  the  assessee  to another  person  for  rendering  similar   service, normalcy  of  the allowance having  regard  to  the practice  in  the  trade, existence  of  any  other extraordinary  and  abnormal circumstances  in  the arrangement  or  special reasons  or  circumstances which   may  suggest  that  the   transaction   was abnormal, and the like.     The  normal business of the respondent  was  in hides and skins, minerals and tobacco.  It does not appear,  however, that the turnover of the  Company was  large.   The contract to purchase  tobacco  on

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behalf  of the Government of India  was  apparently out  of  the  way of the  normal  business  of  the respondent and demanded the setting up of a special organisation.  Under the terms of the contract  the respondent  was  to  be the agent  of  the  Central Government  for  buying, checking,  weighing,  leaf drying,   storing,  transporting,   retaining   and reselling tobacco under and in accordance with  the directions  given  to it from time to time  by  the Government.   The respondent agreed to buy  tobacco within the ceiling price fixed as and when directed by  the Government, and was responsible for  buying proper  grades of tobacco, for  correctly  checking the weights, for taking delivery from the  sellers, for redrying it whenever so directed, for  securing proper packing for transport by rail road or sea so as  to  conform  to standards  of  packing  usually employed  in the export of tobacco or standards  to the satisfaction of the purchaser, and for  getting the  tobacco  inspected  by  the  Tobacco   Grading Inspectorate   of   the  Indian   Central   Tobacco Committee  according to the AGMARK standards.   The respondent  had to place a go down at the  disposal of the Government within their premises at  Guntur. The  respondent had to use its best (1) 20 I.T.R. I. 696 endeavour to buy as cheaply as possible within  the ceilings prescribed and to sell it for such maximum price  as  may be obtainable, not being  below  the price  prescribed  by the  Government,  to  re-sell tobacco which the Government may direct it to  sell by  instructions in writing, in such manner and  at such  price as may be specified by the  Government, and to finance the entire transaction of purchasing tobacco in the first instance out of its own funds. The  respondcat was to take all necessary steps  to safeguard the stocks and to maintain  fire-fighting services.  Goods purchased by the respondent if not of the grade or quality were liable to be  rejected by   order  of  the  Tobacco   Grading   Inspector. Performance  of  the  contract  evidently  required expert  knowledge  of  the practical  side  of  the business of purchasing tobacco, getting it  redried if   it   was  raw,  and   of   packing,   storing, transporting and shipping it.     The  respondent had entered into  a  profitable contract,   but  any  negligence   in   purchasing, storing,  packing,  transporting and  shipping  the goods might have resulted in serious losses to  the respondent.   The Income-tax Officer accepted  that the  expenditure  for payment of  remuneration  for attending  to  the contract was laid  out  for  the purpose  of  the business of  the  respondent,  but reduced the stipulated  rate to 10 per cent on  two grounds:  that  T.M. Ayyadurai was the  brother  of T.M. Rangachari, and that he was, as a director  of the Company, bound to attend to all the  activities of the Company including the contract.     There  is  no evidence that the  agreement  was motivated  by  considerations other  than  strictly business considerations. There is also no  evidence that  as  a director T.M. Ayyadurai  was  bound  to attend  to  all  the  activities  of  the   Company including  the  special contract with  the  Central

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Government.   The  duties which  the  director  was bound  to perform for earning the  remuneration  of Rs. 400/- per month are not on the record, but even in the opinion of the taxing authorities the duties of  T.M.  Ayyadurai  as  director  did  not   cover attendance  to the contract  with  the  Government. T.M.  Ayyadurai and T.M. Rangachari  are  brothers, but that by itself is not sufficient to justify  an inference    that   unreasonable    or    excessive remuneration was agreed to be paid.  The person who was  called  upon to attend to a contract  of  this magnitude was required to have expert knowledge  of the  business, apply his time exclusively  thereto, travel from time to time, maintain supervision  and control   at  the  stage  of  purchase,   redrying, packing,   transport  and  loading  for   shipment. Presumably  T.M. Ayyadurai was such a  person,  and that  is  why he was selected for earning  for  the respondent  a  large amount of commission  by  duly performing the contract.     The  Appellate  Assistant  Commissioner  merely paraphrased the decision of the Income-tax  Officer and  regarded  10 per cent of the  net  profits  as reasonable.   The Appellate Tribunal observed  that the  Appellate  Assistant  Commissioner  had  given "clear and 697 convincing reasons in support of the  disallowance" to which they had nothing more to add.  An analysis of  the  reasons given by  the  Income-tax  Officer discloses  no  grounds  to support  the  view  that remuneration at a rate exceeding 10 per cent of the net  profit was excessive or unreasonable.  We  are of    the   view   that   the  contract  with   the Government  was  for the  respondent  an  important contract    requiring   constant    and    vigilant application  and  supervision  by  a  person  well- acquainted  with  the  practical  details  of   the business.   If the management of the respondent  as prudent  businessmen for advancing the interest  of the  respondent bona fide regarded 30 per  cent  of the  net  profits as reasonable  remuneration,  the revenue authorities were not justified in reviewing their   opinion   and   reducing   the   rate    of remuneration.    It   is   true  that   if   on   a consideration   of  the  relevant  materials,   the Appellate  Tribunal  is  of  the  opinion  that   a particular  remuneration stipulated to be  paid  is not  bona fide, or is unreasonable, the High  Court in  exercising  its advisory  jurisdiction  has  no power  to  interfere  with that  opinion.  But  the material  circumstances relating to the  nature  of the contract, the services to be performed and  the nature  of the duties by the employee were  not  at all  taken  into account by the  Tribunal  and  the income-tax authorities. We  therefore  agree   with the  High Court that the first question  should  be answered in the negative.     The contract under which the respondent Company was appointed managing agent for the Nellore  Power and  Light Company Ltd., was to ensure  till  1960, but it had to be prematurely terminated because the Government  of Madras exercising its  powers  under the Madras Electrical Undertakings Acquisition Act, 1949  had  compulsorily  acquired  the  electricity

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undertaking.    With   the  acquisition   of   that undertaking the right of the respondent as managing agent  ceased.   Under  s.  15  of  the  Electrical Undertakings  Acquisition Act, the  Government  was bound  to  pay  compensation  which  would  include compensation for termination of the managing agency agreement.  The respondent received  Rs.  17,346/as compensation   for  termination  of   the   agency, computed  in the manner laid down in s. 15 of  that Act.  Prima facie, such a receipt being in lieu  of extinction  of  an  asset of  the  assessee,  is  a capital receipt.  It was urged, however, on  behalf of the revenue that the respondent was carrying  on business of taking up managing agencies and that by the extinction of one of the managing agencies, the business  structure  of  the  respondent  was   not impaired.   In a recent judgment delivered by  this Court  in  Kettlewell Bullen and Company  Ltd.,  v. Commissioner  of  Income-tax, Calcutta(1).  it  was pointed out that:                  "It may be broadly stated that  what               is  received for loss of capital  is  a               capital  receipt: what is  received  as               profit  in  a  trading  transaction  is               taxable income. But the               (1)  [1964] 8 S.C.R. 93.               698               difficulty   arises  in   ascertainting               whether  what  is received in  a  given               case  is  compensation for  loss  of  a               source  of  income,  or  profit  in   a               trading transaction."               The Court further observed:                   "It  cannot  be said as  a  general               rule. that what is determinative of the               nature of the receipt is extinction  or               compulsory  cessation of an  agency  or               office.   Nor  can  it  be  said   that               compensation received for extinction of               an  agency may always be  equated  with               price received on sale of goodwill of a               business.    The  test  applicable   to               contracts  for termination of  agencies               is:  what has the assessee parted  with               in  lieu  of  money  or  money’s  worth               received  by him which is sought to  be               taxed?  If  compensation  is  paid  for               cancellation  of a contract of  agency.               which  does  not  affect  the   trading               structure   of  the  business  of   the               recipient,   or  involve  loss  of   an               enduring  asset, leaving  the  taxpayer               free  to  carry on his  trade  released               from  the contract which is  cancelled,               the receipt will be a trading  receipt:               where the cancellation of a contract of               agency  impairs the trading  structure,               or involves loss of an enduring  asset,               the  amount paid for  compensating  the               loss is capital."     Turning  to the facts of the present  ease,  it must  in the first instance be observed that it  is for  the  revenue to establish  that  a  particular receipt is income liable to tax, and beyond stating that  the respondent was the managing agent of  the

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Nellore  Power  and Light Company Ltd. and  of  two other Companies, there  is  no other evidence about the  nature  of  the  business  of  the  two  other Companies of which the respondent was the  managing agent.  about  their relative  importance  qua  the managing  agency  of the Nellore  Power  and  Light Company   Ltd.,  and  whether  by  reason  of   the extinction  of the managing agency of  the  Nellore Power  and Light Company Ltd., any  enduring  asset was   lost  to  the  respondent,  or  its   trading organisation  was adversely affected.  The  Income- tax Officer observed that the "Company’s   business of Managing Agency as such had not come to an end", the Company still continues as "managing agents  of other  companies".  Even after surrender of one  of the  agencies, the Company carries on  business  as before,  its  structure  not  being  affected"  and therefore  "the  receipt  is to  be  considered  as revenue, in accordance with the decision in  Kelsal Parsons and Company v.C.I.R. 21 T.C. No. 608.", and with that view the Appellate Assistant Commissioner and  the  Tribunal agreed.  But in the  absence  of evidence as to what effect the determination of the managing  agency  of the Nellore  Power  and  Light Company   Ltd.,  had  upon  the  business  of   the respondent,   the   mere  circumstance   that   the respondent  had  managing  agencies  of  two  other companies  without  more will not  bring  the  ease within Kelsal Parsons and Company v.  Commissioners of Inland Reve- 699 nue(1).  In Kettlewell Bullen and Company’s case(2) this Court pointed out that ordinarily compensation for  loss  of  office or agency is  regarded  as  a capital receipt, but the rule is subject to      an exception   that   payment   received   even    for termination  of  an  agency  agreement,  where  the agency is one of many which the assessee holds, and the  termination of the agency does not impair  the profit-making  structure  of the assessee,  but  is within  the framework of the business, it  being  a necessary  incident of the business. that  existing agencies may be terminated, and fresh agencies  may be  taken,  is  revenue and  not  capital.   Kelsal Parsons  and  Company’s case(1)  falls  within  the exception  to the ordinary rule, and  circumstances which brought the case of the respondent within the exception  must  be clearly established.  The  High Court was of the opinion that compensation received for taking over the Nellore Power and Light Company Ltd., was a capital receipt not liable to be taxed, and  on  the  materials placed before  us,  we  are unable  to  disagree with the High  Court  on  this question. The  appeal therefore fails and is  dismissed  with costs. Appeal dismissed, (1) 21T.C. 608. (2) [1964] 8 S.C.R. 93. ?(D)5SCI---6 700