07 October 1958
Supreme Court
Download

COMMISSIONER OF INCOME-TAX, NAGPUR Vs RAI BAHADUR JAIRAM VALJI AND OTHERS

Case number: Appeal (civil) 109 of 1954


1

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 16  

PETITIONER: COMMISSIONER OF INCOME-TAX, NAGPUR

       Vs.

RESPONDENT: RAI BAHADUR JAIRAM VALJI AND OTHERS

DATE OF JUDGMENT: 07/10/1958

BENCH: AIYYAR, T.L. VENKATARAMA BENCH: AIYYAR, T.L. VENKATARAMA GAJENDRAGADKAR, P.B. SARKAR, A.K.

CITATION:  1959 AIR  291            1959 SCR  Supl. (1) 110  CITATOR INFO :  E&D        1959 SC 814  (24,52,54)  R          1959 SC1352  (8)  RF         1961 SC1579  (30,31,34)  RF         1964 SC 758  (12)  RF         1965 SC  65  (5,31,33)  R          1971 SC1590  (9)  R          1972 SC 386  (12)  R          1973 SC 515  (9)  R          1973 SC1011  (15,20)  D          1987 SC 500  (36)  RF         1992 SC1495  (31)

ACT:        Income  Tax-Capital  or  Revenue  receipt-Compensation   for        premature  termination of contract-Whether  trading  receipt        -Liability to tax-lndian Income-tax Act, 1922 (XI of 1922).

HEADNOTE: The respondent had been carrying on business in the  produc- tion  and  supply  of limestone since  1920,  and  under  an agreement  entered  into with the Bengal  Iron  Company  was supplying  all its requirements of limestone  and  dolomite. Sometime  later the Indian Iron and Steel Company took  over all  the  assets  and liabilities  of  the  former  company. Subsequently   differences   having   arisen   between   the respondent  and  the  Indian Iron  and  Steel  Company  they entered  into an agreement on May 9, 1940, in settlement  of all  the  disputes  between them whereby,  inter  alia,  the respondent was to work a quarry of the company for a  period Of  25 years and to supply the limestone quarried  therefrom to the company according to its requirements and to get from the  railway  authorities facilities  for  transporting  the limestone  more  economically; and it was agreed  that  till such  facilities were given, the respondent was to  be  paid Rs. 4000/- every month.  Under the agreement the  respondent had  the right to work other quarries of his own and  supply limestone  so  quarried to other  purchasers.   The  railway authorities  having declined to grant facilities, it  became impossible  to  carry  out  the  agreement  in  the   manner contemplated by the parties, who, thereupon, entered into  a fresh agreement on August 2, 1941, terminating

2

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 16  

111 the  agreement  dated May 9, 1940, on  certain  terms.   The agreement  provided inter alia (1) that the  Company  should pay " Rs. 2,50,000/- to the sellers as solatium besides  the monthly  instalments of Rs. 4000/-", remaining unpaid  under the contract dated May 9, 1940, (2) that the company  should purchase  limestone from the respondent for a period  of  12 years,  and (3) that the respondent was to be appointed  the loading contractors of the Company for loading iron ore.  On a  question as to whether the the sum of Rs. 2,50,000/-  was liable  to  tax,  the respondent claimed that  it  was  not, ’being a capital receipt but the income-tax authorities held that  it was a trading receipt and was income chargeable  to tax.   The High Court however held on a reference  under  s. 66(1), that the income was not chargeable to tax, and  hence the  present appeal.  In support of the appeal, the  respon- dent contended inter alia that (1) the contract dated May 9, 1940,  was  for a period of 25 years of which more  than  23 years had still to run at the time of the settlement, and it was therefore an asset of an enduring character, capital  in character, and the compensation paid therefor was a  capital receipt,  and (2) that the true character of  the  agreement was  that  it brought into existence  an  arrangement  which would  enable the respondent to carry on a business and  was not  itself  any  business, and any  payment  made  for  the termination of such an agreement was a capital receipt. Held, that the contract of May 9, 1940, was entered into  by the  respondent in the ordinary course of his  business  and that  the sum of Rs. 2,50,000/- which was paid  as  solatium for the cancellation of that contract, was a revenue receipt and was chargeable to tax. There  is a distinction between a contract entered  into  in the usual course of business and an agency contract.   While it  may  be  possible  to regard  the  latter  as  merely  a framework  for  doing business, the former  constitutes  the business  itself, and, therefore, compensation paid for  the termination  of the former kind of contract must be held  to be revenue, whereas compensation paid for the termination of the latter might be capital in character. It would make no difference in the character of the receipt, when  it  is  compensation for  cancellation  of  a  trading contract, whether its performance is to consist of a  single act or a series of acts spread over a period. Case law reviewed. Van   Den   Berghs   Ltd.  v.  Clark,   [1935]   A.C.   431, distinguished.

JUDGMENT: CIVIL APPELLATE JURISDICTION : Civil Appeal No. 109 of 1954. Appeal  by special leave from the judgment and  order  dated April  21,  1950, of the former Nagpur High Court  in  Misc. Civil Case No. 135 of 1949. 112 R.   Ganapathy Iyer and R. H. Dhebar, for the appellant. Radhavinod  Pal,  J.  M. Thakar and I. N.  Shroff,  for  the respondents. 1958.  October 7. The Judgment of the Court was delivered by VENKATARAMA AIYAR J.-This is an appeal against the  judgment of the High Court of Nagpur in a reference under s. 66(1) of the Indian Income-tax Act (XI of 1922), hereinafter referred to  as  the  Act,  and the point  that  is  raised  for  our determination  is whether a sum of Rs. 2,50,000 received  by the  respondent on August 2, 1941, is chargeable to  income-

3

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 16  

tax.   While,  according to the Department,  the  amount  in question  is a revenue receipt liable to be included in  the chargeable income, according to the respondent it is capital receipt  not  liable to tax.  The Appellate  Tribunal  held, affirming  the decisions of the Income-tax Officer  and  the Appellate   Assistant  Commissioner,  that  the  amount   in question was a trading receipt, and was income liable to  be assessed.  On the application of the respondent, it referred the following question for the decision of the High Court: "  Whether in the circumstances of the case the sum  of  Rs. 2,50,000 received by the assessee 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." The  reference  was  heard by Sen and Deo,  JJ.,  who  held, disagreeing with the Tribunal, that the sum of Rs.  2,50,000 was  a capital receipt in the hands of the  respondent,  and that  it,  was not liable to be taxed.  The  appellant  then filed  an  application under s. 66(A)(2) of the  Act  for  a certificate to appeal to this Court, but that was dismissed, the  learned judges holding that the law on the subject  was well  settled.   The appellant thereafter  applied  to  this Court  for  special leave under Art. 136, and the  same  was granted, and hence this appeal. 113 The  question  whether a receipt is capital  or  income  has frequently  come  up for determination  before  the  courts. Various  rules have been enunciated as furnishing a  key  to the  solution of the question, but as often observed by  the highest  authorities,  it is not possible to  lay  down  any single  test  as  infallible  or  any  single  criterion  as decisive  in the determination of the question,  which  must ultimately  depend on the facts of the particular case,  and the authorities bearing on the question are valuable only as indicating the matters that have to be taken into account in reaching a decision.  Vide Van Den Berghs Ltd. v. Clark (1). That,  however,  is not to say that the question is  one  of fact, for, as observed in Davies (H.  M. Inspector of Taxes) v.  The  Shell Company of China Ltd. (2) "  these  questions between  capital  and income, trading profit or  no  trading profit, are questions which, though they may depend no doubt to a very great extent on the particular facts of each case, do involve a conclusion of law to be drawn from those  facts ".  Vide  also  the observations of Lord Greene,  M.  R.  in Rustproof Metal Window Co., Ltd. v. Commissioners of  Inland Revenue (3).  That being so, we must first examine the facts of  the  present -case, and then consider whether  on  those facts and in the light of the applicable principles, the sum of Rs. 2,50,000 received by the respondent is a capital or a revenue receipt. The respondent is a businessman whose trading activities run in several channels.  He is a railway contractor; he runs  a rice mill and a sugar factory; he is a supplier Of limestone and dolomite.  It is with the last of these businesses  that we  are concerned in these proceedings.  The respondent  had acquired  a quarry at Paraghat and had been himself  working it  and  selling  limestone quarried out  of  it  to,  among others,  a Company called the Bengal Iron Company, Ltd.   On January 5, 1935, the said Company entered into an  agreement with the respondent for the purchase of all its requirements of limestone and dolomite from (1) [1935] A.C. 431.        (2) (1951) 32 Tax Cas. 133 151. (3)  (1947) 29 Tax Cas. 243, 266. 15 114

4

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 16  

the latter at rates specified therein, and these rates  were subsequently  modified  by  another  agreement  between  the parties  dated December 21, 1935.  In 1936 the Company  went into liquidation, and its assets and liabilities were  taken over  by  another Company called the Indian Iron  and  Steel Company, Ltd. under a scheme of amalgamation dated September 8,  1936.  This Company continued to purchase limestone  and dolomite  from the respondent for some time, but  later  on, finding that the rates were uneconomic owing to increase  in the railway freight, it decided to purchase its requirements from  other  sources,  and by notice  dated  May  29,  1939, informed   the  respondent  accordingly.    Thereupon,   the respondent  filed Suit No. 211 of 1940 in the High Court  of Calcutta  for  specific performance of  the  contract  dated January  5, 1935, as modified on December 21, 1935, and  for an injunction restraining the Indian Iron and Steel Company, Ltd.  from purchasing limestone or dolomite from any  person other  than  the  plaintiff,  and  on  March  13,  1940,  an injunction  in those terms was actually issued  against  the Company. Thereafter,  the Company and the respondent entered into  an agreement  in settlement of all the disputes  between  them, and  the same was embodied in a document dated May 9,  1940. As it is this document that forms the source for the payment of Rs. 2,50,000 to the respondent, it is necessary to  refer to the terms thereof in some detail.  Under this  agreement, the  respondent  was to work a quarry of the  Company  at  a place called Gangapur for a period of 25 years and to supply the limestone quarried therefrom to the Company according to its  requirements.   This quarry, it should be  stated,  was situated  near  Kulti  where  the  Company  carried  on  its smelting  operations,  and  obviously it  would  reduce  the working  expenses, if limestone required therefor  could  be got  from Gangapur.  There were, however, no  facilities  in Gangapur railway station for transporting the goods from the quarry,  and so it was arranged that the authorities  should be  moved for permission to construct a siding at  Gangapur, and that the cost thereof should be borne 115 by  the  Company.   It was expected that it  would  take  18 months  before  the siding could be completed,  and  it  was agreed that during that period the respondent was to be paid Rs. 4,000 every month.  Thereafter, the respondent was to be paid  at  the rate of Rs. 2-9-0 per ton of  limestone  which might be loaded in the railway wagons to be arranged for  by the Company.  The working of the quarry was left entirely in the hands of the respondent.  It was he that was to purchase the  machinery and the appliances necessary  for  quarrying. He  was  to  engage  his own workmen  and  put  up  all  the requisite  superstructures.  After the limestone was  raised from  the  quarry,  he was to get it  cleaned  and  Tendered merchantable,  and  it was thereafter to be  loaded  in  the wagon.   There  are two clauses in the  agreement  to  which reference might be made.  Under cl. 6, the respondent agreed "  to  supply  to  the  Company  such  other  quantities  of limestone,  if any, as the Company may order  besides  Kulti requirements ". Clause 13 of the agreement enjoined that the respondent was not to engage, during the subsistence of  the agreement, in any other contract business for the working of any  quarry  within an area of 20 miles from  the  Company’s quarry,  but  this  was  subject to  the  proviso  that  the respondent was free to work any quarry belonging to and held by him. To  continue the narration, the railway authorities did  not agree  to  the construction at Gangapur of a  siding  and  a

5

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 16  

loopline to the quarry, and so it became impossible to carry out the agreement in the manner contemplated by the parties. It is in this situation that the parties came together,  and on  August  2,1941, entered into a new agreement and  it  is with  this  that we are directly concerned in  this  appeal. The agreement recites that the Company feeling difficulty in working their mines referred to in the contract dated May 9, 1940,  made a proposal for termination of the said  contract on certain terms, and that was agreed to.  The terms of  the agreement are (1) that the Company should pay " Rs. 2,50,000 to  the sellers as solatium besides the monthly  instalments of  Rs. 4,000 ", remaining unpaid under the  contract  dated May 9, 1940; (2) 116 that the Company should take all the limestone required  for its furnaces at Kulti from the respondent for a period of 12 years  on terms and conditions set out in an agreement;  (3) that  the  respondent  was  to  be  appointed  the   loading contractors  of  the  Company for loading all  iron  ore  at Monoharpore  for a period of 12 years from January 1,  1942, on  the  terms  and  conditions  specified  in  a   separate agreement.   Pursuant to this agreement, the respondent  was paid  a sum of Rs. 2,50,000 and the two agreements  relating to the purchase of limestone and the loading of iron ore  at Monoharpore were also executed.  The balance due on  account of monthly payment of Rs. 4,000 provided in the agreement of May  9, 1940, was also duly paid.  Now, on these facts,  the question is whether the sum of Rs. 2,50,000 received by  the respondent was capital or revenue. Before discussing the principles applicable to the facts  as stated  above,  it is necessary to deal  with  a  contention raised on the facts of the case on behalf of the respondent. Dr. Radha Binode Pal, who appeared for him, argued that  for the  purpose of carrying out the agreement dated January  5, 1935, the respondent had executed works of a capital  nature such  as construction of quarters, tenements and  the  like, and  had  incurred expenses exceeding Rs. 4 lakhs  -on  that account,  that  all this had to be thrown away when  the  if quarry  at Paraghat had to be abandoned, and the sum of  Rs. 2,50,000  was really a reimbursement of the amount spent  by him as above and was therefore a respondent, the position in law  would  no doubt be as contended for by him.   But  have those  facts been established ? In his statement before  the Income-tax  Officer, the respondent merely stated  that  the amount  in  question  was  paid  as  consideration  for  the termination of the contract of 1935 and not of 1940, and  it is  pointed out by the Tribunal that the respondent did  not substantiate  even this assertion.  There was no  allegation that capital expenses had been incurred in the execution  of the  contract of 1935, and that the amount in  question  was paid as compensation therefor; 117 nor  is there any evidence on that question.  In deed,  when it  is  remembered  that the quarry  at  Paraghat  had  been abandoned before the contract dated May 9, 1940, was entered into,  it  is difficult to imagine how any  amount  paid  as compensation for the cancellation of that contract can  have any connection with expenses incurred with reference to that quarry.   We must hold that the sum of Rs. 2,50,000 was  not paid as compensation for expenses thrown away and cannot  be held to be a capital receipt on that account. Now,  the contention on behalf of the appellant is that  the contract  dated  May 9, 1940, was one entered  into  by  the respondent in the ordinary course of his business, that  the sum of Rs. 2,50,000 was paid admittedly as solatium for  the

6

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 16  

cancellation  of  that  contract, that  the  payment  really represents the profits which the respondent could have made, had the contract been performed, and that it is therefore  a revenue receipt; and a number of authorities were quoted  in support of this contention.  We shall now refer to the  more important   of   them.   ID  Short  Bros.    Ltd.   v.   The Commissioners of Inland Revenue (1), the facts were that the appellant   Company  which  was  carrying  on  business   as shipbuilders  had  entered  into a  contract  to  build  two steamers and later on, agreed to its cancellation on receipt of  a sum of pound 1,00,000.  The question was whether  this was a capital or revenue receipt.  Rowlatt, J., held that it was merely a receipt in a going concern and was revenue, and that  was  affirmed by the Court of Appeal,  Lord  Hanworth, M.R.,  observing that such a contract as the one before  him was liable in the ordinary course of business to be  altered or terminated on terms and the payment of pound 1,00,000  in settlement   of  the  rights  under  the  contract  was   an adjustment made between the appellants and their clients  in the  ordinary course of business.  Similar observations  are to be found in the judgment of Sargant, L. J. and  Lawrence, L. J. It may be noted on the facts of the present case  that the  agreement of January 5, 1935, was modified on  December 21,  1935,  and  the disputes  which  arose  with  reference thereto (1)  (1927) 12 Tax Cas. 955. 118 were settled by the agreement of May 9, 1940, which was,  in turn,  replaced  by  agreement dated August  2,  1941.   The agreements  dated  May 9, 1940, and August  2,  1941,  could therefore  be  properly said to be adjustments made  in  the ordinary course of business. In  The Commissioners of Inland Revenue v. The  North  fleet Coal and Ballast Co., Ltd. (1), the respondent Company which was the owner of a chalk quarry had entered into a  contract with a purchaser for the supply of certain quantity of chalk for  a period of ten years.  After some time, the  purchaser wanted to be relieved from the contract, and the  respondent agreed  to its termination on receipt, of pound 3,000.   The point  for  decision  was whether that was a  capital  or  a revenue  receipt.   In  holding  that  it  was  the  latter, Rowlatt, J., observed: "  If  the contract had gone forward those sums  would  have come  into  profits  every  year  and  now  that  they   are represented  by a commutation, so far as that is  concerned, the point seems to be concluded by Short’s case (2) ". One  of the contentions urged on behalf of the assessee  was that the contract being for a term was a capital asset, that the  effect  of the subsequent agreement terminating  it  on payment  of  pound  3,000 was in  substance  to  assign  the unexpired  portion of the contract for a consideration,  and that  it  would be a capital receipt on the  principle  laid down  in  John Smith & Son v. Moore(1).  In  repelling  this contention, Rowlatt, J., observed : "These  contracts  are not being sold.  They are  not  being even   extinguished  really  for  this  purpose.   What   is happening  is that the profits under them are  being  taken; something is being taken in respect of the profits of  them. That  is the position.  This sum represents the  profits  of the  Company -on the contracts, treating them  as  contracts which nationally have earned or are going to earn a profit." And  the  decision  in  John  Smith  &  Son  v.  Moore   was distinguished. (1) (1927) 12 Tax Cas. 1102. (2) (1927) 12 Tax Cas. 955.

7

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 16  

(3) (1921) 12 Tax Cas. 266, 119 In John Smith & Son v. Moore (1), it may be stated that  the executors sold some outstanding contracts for the supply  of coal to the son of the testator for a consideration, and  it was  held that the payment made by the son for the  purchase of  the contracts was in his hands a capital  expense.   The payment  was  not given by one party to a  contract  to  the other in cancellation of the agreement but by a stranger  to the contract to one of the parties thereto for an assignment of his rights thereunder.  In Jessee Robinson & Sons v.  The Commissioners  of  Inland  Revenue (2),  the  appellant  had entered  into  two  contracts for the sale  of’  yarn.   The purchaser  cancelled the contracts and paid pound 12,500  in settlement  of the claims.  The contention of the  appellant was  that this payment was not a trading receipt  or  profit arising  from  his  trade.  In  rejecting  this  contention, Rowlatt, J. observed: "  It  seems  to  me that there is no  reason  why  the  sum received in that respect for breach of contract is not a sum which is part of the receipts of the business for which that contract was made." Examining the facts of the present case in the light of  the above  decisions, the question to be considered  is  whether the  contract  dated May 9, 1940, was entered  into  by  the respondent in the usual course of his business.  If it  was, then  the  amount paid for the termination of  the  contract must  be held to be a trading receipt.  That the  respondent has  been carrying on business in the production and  supply of limestone is amply established.  The record shows that he had been supplying limestone and dolomite to the Bengal Iron Company,  Ltd.,  from  about  the year  1920  and  that  the contracts of 1935 were entered into only in the carrying  on of  that business.  Vide para. 4 in the plaint in  Suit  No. 211  of  1940 already referred to.  The contract of  May  9, 1940,  was  made  in settlement of the  rights  under  those contracts.  It is to be noted that under the agreement dated August  2,  1941,  under  which he received  a  sum  of  Rs. 2,50,000,  he  also  secured a contract for  the  supply  of limestone  for a period of 12 years.  On these facts, it  is impossible to (1) (1921) 12 Tax Cas. 266. (2) (1929) 12 Tax Cas. 1241. 120 come  to  any  conclusion other than that  the  contract  in question was entered into by the respondent in the  ordinary course  of  his business.  The learned Judges  in  the-Court below observe that the assessee was not a dealer in,  though he was a supplier of, limestone.  This appears to us to be a distinction  without  a difference.  Moreover, it  would  be wholly  immaterial  for  the  present  purpose  whether  the respondent was a dealer in or supplier of limestone, as,  in either  view,  he  would be carrying  on  business  and  the contract  in  question  would be one  entered  into  in  the carrying  on of that business.  We should also observe  that the  statement that the respondent was only a  supplier  but not  a  dealer  in limestone does riot appear  to  be  quite accurate on the facts.  Under cl. 13 of the agreement  dated May  9,  1940, the respondent had the right  to  work  other quarries  of  his own, and the evidence shows  that  he  did supply limestone so quarried to other purchasers. In  support  of  the judgment of the  Court  below,  learned counsel for the respondent urged the following contentions : (1)  The contract dated May 9, 1940, was for a period of  25 years  of which more than 23 years had still to run  at  the

8

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 16  

time of the settlement, and it was therefore an asset of  an enduring   character,   capital  in   character,   and   the compensation paid therefor was a capital receipt. (2)  The true character of the agreement was that it brought into  existence  an  arrangement  which  would  enable   the respondent  to  carry on a business and was not  itself  any business and any payment made for the termination of such an agreement is a capital receipt. (3)  The business which was to be carried on pursuant to the contract  was of a specialised character, that there was  no general market for limestone and dolomite, that the contract in  question formed practically the entire business  of  the respondent and the compensation paid for the closure of that business  would  not  be a revenue  receipt  but  a  capital receipt on account of sterilisation of a capital asset.   It is argued by Dr. Radha Binode Pal that the features 121 stated above were not present in the contracts which came up for consideration in the decisions cited for the  appellant, and  that they are therefore distinguishable, and he  relied on  other authorities as applicable to the fact,,;  of  this case.   These  contentions  and  the  authorities  cited  in support thereof must now be considered. (1)  Is  the receipt of Rs. 2,50,000 a capital  receipt  for the reason that it was compensation for the settlement of  a contract  which had a long life before it ? The argument  of the  respondent  is that there is in the  Income-tax  law  a well-defined   distinction   between   fixed   capital   and circulating  capital  (Vide John Smith & Son  v.  Moore)(1), that  where there is a contract the performance of which  is to  be  not  once and for all but spread over  a  period  of years, it is in the nature of a fixed capital and a  payment on  account  of  it  must be held  to  be  capital  receipt. Reliance  is  placed in support of this  contention  on  the decisions  in Commissioner of Income-tax v. Shaw  Wallace  & Co.  (2)  and Barr, Crombie & Co. Ltd. v.  Commissioners  of Inland  Revenue  (3)  and certain  observations  in  Kelsall Parsons & Co. v. Commissioners of Inland Revenue (4) and The Commissioner of Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi (5). In  Income-tax Commissioner v. Shaw Wallace. & Co. (2),  the respondent Company had been acting for several years as  the distributing agents of two oil Companies.  In 1927-28, these Companies   decided   to   make   their   own   distribution arrangements  and accordingly terminated the agency  of  the respondent and paid compensation therefor.  The question was whether  this amount was a revenue receipt in the  hands  of the  respondent.  It was held by the Privy Council  that  it was  a capital receipt, because it represented  compensation paid  for cessation of business, not profits earned  in  the carrying  on  of  it.   In  Barr,  Crombie  &  Co.  Ltd.  v. Commissioners of Inland Revenue (3), the facts were that (1)  (1921) 12 Tax Cas. 266. (3)  (1945) 26 Tax Cas. 4o6. (5)  [1956] S.C.R. 223. (2)  (1932) L.R. 59 I.A. 2o6. (4)  (1938) 21 Tax Cas. 608. 16 122 under  an  agreement dated May 25, 1937, the  appel]ant  had been appointed manager of a shipping company for a period of 15 years, and one of the terms of the agreement was that  if the  company went into liquidation, the entire  remuneration for the remaining period -was payable forthwith.  On  Novem- ber 5, 1942, the company went into liquidation, and a sum of

9

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 9 of 16  

pound  16,306  16s. 11d. was paid to the  appellant  as  its remuneration for the period of about 8 years which was still to  run.  On a question as to whether this was taxable as  a revenue receipt, it was held that as virtually the whole  of the asets of the appellant company consisted of the managing agency agreement, a payment for its extinction was a capital receipt  and was therefore not taxable.  Distinguishing  the decision  in Kelsall’s case (1) where compensation paid  for the  termination  of an agency agreement was held  to  be  a revenue  receipt, the Lord President Normand  observed:  (at page 411). "  Here we are not dealing with a single payment  in  return for  the surrender of the prospect of making profits in  the final  year  of the agreement, but with a  payment  for  the surrender   of  an  agreement  while  there  was   still   a substantial  period-indeed, more than half of the period  of the agreement-to run ". Lord Moncrieff agreeing with this conclusion observed that " so  far from this being a prepayment of future  remuneration for  services, this was, if regard be had to ’the  substance of the matter a price paid upon the purchase and sale of the main asset of a business." In  Kelsall’s case (1), the assessee carried on business  as commission  agents and acquired a number of agencies in  the course  of that business.  One of these agencies  which  was for a period of three years was cancelled at the end of  the second year on payment of pound 1,500 as compensation.   The question  was  whether  this  was a  capital  or  a  revenue receipt.   In  holding  that it was  the  latter,  the  Lord President,  Normand  observed  that  the  business  of   the appellant was to acquire as many agencies as it could,  that it was incidental to that agency that it should be modified, altered or discharged (1)  (1938) 21 Tax Cas. 6o8. 123 and  that as the period outstanding was one year,  it  could not be said that the appellant was parting with an  enduring asset  of the business.  Lord Fleming in agreeing with  this conclusion  stated that he attached importance to  the  fact that  the  agreement  had  Only one year  to  run  and  that different  considerations  might &rise  if  the  outstanding period was considerable. "  A  different  case  would have  arisen  for  decision  he observed, (at p. 622) " if the agreement had been terminated when  it  had still, say, a period of 10 years  to  run.   A payment  made  in respect of a loss to be sustained  over  a period  of years may well have a different character from  a payment  made  in respect of a loss to be sustained  in  the year in which the payment is received." All  these  cases  were  considered by  this  Court  in  The Commissioner of Income-tax and Excess Profits Tax, Madras v. The  South India Pictures Ltd., Karaikudi (1).   There,  the assessee  was  carrying on business in the  distribution  of films, and in the course of such business entered into three contracts  dated September 17, 1941, July 16, 1942, and  May 5,  1945, with a company called the Jupiter Pictures,  Ltd., for  the  production and distribution of three films  for  a period  of 5 years.  On October 31, 1945, the  assessee  and the  Jupiter  Pictures,  Ltd.,  entered  into  an  agreement terminating  the contracts in consideration of a payment  of Rs.  26,000 as compensation to the assessee.   The  question having  been  raised whether this was a capital  or  revenue receipt,  this  Court held that it was the  latter  and  was liable to be taxed, and the decision in Barr, Crombie &  Co. Ltd.   v.   Commissioners   of  Inland   Revenue   (2)   was

10

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 10 of 16  

distinguished  on the ground that there the whole  trade  of the assessee was built on the agreement dated May 25,  1937, that it was a fundamental asset of the assessee’s  business, and that the payment on account of it was a capital receipt. Now, it is the contention of the respondent that the present case  is governed by the principles laid down in  the  above decisions and not those enunciated in the authorities  cited for the appellant, and that the (1) [1956] S.C.R. 223. (2) (1945) 26 Tax Cas. 406. 124 payment  of Rs. 2,50,000 as compensation on account  of  the agreement  dated  May  9,  1940,  falls  within   Income-tax Commissioner  v. Shaw Wallace & Co. (1) and Barr, Crombie  & Co.  Ltd.  V.  Commissioners of Inland Revenue (2  )  rather than  Kelsall’s case (3) and The Commissioner of  Income-tax and  Excess Profits Tax, Madras v. The South India  Pictures Ltd., Karaikudi (4) because the contract dated May 9,  1940, formed  practically the only business of the respondent  and the  contract  had  at the time of the  settlement  still  a period  of  23  years  to run.  It will  be  seen  that  the receipts, the chargeability of which was in question in  the decisions  cited for the respondent, were all payments  made as  compensation  for the termination of  agency  contracts, whereas we are concerned with an amount paid as solatium for the cancellation of a contract entered into by a businessman in  the  ordinary course of his business, and that,  in  our judgment,  makes all the difference in the character of  the receipt.   In  an  agency  contract,  the  actual   business consists  in  the  dealings between the  principal  and  his customers, and the work of the agent is only to bring  about that  business.   In other words, what he does  is  not  the business  itself  but  something  which  is  intimately  and directly  linked  up with it.  It is therefore  possible  to view  the  agency as the apparatus which leads  to  business rather  than  as the business itself on the analogy  of  the agreements in Van Den Berghs Ltd. v. Clark (5).   Considered in  this  light, the agency right can be held to be  of  the nature  of a capital asset invested in business.   But  this cannot  be said of a contract entered into in  the  ordinary course of business.  Such a contract is part of the business itself,  not anything outside it as is the agency,  and  any receipt on account of such a contract can only be a  trading receipt. That there is a distinction between an agency agreement  and a contract made in the usual course of business will further be clear, if we have regard to one (1) (1932) L.R. 59 I.A. 206.  (2) (1945) 26 Tax Cas. 406. (3) (1938) 21 Tax Cas. 608.   (4) [1956] S.C.R. 223. (5)  [1935] A. C. 431. 125 of  the  reasons on which the conclusion  that  compensation paid for cancellation of agency rights is a capital  receipt is  sometimes rested.  It is that, in substance,  the  agent assigns the agreement to the principal and the  compensation is  price  paid  therefor.  Vide the  observations  of  Lord Moncrieff  in Barr, Crombie & Co. Ltd. v.  Commissioners  of Inland Revenue (1) at page 413 already quoted.  It no  doubt sounds somewhat strange that an arrangement between  parties to a contract settling claims thereunder should be  regarded as an assignment of the rights of one of them to the  other, but  it  at  least emphasises that the agreement  is  to  be regarded as a capital asset of the agent, which is saleable. Such  a  concept will be out of place with  reference  to  a contract  entered  into  in the  course  of  business.   Any

11

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 11 of 16  

payment made for the non-performance or cancellation of such a  contract can only be damages or compensation and  cannot, in  law or fact, be regarded as an assignment of the  rights under  the  contract.   A  claim for  damages  is,  in  law, incapable  of  being transferred, though the  benefit  of  a contract could be assigned while it is subsisting, and  such assignment  can only be in favour of third persons,  not  in favour of the other party to the contract, in which case  it will be a new contract.  Reference may in this connection be made   to   the  observations  of  Rowlatt,   J.,   in   The Commissioners  of Inland Revenue v. The Northfleet Coal  and Ballast  Co., Ltd. (2) already quoted, that  such  contracts were not sold. If,  then, contracts entered into in the course of  business cannot,  unlike  agency contracts, be regarded  as  ,capital assets  of  the business, would it make  any  difference  in their  character  that  they are to be in  operation  for  a period ? On principle, it is difficult to see why it should. If  under  the  terms of a contract a businessman  A  is  to supply goods, let us say, 100 bales of yarn, on a particular day  and  he does that, the price received by  him  therefor will  be  a revenue receipt.  And in the above case  if  the purchaser  cancels  the  contract and pays  damages  to  the seller, that would also be a revenue receipt.  If under  the same (1) (1945) 26 Tax Cas. 406 (2) (1927) 12 Tax Cas. 1102. 126 contract  A  is  to  deliver the  bales  in  four  quarterly instalments,  and he does so and receives the price in  four instalments,  all  the receipts would be  revenue  receipts. And  if  after one instalment is  delivered,  the  purchaser cancels the contract as regards future instalments and  pays compensation  therefor  to  the seller,  such  payment  will undoubtedly be a revenue receipt.  If the contract is that A is  to  supply whatever goods are ordered by  the  purchaser during  a  certain period, let us say, 10 years,  the  price received for the goods ordered and delivered will be revenue receipt.  Now, if the purchaser under this contract puts  an end to the contract after some time, say, at the end of  two years  and pays compensation for the breach of the  contract as  regards the remaining period, does the  receipt  thereof become  a capital receipt ? It sounds illogical so to  hold. How   does  it  affect  the  true  position,   whether   the contracting  parties agree to carry on business in the  sale and  purchase of goods for a stated period on terms  settled between  them,  or whether they enter into a  succession  of contracts for that purpose ? Two  decisions  have been quoted before us as  showing  that payments  under  a  contract entered into  in  the  ordinary course  of business would be revenue receipts,  even  though the  agreement may be for a period.  In The Commissioner  of Inland  Revenue v. The Northfleet Coal and Ballst Co.,  Ltd. (1)  cited above, the contract was for the supply  of  chalk for a period of ten years, and the compensation paid was for the cancellation of the contract for the unexpired period of four  years,  and it was held to be a trading  receipt.   In Shove (H.  M. Inspector of Taxes) v. Dura Manufacturing  Co. Ltd.  (2), the respondent company had introdticed company  A to  company B, as the result of which the former obtained  a remunerative  business with the latter.  In return for  this service, A agreed to pay the respondent a commission on  the business   so  obtained.   Later  on,  this  agreement   was terminated  on payment of a sum of pound 1,500 by A to  the, respondent.  The question was whether this was a revenue

12

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 12 of 16  

(1)  (1927) 12 Tax Cas. 1102.  (2) (1941) 23 Tax  Cas.  779, 783. 127 receipt.  In answering it in the affirmative, Lawrence,  J., observed: " Reliance was also placed on certain dicta in the Court  of Session in Kelsall Parsons & Co. v. Commissioners of  Inland Revenue,  at pages 620, 622 and 624, which suggest  that  if the  contract cancelled has more than one year to  run,  the sum  received  for  its cancellation way  be  capital.   The learned Judges who expressed this view did not say that such sum  must  be capital.  They were dealing  with  a  contract different  from  the present, namely,  an  agency  contract, which  constituted  a  very large  part  of  the  taxpayer’s business ". "  In  view  of  the  decision  in  Short  Bros.,  Ltd.   v. Commissioners  of  Inland Revenue and  in  Commissioners  of Inland Revenue v. Northfleet Coal and Ballast Co.  Ltd.  and the  differences  of facts, I do not feel that  those  dicta ought to be applied to the present case." In  our  opinion, therefore, when once it is  found  that  a contract  was  entered  into  in  the  ordinary  course   of business,  any  compensation received  for  its  termination would  be  a revenue receipt, irrespective  of  whether  its performance  was to consist of a single act or a  series  of acts  spread over a period, and in this respect, it  differs from an agency agreement. In  holding that compensation paid on the cancellation of  a trading contract differs in character from compensation paid for  cancellation  of an agency contract, we should  not  be understood as deciding that the latter must always, and as a matter  of  law  be held to be a  capital  receipt’  Such  a conclusion  will  be directly opposed to  the  decisions  in Kelsall’s  case (1) and The Commissioner of  Income-tax  and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karatkudi  (2).  The fact is that an agency  contract  which has  the  character of a capital asset in the hands  of  one person may assume the character of a trading receipt in  the hands  of another, as, for example, when the agent is  found to make a trade of acquiring agencies and dealing with them. The principle was (1) (1938) 21 Tax Cas. 608. (2) [1956] S.C.R. 223. 128 thus  stated  by Romer, L. J., in Golden Horse  Shoe,  (New) Ltd. v. Thurgood (1): " The determining factor must be the nature of the trade  in which  the  asset  is  employed.   The  land  upon  which  a manufacturer  carries on his business is part of  his  fixed capital..  The  land  with which a  dealer  in  real  estate carries OD. his business is part of his circulating capital. The  machinery with which a manufacturer makes the  articles that  he sells is part of his fixed capital.  The  machinery that  a  dealer in machinery buys and sells is part  of  his circulating  capital,  as is the coal that a  coal  merchant buys and sells in the course of his trade.  So, too, is  the coal  that  a  manufacturer of gas buys and  from  which  he extracts his gas." Therefore,  when  a  question arises whether  a  payment  of compensation for termination of an agency is a capital or  a revenue receipt, it would have to be considered whether  the agency  was in the nature of capital asset in the  hands  of the  assessee, or whether it was only part of his  stock-in- trade.   Thus, in Barr, Crombie & Son Ltd. v.  Commissioners of   Inland  Revenue  (2),  the  agency  was  found  to   be

13

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 13 of 16  

practically  the  sole  business of the  assessee,  and  the receipt  of  compensation on account of it  was  accordingly held  to be a capital receipt, while in Kelsall’s  case  (3) the agency which was terminated was one of several  agencies held  by the assessee and the compensation  amount  received therefor was hold to be a revenue receipt, and that was also the  case  in  The Commissioner  of  Income-tax  and  Excess Profits  Tax,  Madras  v. The  South  India  Pictures  Ltd., Karaikudi  (4).   It  is, however,  unnecessary  to  further elaborate  this point, as we are concerned in  this  appeal, not  with  an agency agreement but with a  contract  entered into  in  the  ordinary  course of  business,  and,  in  our judgment,  compensation  received  on  account  of  such   a contract must be held to be a revenue receipt. (2)  The  above  discussion answers to a  large  extent  the contention of the respondent that the contract (1)  (1933) 18 Tax Cas.  280, 300. (3)  (1938) 21 Tax Cas. 6o8. (2)  (1945) 26 Tax Cas. 4o6. (4)  [1956] S.C.R. 223. 129 dated  ’May 9, 1940’ was merely a framework of his  business and  not the business itself, and that a receipt on  account of  it  must be treated as a capital receipt.  The  decision relied  on in support of this contention is Van  Den  Berghs Ltd.  v. Clark (1).  There, two companies, one  English  and the  other Dutch, which were engaged in the manufacture  and sale  of  margarine  entered into  certain  agreements,  the object  of  which was to avoid competition  and  to  augment their profits.  An elaborate scheme was devised under  which the  two companies were to carry on their business  indepen- dently but "in friendly alliance" and in accordance with the scheme;  and the profits were to be shared between  the  two companies in certain proportions.  The agreements were to be in  operation till 1940, but differences arose  between  the parties in the working of the scheme and the "alliance " was terminated in 1927, the Dutch company paying to the  English company  a  sum  of pound  4,50,000  as  compensation.   The question was as to the character of this receipt, whether it was  a capital or a revenue receipt, and it was held by  the House  of  Lords  that  it was a  capital  receipt  and  not taxable. Now,  it  will  be seen that the contracts  which  were  the source  of  the receipt in question did  not  in  themselves constitute the business which yielded the profits to the two companies.   Those  profits were derived by  them  from  the manufacture and sale of margarine, and there was nothing  in the agreements providing that the companies were to join  in the  manufacture  and sale of the margarine.   The  position under  the agreement is thus stated by Lord  Macmillan,  who delivered the leading judgment: "  The  three agreements which the appellants  consented  to cancel  were not ordinary commercial contracts made  in  the course  of carrying on their trade; they were not  contracts for the disposal of their products, or for the engagement of agents or other employees necessary for the conduct of their business; nor were they merely agreements as to how their (1)  (1935) A.C. 431. 17 130 trading profits when earned should be distributed as between the  contracting  parties.  On the  contrary  the  cancelled agreements related to the whole structure of the appellants’ profit-making  apparatus.   They regulated  the  appellants’ activities, defined what they might and what they might  not

14

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 14 of 16  

do, and affected the whole conduct of their business." Thus,  the  agreements in question were intended  to  ensure that  the business in margarine was carried on to  the  best advantage,  but  did not, in themselves, form  part  of  the business.   They  were  merely collateral  to  it.  For  the reasons given in discussing the nature of agency agreements, the agreements between the two companies must be regarded as not  pertaining  to the trading  activities,  which  yielded profits, and the payment on account of those agreements must be  held to be a capital receipt.  But these  considerations would  be inapplicable to the agreement, with which  we  are concerned.   The business which the respondent was to  carry on  and  which  was to yield profits to  him  was  the  very business  to which the agreement relates.  It is under  this very  agreement that he was to be paid Rs. 2-9-0 per ton  of limestone loaded by him, and the business which he had to do to  earn  the amount was to raise and  supply  limestone  as provided  in the agreement.  There is here no  profit-making apparatus  set up by the agreement &part from  the  business which  is  to be carried on under it.   We  are  accordingly unable  to agree that the present case is governed’ ’by  the decision in Van Den Berghs Ltd. v. Clark (3)  It   remains  to  deal  with  the  contention  of   the respondent that the business which he was to have carried on under  the contract dated May 9, 1950, was  practically  the entirety of his trading activities, and that the termination of  such  a  contract is tantamount to  stopping  his  doing business  and  the compensation paid therefor is  a  capital receipt.  Reliance is placed in support of this argument  on the decision in The Glenboig Union Fireclay Co. Ltd. v.  The Commissioners of Inland Revenue (2).  Now, to appreciate the (1) (1935) A.C. 431. (2) (1922) 12 Tax Cas. 427. 131 truer position, it is necessary to bear in mind the distinc- tion between compensation on account of business carried  on under  an  agreement  with  a  third  party  when  that   is terminated, and compensation which is received on account of a business which the assessee is prevented from carrying  on by  a third person in exercise of an overriding  power.   In the  former case, the payment would in general be a  trading receipt  referable to the business activities carried on  or to be carried on under the agreement and would be taxable as a  revenue  receipt.  There may be exceptions  to  this.   A familiar instance is when the parties agree, as part of  the contract to do business, that one of them shall not carry on similar  business for a stated period after the  termination of the contract, and a compensation is paid therefor.   That has been held to be a capital receipt.  Vide Beak v.  Robson (1).  The reason is that it is a payment made not on account of  profits which might have been earned in the carrying  on of  the  business but as solatium for not  carrying  on  the business.   A payment made in a similar covenant to  operate during the period of the contract, however, has been held to be a revenue receipt, because it arises out of the  carrying on  of the business.  Vide Thompson v.  Magnesium  Elektron, Ltd.  (2).  It might also happen that one of the parties  to the  contract  might  have, in the  carrying  out  -thereof, incurred expenses of a capital character and as a result  of the cancellation of the contract, those expenses would  have been  thrown  away.   A payment made  on  account  of  those expenses would bear the character of a capital receipt.  But apart  from  these  and similar  in-stances,  it  might,  in general,  be  stated  that payments made  in  settlement  of rights under a trading contract are trading receipts and are

15

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 15 of 16  

assessable  to revenue.  But where a person who is  carrying on  business  is  prevented from doing  so  by  an  external authority  in exercise of a paramount power and  is  awarded compensation  therefor,  whether that receipt is  a  capital receipt or a revenue receipt will depend upon whether it  is compensation for injury inflicted on a capital asset or on a (1) (1942) 25 Tax Cas. 33. (2) (1943) 26 Tax Cas. 1. 132 stock-in-trade.  The decision in The Glenboig Union Fireclay Co. Ltd. v. The Commissioners Of Inland Revenue (1)  applies to this category of cases.  There, ,he assessee was carrying on  business in the manufacture of fire clay goods and  had, for  the performance of that business, acquired a fire  clay field  on lease.  The Caledonian Railway which  passed  over the field prohibited the assessee from excavating the  field within   a,  certain  distance  of  the  rails,   and   paid compensation therefor in accordance with the provisions of a statute.  It was held by the House of Lords that this was  a capital  receipt and was not taxable on the ground that  the compensation was really the price paid " for sterilising the asset  from which otherwise profit might have been  obtained ".  That  is say, the fire clay field was  a  capital  asset which was to be utilised for the carrying on of the business of  manufacturing fire clay goods and when the assessee  was prohibited  from  exploiting  the field, it  was  an  injury inflicted  on  his  capital  asset.   Where,  however,   the compensation is referable to injury inflicted on the  stock- in-trade,   it  would  be  a  revenue  receipt.   Vide   The Commissioners of Inland Revenue v. Newcastle Breweries  Ltd. (2).   The principle of these decisions has  no  application where the compensation paid is in respect of rights  arising under  a trading contract.  A payment made in settlement  of that  contract  is an adjustment of the  rights  under  that contract, and must be referred to the profits which could be made in the carrying out of that contract. In  the  present case, the contract dated May 9,  1940,  was simply an agreement to carry on business.  In settlement  of that  contract,  Rs. 2,50,000 was paid  to  the  respondent. That was not a payment on account of any capital expenditure incurred  by  him in the execution of  the  contract.   That indeed was the point sought to be raised by the  respondent, but  therein he has failed.  It is also to be noted that  at no time was he prevented from carrying on business.   Clause 6 of the agreement dated May 9, 1940, contemplates that  the respondent was to carry on generally the business (1) (1922) 12 Tax Cas. 427. (2) (1927) 12 Tax Cas. 927. 133 of  supply  of  limestone even apart from his  work  in  the Gangapur  quarry,  and the agreement dated August  2,  1941, provides  for  his supplying limestone for the  furnaces  at Kulti  for  a  period of 12 years and for  loading  iron  at Monoharpore  for a like period.  There was therefore  at  no time  any agreement which operated as a bar to the  carrying on of business by the respondent. On  a consideration of all the facts established, we are  of opinion  that the receipt of Rs. 2,50,000 by the  respondent is a revenue receipt. and is chargeable to tax. In  the result, the appeal is allowed, the judgment  of  the High Court set aside and the order of the Tribunal restored. The   respondent  will  pay  the  costs  of  the   appellant throughout.                                         Appeal allowed.

16

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 16 of 16