1973 PLP 301 (PTD)

Income‑tax‑

Capital or revenue receipt Lump sum payment for cancellation of agreement ‑Monies agreed to be advanced by assessee to another company for erecting a factor v‑Interest and commission payable to assessee in consideration‑Agreement cancelled‑Lump sum payment to assesses‑Whether income or capital. The assesses‑company entered into an agreement with a Delhi company to lend a sum of Rs. 11.50 lakhs to the latter fn order to erect a factory at Madras, in consideration whereof the assessee was to be paid interest as well as commission for a period of 7 years on all sales of wheat products at Madras by the Delhi company. Due to certain reasons, the agreement was cancelled and at that time the assesses‑company had already advanced a sum of Rs. 5,36,

000. The Delhi company agreed to repay this sun‑, with interest at the stipulated rate and also compensation. The entire amount together with a compensation of Rs. 25,000 was paid by November 30, 1959, and the Delhi company was released of all its obligations under the agreement. In its assessment for 1960‑61, the assesses‑company's claim to treat this sum of Rs, 25,000 as a capital receipt was negatived by the officer but upheld by the Tribunal. On a reference at the instance of the Commissioner: Held: As the mills by setting up for themselves an apparatus to earn profits, engaged themselves in an activity which was not akin to of related to their usual business and which activity had to be shelved and the totality of the new under taking given up in consideration of the lump sum payment, the sum and substance of the transaction was that the profit making apparatus had been compulsorily dissolved and the ultimate receipt was capital in nature and hence the Tribunal's conclusion was right. [Case‑Law referred]. V. Balasubrahmanyan and J. Jayaraman for the Commissioner S. Narayanaswami and T. V. Ramanathan for the Assessee. RAMAPRASADA RAO, J.‑The assesses, an incorporated private limited company, was carrying on business in the manufacture and sale of flour such as Maida, Atta, Sooji, etc. By an agree ment dated April 25, 1959, with a Delhi company known as Hindustan Cold Stores and Refrigeration Private Ltd., the assessee undertook to lend a sum of Rs. 11'50 lakhs to the Delhi company to enable them to erect a flour milling plant at Madras in the name and style of Hindustan Roll Flour Mills for the manufacture of Maida, Atta, Sooji, etc. In consideration of the amount so advanced or to be advanced by the assessee to the Delhi company, the latter agreed to pay interest on the borrowing at 9 per cent. per annum and also a commission of 1 per cent for a period of 7 years on all its sales of wheat products at Madras. The agreement, at all material times, was understood as one by which the assesses lent the amount for interest and for the due repayment of the principal and interest borrowed by the Delhi company, it was agreed that they should execute a deed of pledge over their plant and machinery to be imported by them and erected at Madras and also execute a regular deed of mortgage over the same as well as the immovable properties consisting of land and buildings erected by the Delhi company at the factory site in Madras. Besides, the agreement envisaged a personal guarantee by the managing director and the one other co‑director of the Delhi company. The 1 per cent. commission which was also a consideration for the loan agree ment was to be paid for a period of 7 years on the selling price of all wheat products and by‑products manufactured by the Delhi company at Madras. This commission was to be paid even in the event of the loan advanced being repaid before the stipulated period of 7 years. This financial assistance agree ment, as the parties themselves termed It, could not be fully implemented though the Delhi company executed a deed of pledge and also deposited their title deeds in relation to their immovable property in respect of a loan by then given by the assessee extending to a sum of Rs. 5,36,

000. Due to some difference, the agreement was cancelled and the Delhi company agreed to repay the sum of Rs. 5,36,000 together with interest at the agreed rate and, inter alia, agreed to pay a sutra of Rs. 1,00,000 as compensation to the party of the second part for the loss of bargain consequent upon the termination of the agreement in question and set out a scheme for ‑such repayment. A sum of Rs. 25,000 was paid as on the date of cancellation of the agreement and the balance was agreed to be paid on or before February 29, 1960. Certain concessions were also given to the Delhi party in the matter of such compensation if the entire sum of Rs. 5,36,000 was repaid by the Delhi party by November 30, 1959. The Delhi company paid the principal and interest due and also the sum of Rs. 25,000 being the compensation stipulated to be paid before November 30, 1959, whereupon the company released the Delhi company from the agreement dated April 25, 1959. The assessee company claimed that the sum of Rs. 25,000 received by them pursuant to the aforesaid terms set out in the agreement was a capital receipt and not income. The Income‑tax Officer held that the compensation was for services rendered by the assessee company contemporaneous with the advancement of the loan for finding a site to the Delhi company for erection of their factory sad also for loss of profit on account of the termination of the agreement and therefore was of opinion that it was a business profit and included the same in the company's assessment for the year 1960‑

61. The appellate Assistant Commissioner also was of the same view, but for different reasons, He was of the opinion that the cancelled contract does not relate to the whole structure of the assessee's profit making apparatus. It was simply a financial arrangement and the interest payable was ordinary interest without any reference to or depending upon the profit, Cancellation arose from the exigencies of circumstances and it did not affect the basic structure of the assessee's business. The Appellate Tribunal, however, differed from the revenue that the agreement is not one for the supply of raw materials or connected with the stock‑in‑trade of the assesses. According to them, it is the framework for a profit producing source, The assesses ventured to invest a large sum with the Delhi company for a particular purpose. In return the assessee was to get 1 per cent. as commission on the selling price of all the products to be manufactured by the Delhi company. Such a commission was to be paid for a continuous period of 7 years and the assesses therefore secured an enduring benefit or at least was assured of the same as a result of the arrangement which was reflected in the agreement. By the cancellation of the agreement the assessee had to give up what virtually happened to be a sharing in the business of that other company which was the source of income for the assessee. The Tribunal, therefore, held that the receipt was for the destruction of a capital asset and was therefore of a capital nature. They deleted the addition of Rs. 25,000 to the business income of the assessee for the assess ment year. At the instance of the Commissioner of Income‑tax, an application under section 66(1) was made to the Tribunal to refer a question of law which has arisen out of its order to this Court for opinion. The question referred is : "Whether, on the facts and In the circumstances of the case, the sum of Rs. 25,000, being the compensation received by the assesses‑company from Messrs Hindustan Cold Stores and Refrigeration Private Ltd., is income assessable to income‑tax for the assessment year 1960‑61 ?" Though, no doubt, the agreement by itself reflects only a financial arrangement between the parties, yet the compensation that was agreed to be paid on its cancellation is more for the reason that the assessee was deprived of the commission which it could earn for a period of the 7 years irrespective of the repayment of the advance earlier or at the stipulated time. This defeasance of the commission which was a certain event in case the agreement worked itself out is a deprivation of the benefit which was enduring to the assesses‑company. It was not a casual receipt nor could it be termed to be a business Income as is popularly understood when ft is juxtaposed to the facts and circumstances of this case. It is, therefore, necessary for us to consider in detail, in the light of the facts of the case and In the circumspect of judicial precedents touching upon the subject, whether the sum of Ra. 25,000 received by the assessee‑company during the assessment year is capital receipt or revenue receipt. The problem whether a given receipt or expenditure is to be treated as capital or revenue has considerably engaged the attention of Courts. Its variegated facets, Its different connota tions, whilst having impact on distinct facts and its inhered elusiveness in not being susceptible to a strict definition as such, has given rise to multi‑coloured elucidation and formulae for the understanding of the expression, "capital and revenue receipt". As has often been said, the precedents do not exhaust the subject but at best are all illustrative. Certain aspects arise for consideration in the instant case. Whenever an assessee enters into an agreement, not in his usual course of business but independent thereof, and secures rights and incurs contractual liabilities and is, while implementing the same, the very source of the bargain as contemplated in the agreement is removed and in lieu thereof on such an unexpected snapping of the chain of events and the plugging of the hole in the source, he is compensated, then such a compensation is deemed to be for the very drying up of the source and, as is commonly said, for the destruction of the profit earning apparatus. In such a case the compensation received would be a capital receipt. In this case the assessee forged an apparatus in the shape of a commercial agreement dated April 25, 1959, and Intended that it should give the profits as is popularly understood. Besides interest on investment, the assessee expected to earn commission at 1 per cent. for a period of 7 years on the total sales of wheat products to be manufactured by the Delhi company. This involved the assessee setting up as it were a miniature organisation which is obviously different in concept and working of a flour mill, while h is the assessee's business. The enterprise envisaged in the agreement is neither directly nor indirectly connected with its business. It is not even urged to be so, nor does the record disclose any such nexus. The activity which is thus totally dissociated with the business of the company cannot be characterised as one undertaken in the course of its business and much less in the ordinary course of its business. The rights and liabilities under the agreement projected a picture which is unique and fundamental by itself and had no relation to the principal business of the assessee. The aggregation of those rights reflected in the agreement is a capital asset and any compensation received in exchange for the cessation of such rights ought to be considered as a capital receipt. Mr. Balasubrahmanyan, for the revenue, reiterates that the receipt is income while Mr. S. Narayanaswami contends contra. We shall notice the citations made. Commissioner of Income‑tax v. Rai Bahadur Jairam Valji ((1959) 35 I T R 148 (S C)) was a case where the agreements were held to be mere adjustments made in the ordinary course of business and there was no profit‑making apparatus set up apart from the usual business and, in those circumstances, the receipt by the assessee of compensation for the termination of the agreement watt held to be a revenue receipt. The Supreme Court observed: "In the determination of the question whether a receipt is capital or income, it is not possible to lay down any single test as infallible or any single criterion as decisive. The question 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. That, however, is not to say that the question is one of fact, for these questions between capital and income, trading profit or no trading profit, are questions which, though they may depend to a very great extent on the particular facts of each case, do involve a con clusion of law to be drawn from those facts." In Godrej & Co. v. Commissioner of Income‑tax ((1959) 37 I T R 381 (S C)), a sum of Rs. 7,50,000 was paid to the managing agents of a company as price for the sterilisation of a part of a capital asset which was the framework of the managing agents' profit‑making apparatus and so it was held to be a capital receipt. There the managing agents gave up 50 per cent. of their remuneration and a lump sum of Rs. 7,50,000 was paid as compensation for the injury or deterioration of the managing agency. Such a contraction in the profit‑making apparatus of a managing agency, which deterioration has been evaluated by consent, was held to be a capital receipt. In P. H. Divecha v. Commissioner of Income‑tax ((1963) 48 I T R 222 (S C)), Hidayatullah, J., as he then was, speaking for the Supreme Court, expressed the view that in deciphering whether a receipt is capital or income, one must have regard to the nature and quality of payment. It is not the motive of the person who pays that is relevant. The mere nomenclature does not decide the ‑character of the payment nor its periodicity. If the payment is not received to compensate fur loss of profits of business, the receipt cannot be described as income, profits or gains as commonly understood. Again, the Supreme Court in Kettlewell Bullen & Co. Ltd: v. Commissioner of Income‑tax ((1964) 53 I T R 261 (S C)), after considering the relevant authorities, drew up a principle in these lines : "On an analysis of these cases which fall on two sides of the dividing line, a satisfactory measure of consistency in principle is disclosed. Where on a consideration of the circum stances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue ; where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in louts of what may be regarded as the source of the assessee's income, the payment made to com pensate for cancellation of the agency agreement is normally a capital receipt." In P. L. M. Firm v. Commissioner of Income‑tax ((1968) 68 I T R 856) we observed that if the source of income ceases to exist, then any payment made in consequence of such a cessation is a capital receipt. Wheatcroft in his book on The Law of Income tax, super tax and Profits Tax, has summarised the position and enunciated a general principle at page 1249 as follows: "The sum received by a commercial firm as compensation for the loss sustained by the cancellation of a trading contract or the premature termination of an agency agreement may in the receipient's bands be regarded either as a capital receipt or as a trading receipt forming part of the trading profit. It may be difficult to formulate a general principle by reference to which in all cases the correct decision will be arrived at since in each case the question comes to be one of circumstance and degree. When the rights and advantages surrendered on cancellation are such as to destroy or materially to cripple the whole structure of the recipient's profit‑making apparatus, involving the serious dislocation of the normal commercial organisation and resulting perhaps in the cutting down of the staff previously required, the recipient of the compensation may properly affirm that the compensation represents the price paid for the loss or sterilisation of a capital asset and is therefore a capital and not a revenue receipt." On an overall survey of the main precedents cited, it appears to us that if a businessman sets up for himself a reservoir of commercial activity which he intends to exploit and gain profits and if by any reason the activity is snapped and the reservoir is involuntarily dried up and in lieu thereof the tradesman receives compensation, such a compensation being incompatible with the character of profits or gains and not being a surrogatum for income, is undoubtedly a capital receipt. The classical speech of Lord Macmillan in Ven den Berghs Ltd. v. Clark (H. M. Inspector of Taxes) ((1935) 3 I T R (Eng. Cas.) 17) to the effect that if the congeries of rights which a businessman surrenders is a capital asset and if they relate to the whole structure of his profit‑making apparatus then any receipt in those circumstances is capital and not revenue, still is ruling the field and is an unassailable proposition. In the instant case, the mills engaged themselves in an activity which was not akin to or related to their usual business. They set up for themselves an apparatus to earn profits. This had to be shelved and thus the totality of the new undertaking had to be given up in consideration of a lump sum payment. The magnitude of the receipt is an irrelevant consideration. The sum and substance of the transaction is that the profit making apparatus has been compulsorily dissolved. The entire congeries of rights in the integrated series of activities of the assessee reflects that the ultimate receipt by him is a capital one. The venture started by the assessee was independent and fundamental by itself. He laid movies for the purpose. He had great expectations about the activity. But the agreements which formed the genesis of such a fundamental, new and separable organisation had to be cancelled. Monies were received for such a cancellation. Such mantes do not bear the character of income. We, therefore, agree with the conclusion arrived at by the Tribunal. The question Is answered against the revenue with costs. Counsel's fee Rs. 250.