1. The principle of law that we have to consider on this reference is clear and well established. The only question is how we shall apply it to the facts of the present case.
2. The assessee is a registered firm and its business was to act as the managing agents of Godrej Soaps, Ltd. The agreement of managing agency was executed on October 29,1928, and the agreement provided that the assessee firm should act as the managing agents of the managed company for a period of 30 years from November 9,1933.
The agreement fixed the remuneration that was to be paid to the managing agency firm, and the remuneration fixed was that it was to get every year 20 per cent, on the net profits of the company. There was also a provision that if during any year the net profit exceeded a sum of Rs. 1,00,000, the amount of such excess over Rs. 1,00,000 up to a limit of Rs. 24,000 was to be paid to the managing agents as their remuneration, and it was. further provided that if the profits exceeded Rs. 1,24,000, half of such excess over Rs. 1,24,000 shall be paid to the managing agents. Pursuant to this agreement the assessee company worked as the managing agents of the managed company.
3. On July 26,1946, Mr. T. M. Kajiji, a director of the managed company, wrote to the managing agents pointing out that the scale of remuneration paid to the managing agents under the agreement was extraordinarily excessive and unusual and the company was desirous that the terms of the agreement should be modified and he suggested that the managing agents should accept the remuneration at the rate of 10 per cent, on the net profits. He also stated in the letter that the managed company was prepared to consider any reasonable claim of compensation by the managing agents for giving up the remuneration at the higher scale and agreed to accept the remuneration at the new and lower scale.
Ultimately, an agreement was arrived at by which the managing agents accepted a sum of Rs. 7,50,000 and agreed to modify the terms with regard to the remuneration and the modified terms were that instead of being paid 20 per cent. on net profits and further commission if the pro-fits increased, they were to be paid at the flat rate of 10 per cent, on the net annual profits of the managed company.
4. The assessee company was paid Rs. 7,50,000 in the year of assessment and the question that arises for our consideration is whether this sum of Rs. 7,50,000 is a capital or revenue receipt.
5. Mr. Palkhiwala on behalf of the assessee has contended that this Rs. 7,50,000 represented compensation paid by the managed company to the assessee firm for the release by the assessee company of its valuable rights under the managing agency agreement. It is further pointed out that under the managing agency agreement there were onerous terms imposed upon the managed company. The managed company got itself released from these onerous terms and in order to be so released it paid a sum of Rs. 7,50,000 to the assessee firm. On the other hand, the assessee firm gave up valuable rights which it had under the agreement and received the sum as compensation for the same.
6. Now, it is undoubtedly true that if the transaction which was effected was of the nature suggested by Mr. Falkhiwala, then the payment of Rs. 7,50,000 would be a capital receipt. If this Bum was paid as a compensation in consideration of the assessee firm releasing its valuable rights under the agreement, the sum of Rs. 7,50,000 cannot possibly be looked upon as a revenue receipt. On the other hand, it is equally clear that we are not concluded by the language used by the parties in giving shape and form to a particular transaction. Such language would undoubtedly play an important part in deciding what the nature of the transaction is, it acts as a guide to indicate the intention of the parties. But whatever language the parties may use in order to clothe their transaction, the question for the Court must always be what was the real transaction effected by the parties.
It is equally true that if by a particular transaction a particular financial result is achieved, it does not follow that because the same financial result is achieved, necessarily, a different transaction entered into between the parties must be looked upon as the same transaction. We must, therefore, consider all the surrounding circumstances and the effect of the agreement arrived at in order to determine what was the nature of the transaction. In our opinion it is clear, looking to the terms of the agreement arrived at between the managing agency firm and the managed company, and all the circumstances of the case, that the effect of the agreement was that the assessee company was paid a lump sum in consideration of the assessee company agreeing to serve the managed company as the managing agents on a reduced salary, or, to use a different language, the sum of Rs. 7,50,000 represented remuneration paid to the assessee company in advance.
7. Now, it is very significant to note that the agreement that was arrived at was nothing more than and nothing less than the modification of the original managing agency agreement. The only modification was that instead of the assessee company continuing to serve the managed company as managing agents on the remuneration fixed under the original agreement, the assessee company agreed to serve the managed company on a reduced salary and it received Rs. 7,50,000 for agreeing to the reduction of its remuneration in accordance with the terms fixed under the original agreement. The pivotal point of the agreement is the obligation cast upon the assessee company to continue to serve as managing agents.
Under the original agreement the managing agents had to serve for a period of 30 years. Under the modified agreement that obligation was in no way interfered with. The obligation continued. The only result of the modification was that the assessee company agreed to receive a reduced remuneration in place of the remuneration originally fixed. Mr. Palkhiwala says that the source of the assessee firm's income was the original agreement. He says that because of that agreement the assesses company received a particular remuneration. That source was dried up and in substitution of that source the assessee received a sum of Rs. 7,50,000. Therefore, according to him, the sum of Rs. 7,50,000 represented the source which was no longer in existence.
If his argument is sound, undoubtedly it would then be possible to say that Rs. 7,50,000 represented a capital receipt as representing not income from the source but the source itself. But in our opinion the argument advanced is not tenable. It is fallacious to suggest that the source of the income of the assessee was the managing agency agreement.
The source was the managing agency, the service which the assessee rendered to the managed company as the managing agents. It is that source that brought the income. It is that source which would have given it the remuneration under the managing agency agreement. It was that source which gave it Rs. 7,50,000 in lieu of the higher remuneration which it would have received under the original agreement. Therefore, Rs, 7,50,000 does not represent the source of the income of the assessee but it represents the income which the assessee would have received under the original agreement. The source remained the same. The source was the service to be rendered by the assessee as the managing agents. Instead of that source giving to the assessee remuneration as fixed under the original agreement it gave the assessee a sum of Rs. 7,50,000. If the transaction is looked at in that light, it is clear that the receipt of Rs. 7,50,000 was a revenue receipt and not a capital receipt.
8. Two cases were relied upon by Mr. Palkhiwala, both English cases. The first is a decision of the House of Lords in -- 'Henry (H. M. Inspector of Taxes) v. Arthur Poster, (1932) 16 Tax cas 605 (A). In that case one Dewhurst was a director of the company concerned along with other directors, and under the articles he was entitled to a certain remuneration, and under one of the articles it was provided that if a director retired having served as a director for 5 years or more the director was entitled on retirement, or his representatives on his death, to a lump sum on the basis of what he had received in the past 5 years.
This Dewhurst entered into an agreement with the company by which he gave up his right to receive this amount when he retired and in place of that he received a sum of 10,000 and agreed to accept an annual remuneration of 250 if he continued to serve as a director of the company; and Mr. Palkhiwala strongly relies on this case as laying down the proposition that if a certain amount is received by an employee in lieu of what he might get in future, that amount represents a compensation for relinquishment of the rights of the employee under the original agreement.
Now, there is one very important fact which distinguishes Dewhurst's case from the case before us. As Lord Atkin pertinently points out (p. 645):
'........he (Dewhurst entered into no bargain to serve the company for any particular time: the only arrangement was that as long as he remained a director he was to get a salary of 250 a year with no recourse to Article 109 (which was the article which gave him compensation on retirement).'
9. Therefore, it would have been impossible for the House of Lords to have said in this case that 10,000 represented reduction of remuneration for services to be rendered by Dewhurst. He was under no obligation to serve and it might be said that when this agreement was arrived at the source was literally dried up because the agreement to serve as a director was no longer there. If Dewhurst served at all, it would De at his own option and 10,000 did not represent the income from that particular source.
In the case before us, as already pointed out, under the modified agreement there was an obligation upon the assessee to continue to serve for the remaining period of the managing agency agreement and his right to accept remuneration continued to remain under the agreement. Therefore, while the source in the case before us continued to remain in existence, the source in the case before the House of Lords was no longer in existence.
The House of Lords has also decided this case on the basis that this sum of 10,000 represented a consideration for the company being discharged from a contingent liability. The liability to receive 10,000 was contingent upon Dewhurst retiring at a particular time, and that liability was discharged by the company paying 10,000 to Dewhurst.
At page 649 Lord Thankerton again emphatically states that the payment of 10,000 was not a reward or a return for services as a director to be rendered in the future, for the payment of the 10,000 was in no way conditional on such service and the remuneration for such service was otherwise provided for by the new arrangement. Therefore, there is another distinguishing fact in this case that the view of the House of Lords was that the old agreement was liquidated and new agreement was entered into and 10,000 was paid in discharge of a contingent liability under the old agreement.
10. The other decision relied upon by Mr. Palkhiwala is the decision of -- 'Tilley v. Wales (Inspector of Taxes)', 1943 11 I T R Supp 69 (B). In that case a company agreed to pay the assessee 6,000, a year for acting as managing director and also agreed in the event of the assessee ceasing from any cause to be managing director an yearly pension of 4,000 for 10 years. A subsequent agreement was arrived at and the com-pany was released from its obligation to pay to the assessee the pension as agreed to and also it was agreed that the assessee should accept a reduced salary of 2,000 instead of 6,000 a year and in consideration of the assessee agreeing to these modified terms the company undertook to pay 40,000 in two instalments of 20,000 each, and the question was whether this source of 40,000 represented a revenue or a capital receipt.
The House of Lords decided this case on the basis that different principles applied to the release of the company from its prospective obligation to pay pension and the amount received by the assessee as consideration for agreeing to serve the company in future at a salary of 2000 per annum, and the House of Lords held that to the extent that the company was freed from its obligation to pay pension, the payment received by the assessee in consideration of his giving up his right to receive pension must be looked upon as a capital receipt. The Lord Chancellor took the view that this sum which was apportioned at 20,000 represented commutation of pension, but it is equally significant that with regard to the other 20,000 it was looked upon as representing the amount paid to the assessee for agreeing to serve the company in future at the reduced salary. It was looked upon as a revenue receipt which was subject to tax.
In our opinion, the present case falls under the Second aspect which the House of Lords considered and not the first aspect. Whatever considerations may attach to a case where a party accepts a lump sum for commutation of pension, entirely different consideration would apply where a party accepts a lump sum in consideration of the reduction of the assessee's salary from a higher amount to a lower amount, and if we take the view that Rs. 7,50,000 represent a lump sum paid by the managed company in consideration of the reduction of the assessee's remuneration fixed under the original agreement to a lower remuneration, then clearly the decision of the House of Lords, far from helping the assessee, is directly and clearly against its contention.
11. In our opinion, therefore, the Tribunal was right in the view that it took and we must answer the question submitted to us in the affirmative. The assessee to pay the costs.
12. Answer in the affirmative.