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Commissioner of Income-tax, Bombay City-iii Vs. Kantilal Shah and anr. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 71 of 1969
Judge
Reported in[1979]118ITR647(Bom)
ActsIncome Tax Act, 1961 - Sections 4 and 148
AppellantCommissioner of Income-tax, Bombay City-iii
RespondentKantilal Shah and anr.
Appellant AdvocateR.J. Joshi, Adv.
Respondent AdvocateS.E. Dastur, Adv.
Excerpt:
.....of income tax act, 1961 - whether sums of rs.50000 received by assessee as per agreement with a company was capital receipt - assessee had no income from business and had only income from other sources - agreement was not contract or arrangement in course of regular business of assessee - payment of rs.50000 made under later agreement was being made for premature cutting off of source of income - termination was tantamount to termination or premature determination of capital assets - any amount paid for such premature determination regarded as capital receipt. - - joshi took us through this decision of the supreme court and submitted that the facts concerned therein were clearly distinguishable and there were special features noticed in p. in consideration of the loan the..........1 of the later agreement (annexure 'b') states that the share of profits of the assessee for the firm's year ended 30th september, 1958, comes to rs. 45,243. clause 2 indicates that the profit for the next year, i.e., the period ending 30th september, 1959, is being ascertained and is mentioned at about rs. 45,000. it may be stated that the assessment order for the year 1960-61 shows that this profit was ultimately ascertained at rs. 38,801. clause 3 requires the firm to pay to the assessee all the amounts lying to her credit including the sum of rs. 45,243 (i.e., the amount advanced as capital and the share of profits for the year ended 30th september, 1958), on the 30th day of december, 1959. clause 4 provides that on a before 31st december, 1959, the amount ascertained towards the.....
Judgment:

Desai, J.

1. In this reference, we are concerned with Mrs. Vimla Kantilal Shah, an individual, and the assessment year is 1960-61. For this assessment year, the relevant accounting period in respect of income from Natson Manufacturing Company is the year ended 30th September, 1959, and in respect of the income under the head 'Income from other sources' is the calendar year ended 31st March, 1960. Natson Manufacturing Co. (hereinafter referred to as 'Natsons') is a firm consisting of two partners, A.N. Shah and N. C. shah, which firm was in need of finance and accordingly an agreement dated 7th March, 1958, was entered into between the firm and the assessee. Under the said agreement, a copy whereof is to be found as annexure 'A' to the statement of case, the assessee agreed to advance capital to the said firm for the purpose of its business and development to the extent of rupees one lakh. Clause 3 of the said agreement provided that in consideration of such advance, the firm was to give to the assessee a twenty-five per cent. share from the profits of the firm. The agreement was to be deemed to have commenced from the 1st day of January, 1958, and the share in the profits of the assessee was to be calculated from that date. The period of the agreement provided under clause 6 was five years from 1st January, 1958. By the said clause, it was provided that the accounts should be made up in the first instance up to 30th September, 1958, and thereafter according to the accounting period of the partnership of Natsons, which was the year ending 30th September every year. Clause 7 made provision for what was to be paid to the assessee in case there were no profits of the firm. By the said clause, it was provided that interest would be payable on the sum advanced by her at 6% per annum. It was clarified by a later clause that the agreement was not deemed to constitute a partnership between the two persons constituting Natsons and the assessee or between the firm and the assessee. There was also a provision that if the firm required more capital they were to approach the assessee; the clause, however, did not provide for any obligation on the assessee to advance additional capital beyond the sum of rupees one lakh or indicate the terms of such advance.

2. Thereafter, differences arose between the said firm and the assessee and by another agreement dated 16th December, 1959, the parties cancelled the earlier arrangement; a copy of the later agreement dated 16th December, 1959, is to be found as annexure 'B' to the statement of case. Clause 1 of the later agreement (annexure 'B') states that the share of profits of the assessee for the firm's year ended 30th September, 1958, comes to Rs. 45,243. Clause 2 indicates that the profit for the next year, i.e., the period ending 30th September, 1959, is being ascertained and is mentioned at about Rs. 45,000. It may be stated that the assessment order for the year 1960-61 shows that this profit was ultimately ascertained at Rs. 38,801. Clause 3 requires the firm to pay to the assessee all the amounts lying to her credit including the sum of Rs. 45,243 (i.e., the amount advanced as capital and the share of profits for the year ended 30th September, 1958), on the 30th day of December, 1959. Clause 4 provides that on a before 31st December, 1959, the amount ascertained towards the share of profit for the year ended 30th September, 1959, is also to be paid to the assessee. Clause 5 provides that the earlier finance agreement dated 7th March, 1958, is to be treated as cancelled and determined as at the end of 30th September, 1959, on payment being paid as provided in the later agreement; and it further provides that in consideration of the said termination, the firm has to pay to the assessee the sum of Rs. 50,000 by way of compensation for such earlier determination of the said agreement. This amount of Rs. 50,000 is also to be said on 30th December, 1959. By clause 6 the position is reiterated, viz., that on payment of these amounts, viz., Rs. 45,243, and the other amounts standing to the credit of the assessee, the share of profits duly ascertained for the period ended 30th September, 1959, and the sum of Rs. 50,000 being compensation for determination of the finance agreement, the assessee is to release all her right, title and interest in respect of the said agreement dated 7th March, 1958.

3. The amount of Rs. 50,000 was not shown by the assessee in her return for 1960-61 and the assessment was completed on 9th November, 1960. For the next year, i.e., assessment year 1961-62, the assessees filed the returns on 30th September, 1961, and in this return the sum of Rs. 50,000 was shown in Section 'D' as 'compensation received from Natson Manufacturing Co. for earlier termination of the agreement'. The ITO was of the view that this sum was received in the financial year 1959-60 and was properly assessable in the assessment year 1960-61. As the assessment for the said year had already been completed, the ITO reopened the assessment for the year 1960-61. In the reassessment proceedings after notice under s. 148, it was claims on behalf of the assessee that the amount paid by the firm was in relinquishment of a capital asset and as such a capital receipt. In support of her contention, the assessee relied on the decision of the Supreme Court in P. H. Divecha v. CIT : [1963]48ITR222(SC) . The ITO distinguished the facts of the case of the assessee from the facts in the case before the Supreme Court and held that the compensation paid was for loss of profits and not for loss of capital assets. He also observed that the income from Natson Manufacturing Company had all along been taxed in the hands of the assessee as income from other sources. Accordingly, it was his view that the compensation will be taxable in the financial year 1959-60 in which it was received.

4. The matter was carried by the assessee in appeal. A number of grounds were urged before the AAC. It was submitted that notice under s. 148 for revising the assessment was not called for. It was further urged that the ITO had erred in holding that the compensation of Rs. 50,000 received from the firm pertained to loss of profit and not loss of a capital asset. It was also urged that even if this submission be not accepted, the ITO was in error in holding that the income was assessable for the assessment year 1960-61, and it was submitted on behalf of the assessee that it could not be included in the total income for that year and was relevant only for the assessment year 1961-62. All the three contentions were rejected by the AAC, who confirmed the order of the ITO.

5. The matter was thereafter carried further in second appeal to the Income-tax Appellate Tribunal. The Tribunal confirmed the action of the ITO in reopening the assessment. It then dealt with the second contention, viz., that the payment of Rs. 50,000 was not for loss of profit but must be deemed to be a capital receipt on the facts of the case. According to the Tribunal, this contention deserved to be accepted. According to the Tribunal, the reason for the payment of the sum of Rs. 50,000 had been specifically mentioned in the agreement at annex.'B' as compensation for determination of the financing agreement (annex.'A'). In these circumstances, according to the Tribunal, there was no scope for holding that the profit which the assessee would have earned as per the original agreement continued to subsist. Further, the Tribunal noted the profit obtained by the assessee in the first two years and observed that there could be no comparison of the amount of profits which the assessee could have made for the three years and the sum of Rs. 50,000 which was paid to her by the firm. According to the Tribunal, the capital asset of the assessee before it was the financing agreement which gave rise to the income of the assessee; by the agreement (annex.'B'), the original agreement, the source of income was being cut off. In the view of the Tribunal, therefore, the payment of Rs. 50,000 made under the later agreement (annexure 'B') was being made for the premature cutting off of the source of income. In this view, according to the Tribunal, the receipt of Rs. 50,000 must be held to be for the loss of a capital asset and, hence, a capital receipt which would not constitute taxable income in the hands of the assessee.

6. In the view that it had taken in favour of the assessee on this contention the Tribunal did not go into the question as to whether the amount, if relevant, would be relevant in the assessment year 1960-61. It is from this decision that the reference has been made under s. 256(1) of the I.T. Act, 1961, at the instance of the Commissioner, and the following question has been referred to us :

'Whether, on the facts and in the circumstances of the case, the sum of Rs. 50,000 received by the assessee as per agreement dated 16-12-1959, with Natson Manufacturing Co. was a capital receipt ?'

7. Mr. Joshi referred us to two Supreme Court decisions, which in his submission, would establish that the conclusion which found favour with the Tribunal was totally erroneous and liable to be corrected in the reference. The first of these decisions was CIT v. South India Pictures Ltd. : [1956]29ITR910(SC) and, the second of these decisions was CIT v. Rai Bhadur Jairam Valji : [1959]35ITR148(SC) . In South India Pictures Ltd.'s case : [1956]29ITR910(SC) , the assessee had received a sum of Rs. 26,000 in the accounting year pursuant to an agreement dated 31st October, 1945, concealing several agreements between it and the firm of film producers called Jupiter Pictures. A number of English authorities (some of which also were cited by Mr. Joshi) were referred to in the judgment given by Das C.J., who spoke for the majority of the Supreme Court, and it was concluded that the sum received by the assessee was a sum paid in the ordinary course of its business to adjust the relationship existing between it and the producers of the films. The contention of the assessee that by the financing agreements it had acquired capital assets for carrying on distributing agency business was repelled by the court (see page 918 of the report). The court held, on the facts of that case, that the amount was not received by the assessee as the price of any capital assets sold or surrendered or destroyed or sterilized, but that the amount was simply received by the assessee in the course of its going distributing agency business from that going business. In Jairam Valji's case : [1959]35ITR148(SC) are to be found general observations regarding the proper approach to be adopted by courts in the determination of the question whether a receipt is capital or income. It is not possible, according to the Supreme Court, to lay down any single test as infallible or any single criterion as decisive. The question will be required to be decided on the facts of the particular case and the authorities bearing on the question are valuable only as indicating matters that have to be taken into account in reaching the decision. It was observed by the court that there is a difference between a payment made as compensation for the termination of an agency contract and an amount paid as solatium for the cancellation of a contract entered into by a businessman in the ordinary course of business. It was further observed that an amount received under the latter head would ordinarily be a trading receipt and would be assessable revenue. The court, however, went on to observe and laid down a caution that from this it would not follow that receipts of the former type were always to be regarded as capital receipts.

8. Mr. Joshi also relied on and referred us to various decisions of English courts : (1) Short Bros. Ltd. v. IRC [1927] 12 TC 955, (2) IRC v. Northfleet Coal and Ballast Co. Ltd. [1927] 12 TC 1102, (3) Van den Berghs Ltd. v. Clark [1935] 3 ITR (Eng Cas) 17 HL and (4) Bush Beach & Gent Ltd. v. Road [1939] 22 TC 519; [1940] 8 ITR (Supp) 36 . Most of these decisions have been noted in the two decisions of the Supreme Court and in some other decisions, no which immediate reference may now be made.

9. Before the ITO and the AAC, it had been contended on behalf of the assessee that the facts were identical with the facts in P. H. Divecha's case : [1963]48ITR222(SC) . Before us Mr. Joshi took us through this decision of the Supreme Court and submitted that the facts concerned therein were clearly distinguishable and there were special features noticed in P. H. Divecha's case : [1963]48ITR222(SC) as result of which it was held that the solatium paid to the three partners of Precious Electric Co. was not their income or paid as loss of profits. To a large extent Mr. Joshi's comment on that decision, viz., that the said decision will not apply to an agreement of the type with which we are concerned, appears to be correct.

10. Mr. Dastur on behalf of the assessee, however, drew our attention to two decisions in which similar agreements came up for consideration before the High Courts. A finance agreement was considered by the Madras High Court in CIT v. South India Flour Mills Private Ltd. : [1970]75ITR147(Mad) . In the agreement, the assessee-company had agreed to lend a sum of Rs. 11.50 lakhs to a Delhi company to enable the latter to erect a factory at Madras. In consideration of the loan the assessee was to be paid interest as well as commission for a period of seven years on all sales of wheat products at Madras by the Delhi company. Due to certain reasons, the agreement was cancelled, by which time the assessee had already advanced the aggregate sum of Rs. 5,36,000. This amount was agreed to be repaid with further payment to be made as compensation and ultimately a sum of Rs. 25,000 was paid in the assessment year 1960-61. The assessee's claim that this amount should be treated as a capital receipt was negatived by the ITO and the AAC but upheld by the Tribunal. The matter was then carried further by the department to the High Court. The High Court found that the activity which the assessee had indulged in entering into a finance agreement was one totally dissociated from the business of the company and could not be characterised as one undertaken in the course of its business and much less in the ordinary course of its business. According to the court, the rights and liabilities under the agreement projected a picture which was unique and fundamental by itself, it had no relation to the principle business of the assessee. The Division Bench of the Madras High Court in its decision extracted a passage (at pages 152, 153) from Wheatcroft in his book on The Law of Income-tax, Surtax and Profits Tax and, after so doing, went on to observe as follows (p. 153) :

'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 surrogate for income, is undoubtedly a capital receipt.'

11. It may be noted that the Division Bench had considered the Supreme Court decisions in Jairam Valji's case : [1959]35ITR148(SC) , Godrej & Co. v. CIT : [1959]37ITR381(SC) , P. H. Divecha's case : [1963]48ITR222(SC) as also a later decision of the Supreme Court in Kettlewell Bullen & Co. Ltd. v. CIT : [1964]53ITR261(SC) . It also extracted a passage from the speech of Lord Macmillan in Van Den Berghs Ltd. v. Clark [1935] 3 ITR 17 , on which Mr. Joshi had relied before us. In its view, the agreement between the assessee and the Delhi company which had formed the genesis of a fundamental, new and separate organisation, had been cancelled and moneys received for such cancellation were to be treated as capital receipts and did not bear the impress of income.

12. Mr. Dastur then referred us to an unreported decision of Division Bench of this High Court, to which the learned Chief Justice was a party, viz., Income-tax Reference No. 37 of 1965 CIT v. Khushalbhai Patel & Sons decided on 19th July, 1974 [Since reported in : [1979]118ITR656(Bom) infra]. The Division Bench was considering three finance agreements-two of which the original agreements and the subsequent one was one modifying the earlier rights between the assessee and the Western India Co. Ltd. Under these agreements finance of Rs. 10 lakhs was to be made available by the assessee to the company as and when required by the said company, for which the assessee was to be paid, in addition to interest, commission at certain rate specified in the agreement was ten years but there was a provision that even after this period when the obligation of the assessee would come to an end, the company would continue to be under an obligation to pay the commission though at a lower rate. The obligation proved to be too onerous for the company which took up the stand that the provisions were illegal as offending the provisions of the Bombay Money-lenders Act. A suit was filed by the company and a counter-claim therein by the assessee and ultimately by a consent decree it was agreed that the company would pay to the assessee-firm as and by way of compensation and/or damages for the termination of the agreement the sum of Rs. 3 lakhs by five equal instalments of Rs. 60,000 each. It is this compensation which was the subject-matter of the decision of the High Court in the said reference. The ITO had repelled the contention of the assessee that the sum received represented a capital receipt. The assessee, appealed to the AAC but the appeal proved infrucuous. Before the Tribunal, however, the assessee succeeded, which resulted in the reference to the High Court at the instance of the Commissioner. Mr. Joshi on behalf of the revenue had relied on the very authorities which he cited before us and contended that the compensation must be deemed to be in lieu of loss of interest and commission receivable under the agreement. The Division Bench noted that the terms of the agreement were very much in favour of the assessee and onerous as far as the company was concerned. It further noted that this was the first and probably the only finance agreement or agreements which the assessee had entered into although it was a partnership of businessmen who cold by mutual agreement carry on any business or venture when it desired. It also noted that the amount of commission which the assessee was receiving under the finance agreement was much more and could not at all be compared with the interest that was received and it was held that the arrangement as evidenced by the three agreements could not be regarded as being one of the routine trade contracts entered into by the assessee-firm with the company in the ordinary course of its business. The arrangement was held to be one which created a steady source of income of the assessee, for the loss of which, upon the termination of the arrangement, the amount of Rs. 3 lakhs became payable to the assessee. In the result, the view taken by the Tribunal was approved and the question answered in favour of the assessee.

13. The various authorities which were cited at the bar before us on behalf of the revenue have been fully and exhaustively discussed in the above decision and, in our opinion, it is unnecessary to enter into a similar exhaustive discussion in our case. Mr. Dastur on behalf of the assessee has emphasised that the assessee was a lady and in the year under consideration she had no income from business and had only income from other sources. There is no finding that at any time previous to this she had entered into similar finance agreements. Although the finance agreement with which we are concerned (annex. A to the statement of case) does not have all the peculiar features that were before the Division Bench in Khushalbhai Patel & Son's case (I.T. Reference No. 37 of 1965-Since reported in : [1979]118ITR656(Bom) infra), it still possesses the unusual feature that the assessee is entitled under the same to 25% of the profits earned by the firm of Natsons, which resulted in her securing profits of Rs. 45,243 in the first year as against the obligation to advance a loan up to the limit of rupees one lakh only. This arrangement also then could be regarded as one which is extremely beneficial to the assessee and onerous for the firm of Natsons Manufacturing Company. It is impossible upon these facts to hold that this agreement was a contract or arrangement in the course of the regular business of the assessee; and, if that is so, it must follow that the termination was tantamount to a termination or premature determination of a capital asset and any amount paid for such premature determination must be regarded as a capital receipt. This has also been held by the Division Bench of this court in Khushalbhai Patel & Son's case (I.T. Reference No. 37/65-Since reported in : [1979]118ITR656(Bom) infra), and the principle of that decision appears to us to be fully applicable to the facts of this reference.

14. In the result, the question referred to us is answered in the affirmative and in favour of the assessee. The Commissioner will pay to the assessee the costs of the reference.


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