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Addl. Commissioner of Income-tax Vs. Dr. K.P. Karanth - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAndhra Pradesh High Court
Decided On
Case NumberCase Referred No. 16 of 1976
Judge
Reported in[1983]139ITR479(AP)
ActsIncome Tax Act, 1961 - Sections 256(1)
AppellantAddl. Commissioner of Income-tax
RespondentDr. K.P. Karanth
Appellant AdvocateP. Rama Rao, Adv.
Respondent AdvocateS. Parvatha Rao, Adv.
Excerpt:
.....under section 256 (1) - whether amounts totaling rs. 50000 received by respondent-assessee are a revenue receipt liable to be taxed or capital receipts not liable to be taxed - high court observed it cannot be said that assessee received amounts in course of business - assessee has surrendered to company his technical knowledge and know-how for manufacturing drugs - therefore making use of his own knowledge and technical know-how is a capital asset unproductive of profit - there is no material to show that earlier agreement entered into by assessee with company were in ordinary course of his business - it is not possible to contend that amounts received by assessee were either in lieu of salary or by way of profits in business - held, on facts and circumstances receipt of sum of rs...........for consideration was whether these amounts totalling rs. 50,000, received by the assessee, are a revenue receipt liable to be taxed or capital receipts not liable to be taxed. 5. the ito negatived the contention of the assessee that the amount of rs. 50,000 received by him is capital receipt and came to the conclusion that it is a revenue receipt by holding that by means of the agreement the assessee was not debarred or in any way precluded from exploiting the process either by manufacturing or by selling for valuable consideration the rights of manufacturing process to any other party he may choose and the amounts received by the assessee were only in full settlement of the amounts receivable by him as royalty under the former agreement and, therefore, it is business income and.....
Judgment:

Ramachandra Raju, J.

1. The reference is made under Section 256(1) of the I.T. Act, 1961 by the Income-tax Appellate Tribunal, Hyderabad Bench 'A', at the instance of the Addl. CIT, Andhra Pradesh, Hyderabad. The question referred for the decision of this court is, whether, on the facts and in the circumstances of the case, the sum of Rs. 30,000 and Rs. 20,000 received by the respondent-assessee from M/s. Biological Products (P) Ltd., respectively, during the periods relevant to assessment years 1966-67 and 1967-68 are not taxable.

2. The assessee is a qualified chemist, who was initially in the service of a Swiss firm as a chief chemist. He had acquired considerable experience, knowledge and know-how in the manufacture of drugs including, INH and Dapsone for fighting T.B. and Leprosy, respectively. He left the services of the Swiss firm in the year 1960 and took up employment with M/s. Biological Product (P) Ltd. (hereinafter referred to as 'the company'). Under an agreement dated August 11, 1962, entered into between the assessee and the company, in addition to some salary, the assessee was entitled to receive royalty on certain percentage basis on the total sales of certain items of drugs of which he had special knowledge. According to the terms of this agreement, subject to a maximum period of ten years, so long as the company manufactures the said products, whether the assessee remains in the service of the company or not, he shall be paid by the company the royalty. Later when certain disputes had arisen between the assessee and the company, he left the services of the company in April, 1963, and started an industry of his own in Sanathnagar with the financial assistance of theGovernment and using his own process started manufacturing the Anti-T.B. drug, INH. Thereupon, the company stopped all payments due to the asses-see under the agreement dated August 11, 1962. After some correspondence and negotiations, the disputes were settled resulting in entering into between them another agreement dated October 3, 1963, in substitution and supersession of the earlier agreement dated August 11, 1962. Under this new agreement, the assessee was also to receive, from the company, royalty, but at a different percentage on the net invoiced sales of each of the products mentioned above in a calendar year for a period of ten years from October 18, 1962.

3. Subsequently, the company appears to have issued a legal notice to the assessee to stop manufacturing INH and Dapsone alleging that his activity was in breach of the terms of the agreement dated October 3, 1963. Then the assessee filed a suit, O.S. No. 27 of 1964, on the file of the court of the 1st Addl. Chief Judge, City Civil Court, Hyderabad, to assert his legal right to manufacture the drugs using his own technical know-how and to put an end to the interference by the company in his manufacturing activity. The suit was ultimately compromised as per an agreement dated January 17, 1966, entered into between the assessee and the company. It is under this agreement, the assessee received the two sums in question totalling Rs. 50,000.

4. The question for consideration was whether these amounts totalling Rs. 50,000, received by the assessee, are a revenue receipt liable to be taxed or capital receipts not liable to be taxed.

5. The ITO negatived the contention of the assessee that the amount of Rs. 50,000 received by him is capital receipt and came to the conclusion that it is a revenue receipt by holding that by means of the agreement the assessee was not debarred or in any way precluded from exploiting the process either by manufacturing or by selling for valuable consideration the rights of manufacturing process to any other party he may choose and the amounts received by the assessee were only in full settlement of the amounts receivable by him as royalty under the former agreement and, therefore, it is business income and chargeable as such. The appeal filed by the assessee was allowed by the AAC by holding that the amounts received by the assessee have to be considered only as capital receipts and, therefore, they are not taxable. In the appeal filed by the ITO, the Income-tax Appellate Tribunal agreed with the AAC by holding that the amounts received by the assessee are not revenue receipts at all and, therefore, they are not taxable and, accordingly, dismissed the appeal of the Revenue.

6. Both the original agreements entered into between the assessee and the company stipulated payment of royalty to the assessee, on a percentagebasis on the total value of the sales of the drugs in question, for his contribution towards their manufacture. It is the case of the company that according to the terms of both the agreements dated August 11, 1962, and October 3, 1963, the assessee was not entitled to manufacture those drugs himself or assist, directly or indirectly, any other party to manufacture the same, by giving the know-how or supplying the blue prints, etc., or in any other manner. After the assessee left the services of the company and the second agreement dated October 3, 1963, was entered into, the assessee started manufacturing the anti-T.B. drug, INH. When the company issued a legal notice to the assessee requiring him to stop manufacturing INH and Dapsone alleging that his activity in manufacturing them was in breach of the terms of the agreement dated October 3, 1963, the assessee filed the suit, 0. Section No. 27 of 1964, to assert his legal rights to manufacture those drugs and to put an end to the interference by the company. The main prayer of the assessee, in that suit, was to restrain the company from interfering with or obstructing in any manner the assessee in carrying on his business by using and utilising the technical knowledge and know-how of the process of manufacturing INH. That suit was, ultimately, compromised under the agreement dated January 17, 1966, and that suit was disposed of as per the terms of that agreement. It is not in dispute that as per the terms of that agreement, the assessee had given up his right to manufacture the drugs in question or assist directly or indirectly any other party to manufacture the same by giving the know-how or supplying the blue prints, etc., or in any other manner. This is where the ITO has committed a mistake in thinking otherwise.

7. It is convenient to extract here the operative portion of el. (3) of the agreement dated January 17, 1966, which is as follows :

'In consideration of the withdrawal of the suit O. S. No. 27 of 1964, afore-described and the abrogation and annulment of the agreement dated October 3, 1963, aforementioned, B.E. Ltd. (company) shall hereby agree to pay Dr. Karanth (assessee) a sum of Rs. 50,000 (Rupees fifty thousand only) in full and final settlement, for all times, of all his claims whatsoever under the aforesaid agreements on the manufacture of para Amino Salicylic Apid and its salts. B.E. Ltd. shall pay Dr. Karanth the said sum of Rs. 50,000 in equal monthly instalments of Rs. 10,000. The first instalment of Rs. 10,000 shall be paid on or before January 31, 1966, and the subsequent four instalments shall be paid on or before the last day of each of the months of February, March, April and May, 1966.'

8. Under the agreement, the assessee received Rs. 30,000 in the accounting year relevant to the assessment year 1966-67 and Rs. 20,000 in the accounting year relevant to the assessment year 1967-68.

9. In the suit filed by the assessee, he did not make any claim under the two agreements dated March 11, 1962, and October 3, 1963, entered into by him with the company, for any payment of royalty or any compensation. Therefore, essentially the - dispute between the assessee and the company at that time was whether the assessee can carry on his business by using and utilising the technical knowledge and know-how for manufacturing the drugs. Under the compromise, that claim of the assessee was given up and in lieu thereof the company agreed to pay him a lump sum amount of Rs. 50,000 and, subsequently, paid that amount as mentioned above. No doubt in the compromise agreement, the agreements entered into between the assessee and the company originally and their annulment and abrogation were also mentioned. That must have been only incidental, because in the suit filed, the assessee was only claiming his right for using and utilising the technical knowledge and know-how of the process of manufacture of INA and not any rights under the two agreements. Therefore, it must be taken that it is mainly on account of the assessee giving up his right to carry on his business by using and utilising the technical knowledge and know-how, the company agreed to pay the assessee the amount of Rs. 50,000.

10. Sri Rama Rao, learned counsel for the Revenue, has contended that the amounts received by the assessee must be taken as in lieu of salary or by way of profits of business.

11. The amount received by the assessee cannot be said to be by way of 'salary'. The assessee Ceased to be the employee of the company at the relevant time. There was no claim on behalf of the assessee for any payment on account of his past services to the company. It is also not an amount received by the assessee by way of compensation from the company, being his former employer, in connection with the termination of his employment or the modification of the terms and conditions relating thereto to think that the amount received by the assessee is in lieu of salary. We do not also think that the amount received by the assessee can either be said to be profits received by way of business to bring it under the category of 'business income'.

12. In the decision in Chunduri Venkata Reddy v. CIT : [1959]35ITR87(AP) the facts are that the assessee was appointed as sole distributor of oil expellers manufactured by a company for a period of six years. The company failed to supply the expellers to the assessee as specified in the agreement, and in consequence the assessee filed a suit claiming damages and the right to manufacture a particular type of oil expeller and an injunction restraining the company from dealing in that type of expellers. The company also filed a suit claiming termination of the agreement and also an injunction to restrain the assessee from manufacturing oil expellers undera specified trade name. Both the suits were compromised. Under the terms of the compromise, the sole distributorship granted to the assessee was terminated. Both the parties were allowed to manufacture their own oil expellers. The company further agreed to supply four oil expellers free of cost to the assessee by a specified date and the expellers were accordingly supplied to the assessee by the company. The question that arose for the decision of this' court was whether the value of the expellers so supplied, which was fixed at Rs 40,000, was income in the hands of the assessee liable to be taxed. After discussing the case law, the learned judges observed thus (at p. 96);

'If there was an agreement enuring for a period of years and by mutual consent the agreement is cancelled and payment is made, such payment would be regarded as capital payment. The fact that the assessee is carrying on similar other businesses would not alter the character of the receipt. The question to be put is ; is the money received in the course of a going concern. If it is not, it would cease to be a revenue receipt. Further, even if the amount of compensation for the terminiation of the business is computed on the basis of profits which would have been earned but for the cessation of the business, it would make no difference, it would still be regarded as 'capital receipt'. A sum received for sterilising as it were a capital asset, the consequence of which would be that it becomes unproductive of profit, cannot be regarded as income for purposes of taxation.'

13. In the case before us, it cannot be said that the assessee received the amounts in the course of business. What happened was, the assessee has surrendered to the company, his technical knowledge and know-how for manufacturing the drugs in question. Thus, making his own knowledge and technical know-how, which is a capital asset, unproductive of profit.

14. In CIT v. Prabhu Dayal : [1971]82ITR804(SC) decided by the Supreme Court, the facts are : that the assessee discovered by chance the existence of kankar in the Jind State and brought about an agreement between the State of Jind and one Shanti Prasad Jain for the acquisition of sole and exclusive monopoly rights for manufacturing cement. Subsequently, the rights under the agreement were transferred to a company of which the assessee was one of the promoters. For the services rendered by the assessee, the company agreed to pay him a commission of 1 per cent. on the yearly net profits earned by the company. The agreement was acted upon till 1950, and thereafter, the company did not pay the commission. The assessee filed a suit which ended in a compromise. Under the compromise, the assessee was paid certain amounts for the years 1951, 1952 and 1953 as commission, about the nature of which there was no dispute, it being a revenue receipt. Under the compromise, the assessee received a furthersum of Rs. 70,000 by way of compensation for the termination of the agreement between him and the company as from January 1, 1954. In deciding that case, the Supreme Court has observed thus (at p. 811):

'Where payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business or 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 though 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 loss of what may be regarded as the source of assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.'

15. On the facts of that case, the Supreme Court said thus (p. 811):

'The assessee, possibly by some fortuitous circumstance, discovered kankar in some place in Jind State. This circumstance gave him an opportunity to bring about an agreement between the State of Jind and Shanti Prasad Jain and when Shanti Prasad Jain transferred his right to a new company, in the formation of which the assessee had a hand, he was promised certain yearly commission on the net profits earned by the company. None of these activities of the assessee can be considered as a business activity but yet he did acquire an income-yielding asset as a result of his activities. But the compromise decree destroyed that asset and in its place he was given Rs. 70,000 as compensation. This payment was neither in respect of the services rendered by him in the past nor towards the accumulated commission due to him. It was paid as compensation to him because he gave up his right to get commission in future to which he was entitled under the agreement. It was a price paid for surrendering a valuable right which, in our opinion, was a capital asset.'

16. In the present case, even assuming that the amount paid to the assessee was also by way of compensation for abrogating and annulling the agreements entered into between the company and the assessee earlier, still under the terms of the compromise, the assessee was deprived of what, in substance, is his source of income. We do not think the said annulling and abrogation of the agreements can be said to be a normal incident of the business which leaves the assessee free to carry on his trade.

17. Sri Rama Rao has relied on some decisions, which are discussed below in support of his contention that the amount of Rs. 50,000 received by the assessee should be taken as income liable to be taxed. In Travancore Sugars and Chemicals Ltd. v. CIT : [1966]62ITR566(SC) , the facts are that as per the terms of sale transaction with regard to the assets of an undertaking some percentage of annual profit was agreed to be paid by the purchaserin addition to a specified cash consideration. The question that had arisen before the Supreme Court for decision was whether the commission paid on the annual profits was capital expenditure or revenue expenditure. On the ground that the payment was related to the annual profits which flowed from the trading activities of the assessee and had no relation to the capital value of the assets and as the payment was not related to or tied up in any way to any fixed sum agreed between the parties as part of the purchase price, the Supreme Court said that the payment made is in the nature of a revenue expenditure and not a capital expenditure. That case has no application here. For one thing, the question there was whether the expenditure was revenue expenditure or capital expenditure. We are not concerned here with the case of an expenditure. Here, it is a case of a receipt. Though the amounts paid in the above case were by way of payment of part of the sale consideration, the Supreme Court came to the conclusion that the expenditure was of a revenue nature, because the payment was related to the annual profits and the payment was not related to or tied up in any way to a fixed sum agreed between the parties as part of the purchase price. We do not think anything said by the Supreme Court, in that case, would be of any help to the Revenue on the facts of the present case.

18. In Hylam Ltd. v. CIT : [1973]87ITR310(AP) which was also decided by this court, the assessee entered into an agreement with an English company to use some patented process of manufacture. By that agreement, the English company granted to the assessee an exclusive non-assignable licence to manufacture laminates, in accordance with the processes covered by the patents. As a consideration for the grant, the assessee was to pay 5 per cent. royalty on the net selling price of all laminated products made and sold in accordance with those patented processes. When the total of the royalty payments reached 5,000, the assessee was no more liable to pay the royalty. The Supreme Court held that the payments made by the assessee towards royalty were of a capital nature and inadmissible as deductions in the computation of the assessee's business income for the relevant years, on the ground that the acquisition of knowledge in respect of the new product would amount to the acquisition of an advantage or an asset for the extension of the assessee's business. Here also the court was concerned with a case of an expenditure and not with a case of a receipt. That case also has no parallel to the facts before us. There, the court was considering the line of demarcation between, capital expenditure and revenue expenditure and not between a capital receipt and a revenue receipt. Nothing said in that case also would be of any help to the Revenue here.

19. The other cases relied on by Sri Rama Rao also would not help the Revenue much for the purpose of this case. In CIT v. Gangadhar Baijnath : [1972]86ITR19(SC) , the question that arose for the consideration of the Supreme Court was whether the compensation paid for a relinquishment of interest in a partnership would be a capital receipt or business income. The Supreme Court said that a partnership was terminable at will and any of the partners of the firm could have brought the partnership to an end. Consequently, the possibility of the termination of a partnership of the type in question was inherent in the very course of business. Such being the case, it was not possible to hold that the compensation paid for a termination of the contract was a capital receipt. In this connection, the Supreme Court also referred to its earlier decision in Jairam Valji's case : [1959]35ITR148(SC) , where the Supreme Court has observed :

'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......'

20. There is no material in the present case to show, much less there is a finding, that the earlier agreement entered into by the assessee with the company were in the ordinary course of his business.

21. In CIT v. Manna Ramji & Co. : [1972]86ITR29(SC) , the facts are that the assessee-firm, which carried on business in timber, had an office and six sheds for storing timber, which it had constructed on a site taken on a long lease. In 1944, the Collector requisitioned the premises under the Defence of India Act. On a claim for compensation, the court awarded, in addition to rent for the premises, a lump sum of Rs. 1,25,500 for loss of earnings. After making adjustments for expenditure incurred by the assessee for pursuing the claim for compensation, the balance of Rs. 1,05,074 was brought to tax. On a reference, the High Court held that the amount received was in the nature of a capital receipt. The Supreme Court, reversing the decision of the High Court, held that the amount received by the assessee as compensation for the loss of earnings was a. revenue receipt in the hands of the assessee as that was not a case where the assessee was permanently deprived of a source of income. As a fact, it was found there that the assessee's business has not come to a standstill altogether and he continued to carry on his business though at a reduced scale after requisition and the injury that was caused to the assessee was the volume of business and not to the profit-making apparatus. Therefore, on the facts of that case, the Supreme Court came to the conclusion that the amount received by the assessee is in the nature of a revenue receipt.

22. It has been agreed by the courts now that the question as to whether a particular amount received by an assessee should be treated as a capital receipt or a revenue receipt, though not one of fact and thus involves conclusions of law on facts, it is dependent to a very great extent on theparticular facts of each case. From the discussion made above, it is clearthat it is not possible to contend that the amounts Received by the assesseewere either in lieu of salary or by way of profits in business. On the factsand circumstances of this case, we think the receipts of the sum ofRs. 30,000 and Rs. 20,000 by the assessee are not revenue receipts and,therefore, not taxable.

23. The question referred to us is answered accordingly, in the affirmative and in favour of the assessee. The assessee will be entitled to his costs. Advocate's fee Rs. 250.


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