1. This reference under s. 256(1) of the I.T. Act, 1961 (hereinafter referred to as 'the Act'), at the instance of the Department raises the following question of law :
'Whether, on the facts and in the circumstances of the case, the whole amount of Rs. 98,000 accrued to the assessed on December 18, 1958, the date on which the suit was compromised and was taxable in the assessment year 1956-60
2. The facts briefly are these. The reference arises out of proceedings for assessment to income-tax of Shri C. L. Sikka, an individual. The relevant assessment year is 1959-60, the accounting period ending on March 31, 1959. The assessed filed a return of income declaring the income to be nil. The ITO, however, noticed that the assessed had received a payment of Rs. 1,00,000 on December 18, 1958, from M/S. Urban Improvement Housing & Construction P. Ltd. (for short called 'the company') as a result of a compromise arrived at in the court between the assessed and the company.
3. The circumstances relating to the receipt of the said sum of Rs. 1,00,000 by the assessed, may now be stated. The company was engaged in a business of colonisation. It owned 350 to 400 bighas of land on the main Kutab Road known as Green Park. The company had drawn up a colonisation scheme of the Delhi Improvement Trust. The assessed was an engineer who had then recently retired from the Army. By an agreement dated April 27, 1955, the company appointed the assessed as its technical director and adviser. The salient terms of this agreement may now be noticed. The assessed was appointed as technical adviser of the company and was to become an additional director on acquiring 10 shares of the company. He was to responsible for the entire scheme of colonisation and for its development. He was to develop the plots, keeping down the total expenses in development organisational affairs within a figure calculated at Rs. 4.10 per sq. yard of the total area of plots marked out for sale. He was to sell the plots at prices of not less than Rs. 10 persq. yard on terms to be approved by the company. The assessed was to have no claim against the company for any remuneration, etc., though on the sale of any plot at net price above Rs. 10 per sq. yard and no full realisation of the value of the plot, the company was to pay to the assessed by way of remuneration for his service to the company half of the amount in excess of the price of Rs. 10 per sq. yard realised from the purchasers.
4. Till April, 1956, the assessed discharged his duties under the agreement and drew sum aggregating to Rs. 38,940 from the company towards his remuneration in terms of the agreement. After April, 1976, however, there were some disputes between the assessed and the company and all payments to the assessed were stopped. The assessed filed a suit for rendition of accounts on August 27, 1956. The assessed alleged in that suit that the company had not paid to the assessed large amounts due to him aggregating to over Rs. 55,000 up-to-date, although the assessed was still duly discharging his duties under the agreement. As the assessed was not in possession of the exact and correct amount contained in the books of the company, he prayed for a decree for rendition of accounts and, after the accounts were rendered by the company, for a decree for the amount found due to the assessed from the company as per terms of the agreement Subsequently, the company also filed on or about April 6, 1957, a suit against the assessed for the recovery of Rs. 36,940 on account of the alleged over-withdrawals of remuneration by the assessed. Eventually, the suit filed by the assessed for rendition of accounts was compromised and a written application under Order 23, rule 3 of the Code of Civil Procedure was filed. A copy of the plaints in the two suits and the application form part of the statement of the case. The compromise application is dated December 18, 1958, within the period of accounting, with which we are concerned. In accordance with this agreement, the assessed was paid a sum of Rs. 1,00,000.
5. The ITO was of the opinion that the assessed was an employee of the company. Out of the sum of Rs. 1,00,000, admittedly, a sum of Rs. 2,000 represented the price of two ordinary shares which the assessed had transferred by way of sale. The ITO held that the balance of Rs. 98,000 was liable to tax in the hands of the assessed either as salary or as compensation. The assessed filed an appeal. The AAC, after considering the circumstances of the case in detail and the decided cases cited before him, came to the conclusion that the amount received by the assessed was towards his remuneration and was received in the course of carrying on his professional activity. He did not accept the contention that the amount represented compensation for being deprived of any source of income. The AAC concluded that the amount had been rightly taxed as income and that even if s. 7 of the 1922 Act did not apply, the provisions of s. 10 of the 1922 Act would clearly apply in this case.
6. The assessed went up in second appeal to the Income-tax Appellate Tribunal (for short called 'the Tribunal'). The Tribunal first of all addressed itself to the contention whether the disputed amount was liable to be assessed under the head 'Salary'. The Tribunal came to the conclusion that the remuneration received by the assessed could not be taxed under the head 'Salary' by virtue of clause (1) of Explanationn II to s. 7 of the 1922 Act because the assessed could not be described as an employee of the company having regard to the terms of the agreement. The Tribunal then addressed itself to the alternative contention whether the disputed amount is taxable under s. 10(5A)(c) of the Act of 1922. Here again, the Tribunal, after considering the provisions of the agreement, came to the conclusion that the assessed had a very restricted role to play in the affairs of the company and could not be said to have been managing the whole or substantially the whole of the affairs of the company and, thereforee, s. 10(5A)(c) had no application in the present case. The Tribunal also considered the question whether the receipt was a revenue receipt or a capital receipt. The Tribunal scrutinised the evidence in the present case, in the background of the legal position culled out from several decisions of the Supreme Court and High Courts, and came to the conclusion that the compensation was paid not as solarium for loss of any source of income or for loss of any income-earning apparatus or for any unexpected damage caused to the income-earning structure of the assessed but was paid as surrogate for profits likely to arise to the assessed if the contract had run its normal course. The Tribunal, thereforee, held that the receipt of Rs. 98,000 was a revenue receipt liable to tax.
7. Having come to the conclusion that the sum of Rs. 98,000 constituted an income receipt, the Tribunal addressed itself to an alternative argument on behalf of the assessed that the entire sum of Rs. 98,000 was not taxable in the assessment year under appeal. It held :
'The question that now arise for consideration is whether the entire sum of Rs. 98,000 is taxable in the year under appeal or requires to be spread out over more than one year. According to the assessed's alternative argument, the compensation was paid partly in respect of the sales already effected by it and partly in respect of the loss of future profit. He contended that the compensation to the extent it related to sales already effected must be treated as income arising during the relevant period of sales and must be taxed in the relevant assessment years. The assessed had already received a sum of Rs. 38,000 odd as remuneration in respect of the plots sold by him. In addition, the assessed claimed a sum of Rs. 55,000 for the plots sold by him before the date of the suit. The assessed did not furnish particulars of the sales of such plots in the absence of which it is difficult to determine the total plots sold by him and to determine what amount or remuneration had become due to him and what point of time. This information would be necessary to determine the assessment year in which the remuneration which had already become due to him in respect of plots actually sold would be assessable. The balance amount our of Rs. 98,000 accrued to the assessed during the year under appeal as it is not relatable to any plots actually sold but is relatable to the loss of future income. As the relevant information is not before us we restore the case to the ITO with a direction to find out the number of plots actually sold by the assessed, the price for which they were sold and to determine what remuneration had accrued to the assessed in respect of such sales and to determine the period when such remuneration accrued and to include the remuneration relatable to the plots sold during the previous year only in the assessment for the year under appeal. Whatever amount out of Rs. 98,000 is not relatable to the plots actually sold shall be included as income of the year under appeal.'
8. Mr. G. C. Lalwani, the learned counsel for the Revenue, urges before us that the disputed amount of Rs. 98,000 is liable to be assessed under the head 'Salary' under s. 7 read with clause (1) of Explanationn II of the 1922 Act. He invites our attention to the various clauses of the agreement dated April 27,1955. After considerable discussion the argument was given up. The alternative ground of the Revenue that the disputed amount is taxable as income under s. 10(5A)(c) of the Act was again not seriously pressed, though a reference was made to it. Learned counsel for the Revenue proceeds on the basis of the finding recorded by the Tribunal that the revenue receipt of Rs. 98,000 is profits and gains of business or profession of the assessed to contend that the entire receipt of Rs. 98,000 is taxable in the relevant assessment year. Reference is made to s. 13 of the 1922 Act corresponding to s. 145 of the 1961 Act. He submits that two main methods of accounting are the cash system and the mercantile system. The computation of income has to be made on the basis of the method of accounting regularly adopted by the assessed, even though the method is neither purely cash nor purely mercantile but is a mixture of the two methods. Reference is made to the fact that the assessed had withdrawn and received before April, 1956, a sum of Rs. 38,940 from the company towards his remuneration. Mention is also made of any averment made in the plaint of the suit of the suit of the assessed that the company had not paid to the assessed large amounts due to him aggregating over Rs. 55,000 up-to-date (August 27, 1956), although the assessed was still duly discharging his duties under the agreement. The submission is that the system of accounting followed by the assessed as regards his dealing with the company was on receipt or cash basis. Under s. 5 of the Act, profits are taxable when they accrue or arise or are received and the assessed had adopted the method of accounting on receipt basis and, thereforee, the entire amount of Rs. 98,000 received by the assessed in the relevant accounting year was taxable as revenue receipt in the assessment year in question.
9. Mr. K. P. Bhatnagar, the learned counsel for the assessed, also proceeds on the basis that it is a revenue receipt as profits and gains of business or profession and urges that the directions were rightly given by the Tribunal. Reference is then invited to clause 7 of the agreement, the application of the assessed and the company under Order 23, rule 3 of the Code of Civil Procedure to urge that the payment of Rs. 98,000 received under the compromise was partly adjudication of rights in the relevant previous year for the amount due, partly for settlement of the disputes and partly the creation of a right to the payment of the amount which is a substitute for profits likely to arise to the assessed (in the future) if the contract had run its normal course.
10. We may recall certain facts. Clause 7 of the agreement dated April 27, 1955, provides as to when the income would accrue to the assessed. It arise on the sale of any plot at a next price above Rs. 10 per sq. yard and on full realisation of the value of the plot. The company is to pay half of the amount in excess of the price of Rs. 10 per sq. yard. Under the agreement between the assessed between the assessed and the company, profits and gains accrue to the assessed on effecting the sales. The amount may not have been received by the assessed. The receipt is in no sense the sole test of charge ability under the Act. It could be brought to tax on the mercantile system of accounting adopted by the assessed.
11. The ITO, in his order, noticed that up to April, 1956, the assessed worked unobstructed and he drew Rs. 38,940 from the company as his remuneration. The ITO also observed that although the final payment payable to the assessed was not determined, but the drawing of Rs. 38,940 was almost equal to his remuneration due on a rough basis, i.e., to say they were in nature of advance for remuneration and thus taxable in the assessment year 1956-57 and would be taxed in that year. Thus, even the ITO had considered the remuneration of Rs. 38,940 as having accrued to the assessed in the assessment year 1956-57. There was no settlement of accounts and the calculated profits would not have been received by the assessed. It shows that the assessed's accounts are kept on accrual basis. The income is being taxed as having accrued or earned by the assessed in the assessment year 1956-57. The choice of the method of accounting lies with the assessed. Even for the first year the method of accounting would be deemed to have been employed if the same is shown to have been regularly employed in the subsequent years. The ITO does not say that the method of accounting of the assessed is on cash basis. The assess then in the plaint of suit of August 27,1956, claimed that large amounts due to him aggregating to over Rs. 55,000 had not been paid by the company. The profits had accrued or arisen even though not paid to the assessed. They are claimed irrespective of the receipt. The assessed was still duly discharging his duties under the agreement as mentioned in the plaint though not receiving any amount. Thus, there was no cessation of accrual to the assessed of the profits or gains arising out of the agreement.
12. The application for compromise records the terms of the compromise. It mentions the receipt by the assessed of amounts towards his remuneration in terms of clause 7 of the agreement dated April 27, 1955, and other debits made in the personal account of the assessed. This had already fallen due. The assessed was paid a sum of Rs. 1,00,000 and on the payment of the said amount the entire claim of the assessed against the company stood satisfied and adjusted. This satisfaction and adjustment of the claim of the assessed was partly towards the amount of Rs. 55,000 claimed as due to the assessed on the date of institution of the suit, partly for the profits or gains accruing or arising after the date of institution of the suit up to the date of the compromise, and partly for the loss of profits which the assessed would have earned had the agreement run its full term. The amount paid for profits likely to arise to the assessed if the contract had run its normal course has certainly accrued to the assessed on the recording of the compromise and in the relevant previous year. The other payment is towards adjudication of rights of the amount accrued due in the earlier years. The directions, as reproduced above, were thus rightly given by the Tribunal in the facts and circumstances of this case.
13. The reference is answered against the Department and in favor of the assessed with no order as to costs.