RAMACHANDRA IYER J. - The following question were referred to us under section 66(2) of the Indian Income-tax Act :
'1. Whether, on the facts and circumstances of the case, the Appellate Tribunal was justified in including the entire amount of Rs. 75,815 in the income of the assessee in the year of account without allocating the same on the time basis after allowing the depreciation only at 60 per cent. into account
2. Whether, on the facts and circumstances of the case, the amount of Rs. 32,683 does not amount to a capital receipt not liable to be assessed ?'
The questions arise in relation to the assessment of the Bharani Pictures for the year 1949-50, the year of account ending with December 31, 1948. The assessee is a registered firm consisting of two partners, Mrs. P. Bhanumathi, a cinema actress, the her husband, P. Ramakrishna Rao. The firm was engaged in the business of producing cinematograph films, and it commenced its business in September, 1945. The first of the two questions set out above relates to the assessment of the profits earned from one of the pictures produced by the firm, viz., Rathnamala. When the case was taken up for hearing the learned advocate for the assessee intimated that the assessee does not want to press for the decision of the court in question No. 1. We, therefore, consider it unnecessary to offer our opinion on the point covered by the question.
The other question relates to film in Tamil, Pulandiran, which the assessee originally planned to produce. Towards that end the assessee also engaged certain artists and technicians. Mrs. Bhanumathi, one of the partners of the assessee firm, was herself the principal actress one of the partners of the assessee firm, was herself the principal actress in the proposed film. Soon thereafter, the assessee took a partner, Masers, Balaji Pictures, Madras, for the venture. The terms of the Partnership agreement were reduced to the form of a document on July 26, 1946. Under that agreement, the cost of production of the picture and collections therefrom were agreed to be shared in the proportion of 2 : 1, by the assessee and Messrs. Balaji Pictures, its partner. It is unnecessary for the purposes of this reference to refer to the other terms of the agreement except clauses 4, 5 and 10. By the first of the abovementioned clauses, the parties agreed that neither of them could sell, mortgage, or create any charge in respect of their shares in the negative of the picture to be produced, without the consent of the other. Under clause 5, it was agreed that, if monies were realised by the sale of the rights in the negative of the picture, whether as a whole or in part, or whether before the production of the picture or afterwards, the parties were to share the proceeds in the same proportion as their interest in the venture. Clause 10 ran as follows :
'That during the course of production, if an reasonable sale offer either in part of whole comes, both the parties shall mutually agree and effect is not accepted by an one of the parties, such party should undertake to purchase it for himself or cause sale for more amount than what is offered by others.'
The covenants referred to above indicate that the object of the parties was to undertake the production of the picture as a commercial transaction, to produce and exploit the picture or to sell it away if it could be done to the best advantage of the partners, whether before or after its production. A sale of the rights of a partner in the film as between partners was also contemplated, and provided for.
The assessee did not itself advance any substantial sum of money; it entered into a financial agreement with one D. Rama Doss, who agreed to finance half the amount required by the assessee for the production of the picture on his being paid half share in the collections out of the assessees 2/3rd share in the picture. Rama Doss paid Rs. 35,100 towards his share of the finance. The process of production commenced. The artists were paid some salary, and certain other expenses were also incurred. A sum of Rs. 39,957-15-2 was spent by the assessee, that is, a little over what Rama Doss had paid. Disputes then arose between the partners. The parties agreed to adjust their differences, by the assessee retiring from the venture on being paid a certain amount, and Balaji Pictures and Rama Doss joining together to complete the picture. The agreement is in writing, and is dated August 25, 1948. Under its term, the assessee was paid a further sum of Rs. 37,500 in full quit of its interest in the picture, and the amounts expended for the actors, who had evidently been engaged by the assessee, were to be released from their obligation to act in the picture. The effect of the transaction was the assessee got Rs. 35,100 from Rama Doss and Rs. 37,500 under the release deed, while the expenses a mounted to only Rs. 39,957-15-2, the profits being Rs. 32,642.
It is the character of this receipt that has to be adjudged in this reference. It is necessary, therefore, to consider the purpose for which the payment was made to the assessee under the release deed dated August 25, 1948. That document states that the sum of Rs. 37,500 is paid to the assessee in consideration of its giving up its picture and that it shall have thereafter no interest in the production and management of the picture. The document contains certain other provisions as well. Clauses 4 and 7 therein contain certain covenants of a restrictive nature.
'Clause 4 : Party No. 1 (assessee) shall deliver or cause to be delivered to party No. 2 (Messrs. Balaji Pictures and Rama Doss) all positives, negatives, scripts, songs, dialogues, etc., relating to the said picture except the recorded music of Mrs. P. Bhanumathi to which parties Nos. 2 and 3 shall have no claim whatever. Party No. 1 shall not be entitled to use or cause to be used in any manner the said recorded music of Mrs. P. Bhanimathi.
Clause 7 : Party No. 1 shall not be entitled to produce or participate in producing any picture relating to the same subject as the said Pulandiran in any language for a period of ten years.'
Clauses 9 and 10 provide that is two of the artists, who were released from obligation to further participate in the picture, were to act in the picture, the assessee was to be paid a stipulated sum of money. Clause 2 of the release deed would appear to suggest that the entire consideration paid was for the release of the assessees rights in the picture; prima facie there is nothing to indicate that the consideration paid was for the restrictive covenants as well. But, at the same time, it must be remembered that the release deed is single and indivisible, and the covenants contained therein being part of the agreement, it could be said that it was as much supported by the consideration as the actual release of the right in the picture.
The Income-tax Officer included in the assessment the sum of Rs. 32,642 as the profits of the assessee. Both the Appellate Assistant Commissioner and on further appeal the Tribunal Concurred with the view of the Income-tax Officer and held that sum clearly represented a trade receipt of the assessee liable to be assessed. That view is challenged in this reference.
For the assessee, it is contended that, on a true construction of the agreement dated August 25, 1948, the amount of Rs. 37,500 paid to the assessee of it rights in the partnership firm with the Balaji Pictures. It is contended that an interest in a joint venture was property and that as the venture itself was the profit-earning apparatus, anything received for giving up that right would be a capital receipt. Reliance was placed on the decisions in Commissioner of Income-tax v. Vazir Sultan and Sons and Godrej and Co. v. Commissioner of Income-tax to support the contentions. Those cases, however, related to abridgment of rights of an agent under sales or managing agency agreement. It was held that compensation given for the abridgment of such rights, would partake the character of a capital receipt, there having been, as a result of the agreement, a deterioration of injury to the business structure or profit earning apparatus of the assessee.
But an agency contract cannot always be considered as a profit earning the apparatus, so as to render any compensation for an injury caused to that contract to be treated as a capital receipt. Where the work of an agent is to bring about the business between his principal and his customers, the agency would be the apparatus which leads to business and, therefore, so far as the agent is concerned, a capital asset. But where, however, the assessee has a business in taking up agency on behalf of others i.e., the agency is one of the business which the assessee has, such business could beheld to be a circulating capital or stock-in-trade, and the compensation received in respect of injury thereto would be revenue receipt. The basis of the distinction is clearly laid down in Commissioner of Income-tax v. Rai Bahadur Jairam Valji.
A case like the present, where the partnership is not the structure of the profit-earning apparatus of this assessee, but rather a venture for the purpose of carrying on its existing business of film production by taking in the help of another, cannot obviously come under the former category. That does not, however, mean that in all cases the right of a partner in a firm is not a right of property, but a commercial asset. The question would depend on the nature of the partnership and the business.
In Rangaswami Naidu v. Commissioner of Income-tax, to which one of us was a party, it has been held that the right of a partner in a firm is property, and would form a capital asset of the partner. The question that arose for consideration in that case was whether the profit made in the sale of a partners interest in the firm (that being authorised by the terms of the partnership) was a capital gain. It was held that the congeries of rights, which the partner enjoyed in the partnership firm, should be contoured as a profit yielding asset, and, therefore, a capital asset. The decision in that case related to the sale of the interest of a partner in the firm, whose business what that of a managing agent to a certain cotton mill. A sale of a partners share in such a case would certainly be a sale of the capital asset on the principle recognised in the decisions of the Supreme Court referred to above.
Where, however, a partnership is entered into for the purpose of doing one of the items of the business, it cannot be said that the partnership is a structure of the business, but on the other hand it would be one entered into in the ordinary course of its business. In Commissioner of Income-tax and Excess Profits Tax v. South India Pictures 1 the assessee carried on business in the distribution of films. It was his practice to produce or purchase films and distribute the same for exhibition. In the course of the business, the assessee advanced monies to a certain picture producing concern, and under the agreement with the concern acquired certain rights of distribution over three films manufactured by them. After exploiting the rights of distribution of those pictures for sometime, and after the monies advanced by the assessee had been fully repaid, an agreement was entered into by the assessee with the producers, canceling the agreement relating to the distribution rights of the three films, in consideration of which the assessee was paid a sum of money. The question that arose for consideration by the Supreme Court was whether that receipt was a capital or revenue nature. It was held that the compensation paid was not for preventing the assessee from carrying on his business, but one paid in the ordinary course thereof to adjust the rights between the assessee and the producers of the film and that the agreement canceled could not be deemed to be such a fundamental asset of the assessee, on which his whole trade had been built, so as to constitute the framework of the profit-making apparatus. From the majority judgment of the Supreme Court, it is clear that the tests to be applied for ascertaining whether a particular receipt by the assessee in such circumstances was a revenue or capital receipt are (1) whether the original agreement entered into by whether the termination of the agreement was one done in the course of its business. If the answers to these questions are in the affirmative, any compensation received for the termination of such agreement would be a revenue receipt.
The assessee is a firm engaged in the production of films. Pulandiran was not its only venture; it was only a part of its business activity. It had already started production of another picture, Rathnamala. It had also engaged artists for the production of Pulandiran. It was only during the course of its production that it entered into partnership with Balaji Pictures. Such contracts are but a normal feature in the business relating to a film production; it facilitates the coming in of the necessary finance, and brings together varied talent whose combined effort would go to make a better or more successful picture. That such combinations are common is shown by the fact that the assessee itself combinations are common is shown by the fact that the assessee itself entered into a financial arrangement with Rama Doss, agreeing to give him one-half share of its proceeds. A partnership, as in the present case, for the production of the film, should be held, therefore, to be one entered into in the ordinary course of trade.
The question then is whether the termination of the agreement was made in the course of its business. It is evident from the terms of the agreement of partnership that the parties did contemplate a sale of the picture to an outsider or even inter se the partners even before the completion of the picture. It is, no doubt, true that the partnership agreement evidences a joint venture, but the joint ventures was only for obtaining a commercial asset, that is, to secure a stock-in-trade. If that venture fails, it is only an incident in the assessees business. It is not such a fundamental asset like a managing agency agreement, which, if terminated, would put an end to the entire profit earning structure. Applying the principle of the decision in Commissioner of Income-tax and Excess Profits Tax v. South India Pictures Ltd., we are of opinion that there has been no injury or abandonment of any capital asset of the assessee, so as to make the compensation received under the agreement of release a capital receipt.
It was next contended that the two restrictive covenants in paragraphs 4 to 7 of the agreement of release, dated August 25, 1948, would show that the contract was not one merely dealing with a commercial asset, but one that affected the future business of the assessee, and that the compensation paid should beheld to be one for the injury done to the profit making asset. The contention was raised on the basis of the principle laid down in Beak (H.M. Inspector of Taxes) v. Robson. In that case, the assessee agreed to serve as director of a company on certain terms as to salary and bonus. The agreement provided that, if his service agreement was terminated by the company for any of the reasons which enabled them so to terminate, he, is consideration of a payment of a sum of Pounds 7,000, was not to compete directly indirectly with the company within a radius of 50 miles of its place of business, until five years had elapsed after the termination of his service. It was held that the payment of Pounds 7,000 was made for giving up a right wholly unconnected with his office and being operative only after he ceased to hold that office, could not be held to be emoluments of the office. It must be noticed that the payment in the case was made not in consideration of any service rendered or to be rendered as an employer, but for a covenant not to do business after the termination of the service, and as such was not a salary or profit from business. The fact that the covenant was embodied in the service agreement as one of the terms on which the assessee was taken into service was held to make no difference.
That, however, is not the position in the present case. As pointed out already, clause 2 of the release deed states that Rs. 37,500 was paid 'in consideration of the amount of expenses, already incurred by party No. 1 (assessee) and in consideration of their giving up their rights in the picture as aforesaid.' The word 'aforesaid' refers to clause No. 1 which states that the assessee was to have no interest in the picture, while the other party to the release was entitled to produce and exploit it. Thus the consideration of Rs. 37,500 is not expressed to be for any restrictive or future covenant as the one in Robsons case. As we pointed out already it can be argued that the consideration paid was for the entire agreement including the covenants. The question then would be whether those covenants are such that the position of the compensation relating to it could be held to be a capital receipt. In clause 4 to which reference has been made earlier in the judgment, both the parties to the agreement agreed not to use the recorded music of Mrs. Bhanumathi is any manner. It must be remembered that Mrs. Bhanumathi in any manner. It must be remembered that Mrs. Bhanumathi, in addition to being a partner in the assessee firm was her an actress in the picture, Pulandiran, and was to be remunerated by a salary. Certain of her songs had evidently been recorded before the release deed was executed. Those songs were part of the picture. Mrs. Bhanumathi, who had received salary for the songs recorded, could have no rights in the same. The Partners would undoubtedly have rights to her recorded music, but the assessee had, for a consideration, given up its rights. The covenant of the assessee not to use such recorded music cannot be deemed to be a restrictive covenant, because neither Mrs. Bhanumathi nor the assessee firm had any right to those songs, they having already parted with their respective rights. The mere circumstance that the other party to the agreement also released his rights to use recorded music cannot mean that the assessee would have, under the law, any right which it gave up by reason of the covenant. The covenant in clause 4 is not unconnected with the commercial asset, for which the assessee was paid.
Clause 7 prohibits the assessee from producing any picture relating to the same subject as Pulandiran for a period of ten years. It is contended for the department that that is an ordinary incident of every contract of sale of a film not to infringe its copyright. But, it must be remembered that there was no completed picture by the time when the release deed was executed. There could, therefore, have been no copyright. What, therefore, the agreement provided for was to prevent the retiring partner from taking advantage of his position and produce a rival picture which would affect the commercial value of the picture in respect of which he was paid Rs. 37,500. It is fairly well recognised that the life of a cinematograph film would be about 3 years, after which period the profit earning capacity would be next to nothing. When, therefore, the assays covenanted not to produce a picture on the same subject as Pulandiran, the covenant probably exceeded what was merely incidental to the transfer of rights, evidenced by the release. Whether such an obligation cast on the assessee was one purely for the unhampered exploitation of the rights released, or it transgressed those limits, is a question to be decided on the facts of the case, e.g., how long it would take to complete the film Pulandiran and how long it value as a commercial asset would last. If it were found that the covenant exceeded the limits of what is necessary for the exploitation of the contemplated picture, the covenant to the extent of the excess would be a restrictive covenant independent of the released rights and the principle of Robsons case would perhaps apply.
In Higgs (H.M. Inspector of Taxes) v. Olivier, a question arose with reference to a contract of employment. An actor agreed to give his exclusive services to a film company both as director and actor. For the services rendered, he was paid. There was a further agreement by which the actor, in consideration of sum of money received by him, undertook not to act in, produce or direct, any film for any other person for a period of 18 months. It was held that the receipt was not one earned by the exercise of any vocation by the assessee, and, therefore, not liable to tax. That was a case where the original agreement of service was fulfilled and completed, and the subsequent agreement which embodied the restrictive covenant was an independent one. In dealing with the question whether the compensation in such a case could be said to be a capital receipt, the Master of the Rolls, after referring to the decision in Glenboigs case, observed at page 146 :
'I think there is a true analogy between such an arrangement as that or between a sale of one of a traders capital assets and a restrictive covenant of a substantial character entered into by a trader relating to trading. I think Sir Frank was disposed to agree that if a trader or a professional man for a money consideration covenanted to give up his trade or profession for the rest of his life, then it would be difficult to say that the money received was profits or gains accruing or arising from his trade or profession. On the other hand it is not difficult to easily be taken out of the ambit of the taxing provision. One example period not to act for one particular company out of a large number. I gave myself the example of an actor who covenanted for a limited period not to act under his won or well known stage name. But between the two extremes there is a large area, and for myself I am disposed to think that within that area it may well be a matter to degree. In so far as it is a matter of degree it would be, I think, a question of fact.'
The question whether the agreement in the present case not to compete by producing a film similar to Pulandiran was purely incidental to the release of the rights of the assessee in the picture or whether if was independent of it in regard to any portion thereof, was not considered either by the department or the Tribunal. That aspect of the matter was not put forward by the assessee before them. If, however, it were to be held (1) that the consideration for the release was intended to cover both the release of the rights in the picture and the restrictive covenants, and (2) that the restrictive covenant in the clause 7 was independent (in part or whole) of the rights in the picture given up, there would be a case for allocating the respective parts of the consideration and ascertaining the extent of taxability. In Sadasivam v. Commissioner of Income-tax 1 a Bench of this court, to which one of us was a party, held that, if a consolidated payment was received for a mixed consideration compounded of elements, some of which were of trading or revenue nature, other bein g the realisation of a capital assets, the tax authorities should apportion the receipt the levy tax on that portion of the amount which represented revenue receipt. In the course of the judgment, reference was made to the decision in Carter v. Wadman, where, in consideration of the termination of the employment of the assessee, a certain compensation was given. That amount represented the remuneration payable to the assessee had also damages for the termination of the employment which was in the nature of capital receipt. It was held that, where a lump sum payment was made in respect of two different matters, one of which would lead to an assessment for tax and the other would not, the commissioners would have to apportion the sum.
But there are several difficulties in adopting the principle of that decision in the present case. The release deed states that the consideration paid was only for the giving up of the rights by the assessee in the picture. There are no materials to show that the restrictive covenant was independent of the main contract of release. No facts were placed by the authorities to evaluate the consideration referable to the covenant contained in clause 7. The question was not even raised before the Tribunal of the officers. The question referred to us does not comprehend a subsidiary position whether any part of the sum of Rs. 32,683 would amount to a capital asset. The new case that the consideration paid for the release should be allocated between the two heads of capital the revenue cannot now be allowed.
Our answer to the question referred to us is against the assessee, that is, that the sum of Rs. 32,683 would not represent a capital receipt, and is liable to be assessed. The assessee will pay the costs of the department. Counsels fee Rs. 250.
Reference answered accordingly.