1. This is a reference by the Commissioner of Income-tax, Assam, and the question arises whether or not a certain sum amounting to Rs. 55,000 paid in April 1926 by a Mr. Trotman to the assessee is liable to income-tax.
2. It appears that Mr. Trotman in 1924 was the owner of a business which he carried on under the style of John Smeal & Co. Mr. Mundy, the assessee, was engaged by Trotman as an assistant in the business. It may be that the word 'assistant' is not a quite sufficient description and that Mr. Mundy might be described as manager; but Mr. Mundy began as a servant of Mr. Trotman and he had to begin with no interest save that of an employee in his master's business. It appears that by 21st May 1924 Mr. Mundy, had been serving his employer so well that for a good many years past it had been understood between them that, although there was no formal partnership, he had the position which Mr. Trotman described as 'virtually that of a quarter shareholder in the business.' The reason of this was that Mr. Mundy was being remunerated, it would seem by 25 per cent of the profits, and Mr. Trotman held out to Mr. Mundy that he was going to make a will, that he wished to convert the business into a limited liability company and to give Mr. Mundy a share. As to his intention to give Mr. Mundy this interest in this way there is evidence of a letter of 21st May 1924 Trotman saying that he is putting his intention into writing so that Mundy might have a tangible guarantee of his position. Later on, it appears that Mr. Mundy was taking up the position that he had been given a right to a quarter interest in the capital of this business, that he was a partner or at the worst was a person who had an enforceable agreement with Trotman to give him the interest of a partner to the extent of one-fourth share. Trotman was taking up the attitude:
You are not a partner in fact. It is true that I did promise that I was going to convert the business into a limited company and give you a quarter of the shares. That has not been done and you Mundy are not desirous any longer that I should do so.
3. Mundy was maintaining that he had an even higher right, namely a right to a quarter interest in the business apart from any question of a limited company. In that position Mundy made an offer to Trotman that he was willing to take Rs. 70,000 for his quarter share of the business and there is no doubt, on the terms of the letter, that he was claiming it not as an ex gratia payment but as a sum of money which he would take in lieu of what he alleged to be his right. Now Trotman in reply did not admit that Mundy had the right he claimed, but he said that just as he was willing to convert the business into a limited company and give Mundy one quarter of the shares, so in lieu of that he was willing to let Mundy have Rs. 60,000, i.e., 4o give in cash what he had expressed willingness to give in kind. This offer was accepted in a letter in which Mundy said:
I am willing to accept your offer of Rs. 60,000 in payment of my quarter share of the business.
4. Now, the Commissioner of Income-tax, Assam, was, in the first instance, the authority to find upon all necessary questions of fact. It is quite true that tie has found that Mr. Trotman's letters only amounted to an agreement that, if the business was converted into a limited company, Mundy would have a quarter of the shares. He says the agreement might have been enforcible, but as Mundy did not in the end accept the offer of a quarter share in the company that matter ended there. 'Accordingly' says the Income-tax Commissioner 'there is no partnership proved.' We are thrown back on the letter in which Trotman speaks of Mundy as having the position virtually of a quarter shareholder in the business. Thereupon, the Income-tax Commissioner goes on to say:
In my opinion, this does not constitute a saleable interest; and the payment by Mr. Trotman was an ex gratia payment to Mr. Mundy in consideration of ths facts that the latter had served him long and well.
5. Now, in my judgment, the Income-tax Commissioner misdirected himself in law in holding that, upon these findings of fact, this payment was for tax purposes to be regarded solely as an ex gratia payment to Mr. Mundy in consideration of the fact that the latter had served him long and well. It may be quite rue that Mr. Mundy had no right of a partner; but he certainly was claiming to have that right and he was claiming upon grounds which, as far as I can see, may well have had some foundation. The letter accepting Rs. 60,000 was a letter accepting it 'in payment of my quarter share of the business.' We have to look at this sum and determine the nature and character of the receipt) from Mr. Mundy's point of view. He, not Mr. Trotman, is the assessee. How and for what did Mundy receive or acquire the money? He got it by pressing and then compromising a claim to a partnership which claim was no doubt fairly formidable or the sum of Sections 60,000 would not have been given in exchange therefor. It seems to me that the Income-tax Commissioner thought himself obliged on the correspondence to hold this to be an ex gratia payment in consideration of the fast that Mr. Mundy had served Mr. Trotman long and well, merely because he could not find that, in point of fact, there was a right of a partner in Mr. Mundy. In so doing I think the Income-tax Commissioner has misdirected himself and I am clear that, on this correspondence alone, Mr. Mundy took this money in satisfaction of his claim to be entitled to a quarter share in the business. It seems that there was a suit between the parties in which an issue was framed:
Did the plaintiff Mundy become partner with the defendant from April 1924.
6. Now, this payment of Rs. 60,000 was in settlement of Mundy's claim. That being so, it appears to me that we have to consider whether such a payment is 'income, profits, or gains' at all within the meaning of the Income-tax Act. If a man claims an interest in the capital of a business and in the end receives Rs. 60,000 in satisfaction of all claims he may have in the capital of the business, is that income liable to income-tax? In my opinion it is not liable to income-tax and for the same reason that withdrawal of capital from a firm would not be liable to income-tax. We have not had the matter argued by learned Counsel for the assessee at any length; but I may say that, if the as-sessee's case had depended upon his showing that the payment was within Clause (7), Sub-section (3), Section 4, as at present advised, I should have thought that the payment being one arising out of business that clause did not apply. I am of opinion that the sum of money here concerned is not 'income, profits, or gains' within the meaning of Section 4 at all.
7. A recent case, In re Turner Morrison & Co. Ltd. : AIR1929Cal212 has been cited to us on behalf of the Commissioner of Income-tax. That case appears to have been decided under Clause (7), Sub-section (3), Section 4, and other arguments appear to have been addressed to the Court upon the question whether the sum of money there fell within Section 10, or Section 12, Income-tax Act. I do not observe that the case was argued upon the footing that the payment in that case was of a character such as would prevent it from being 'income, profits or gains' at all within the meaning of the Income-tax Act, I think the special circumstances of that case probably account for the fact that this aspect of the question was not dealt with in the judgment. It appears from the terms of the Articles of Association of the company that the managing agents had to take whatever remuneration the company would agree to in its annual meeting. In the course of a year the company went into voluntary liquidation and, in these circumstances, assuming that there was no other reason why the managing agents should not make a claim for wrongful dismissal, it is obvious that they would have some difficulty in recovering much by way of damages for wrongful dismissal if their remuneration after doing the work was entirely in the hands of their employers. It would seem that as the company was being wound up, a large sum of money was paid to the managing agents, a sum considerably in excess even of the remuneration which had been paid for a whole year in either of the preceding years; and, in these circumstances, it is perhaps not altogether to be wondered at that the sum of money in that case was dealt with as a question of ex gratia payment made to the managing agents in consideration of the fact that they were losing their expectation of continuing to do business as the managing agents of the company, la any case that matter is not on all fours with the question with which we are here concerned. If I am right in thinking, upon the correspondence in the present case that Rs. 60,000 was paid and received in satisfaction of bona fide claim on the part of the assessee to be entitled to an interest in the capital of a certain business, it does not seem to me that that is liable to income-tax.
8. Accordingly the question propounded to us should in my opinion be answered in favour of the assessee. The question is not perhaps very happily worded:
Was the Income-tax Officer correct in holding that the applicant's interest in the business did not amount to a partnership or to such an interest as would entitle the Income-tax Department to regard money received in exchange for it as a capital receipt and not income.
9. In my judgment, as to the latter part of that question, the Income-tax Officer was not correct. Whether Mr. Mundy had or had not a right to a quarter interest in this business, if he received the Rs. 60,000 in satisfaction of a bona fide claim that he was entitled to a-quarter interest in the capital the money so received is not taxable. The assesses will have his costs of this reference.
C.C. Ghose, J.
10. I agree.
11. I agree.