PETITIONER: COMMISSIONER OF INCOME TAX BOMBAYCITY Vs. RESPONDENT: CHUNILAL V. MEHTA AND SONS (P) LTD. DATE OF JUDGMENT11/08/1971 BENCH: HEGDE, K.S. BENCH: HEGDE, K.S. GROVER, A.N. CITATION: 1972 AIR 268 1972 SCR (1) 117 1971 SCC (3) 587 CITATOR INFO : RF 1991 SC 686 (16) RF 1991 SC 999 (14) ACT: Income-tax Act, 1922, s. 10 (5-A)-Compensation received on termination of managing agency taxable under section-Section enacted by Finance Act, 1955--Managing Agency terminated on April 23, 1951-Suit for compensation under agreement filed by managing agents-Compensation amount as determined by High Court received by managing agents in December 1955-Managing agents maintaining accounts on mercantile basis-Compensation amount when falls due? -Whether taxable in assessment year 1956-57. HEADNOTE: The assessee held the managing agency of a public limited company Under the agreement the assessee was to continue as managing agents for a minimum period of 21 years. On April 23, 1951 the Directors of the managed company passed a resolution terminating the services of the assessee as managing agents. This resolution was affirmed by the shareholders at their extraordinary general meeting held on May 23, 1951. There was dispute about the compensation payable to the assessee. In a suit filed by the latter the trial judge as well as the Appellate Bench of the Bombay High Court held that under the terms of the agreement the assessee was only entitled to liquidated damages at the rate of Rs. 6000 per month for the unexpired period of the agency namely 3 years 2 months and 7 days. The suit was decreed for Rs. 2,34,000 on November 17, 1955 and the assessee received the amount in December 1955. The assessee contended before the Income-tax Officer that as it maintained accounts on the mercantile system and the amount had become due in 1951 the same could not be taxed in the assessment year 1956-57 under s. 10,(5A) of the Income-tax Act, 1922. Before the said section was introduced into the Act by the Finance Act, 1955 compensation received on termination of a managing agency was treated as a capital receipt; after its enactment such compensation became taxable as income. The section was not retrospective, so that if the assessee's plea that the compensation amount accrued in 1951 was accepted it could not be treated as income at all. The Income-tax Officer and the Appellate Assistant Commissioner rejected the plea. The Tribunal however held that on the facts and circumstances of the case the compensation became due to the assessee on April 23, 1951 and therefore it could not be brought to tax in the assessment year 1956-57. The High Court in reference held that the amount was not taxable but the interest thereon could be taxed in 1956-57. The Revenue appealed. HELD: (i) It was rightly held by the High Court that the assessee was entitled under the agreement to liquidated damages at the rate of Rs. 6,000 per month for the unexpired period of the managing agency. 118 As such the assessee's right to get the compensation arose on April 23, 1951 when the resolution terminating the managing agency was passed. [123A-B] (ii) Section 10 (5A) refers to 'payment due or received'. The expression 'due to' refers to those assessees who maintain their accounts according to the mercantile system of accountancy and the expression received by' applies to those assessees who adopt the cash system of accountancy. Since the assessee in the present case maintained the mercantile system of accounting the relevant assessment year for the compensation accruing on April 23, 1951 was the succeeding assessment year. [123 C-D, H] Commissioner of Income-tax, Madras V. A. Gajapathy Naidu, 53 I.T.R. 114, applied. (iii) The plea on behalf of the Revenue that the right to get the amount arose when the quantum of compensation was determined by the High Court, could not be accepted. The fact that the assessee was claiming an exorbitant sum to which it was not entitled would not convert its right into a contingent right. [124 E-G] Thiagaraja Chettiar & Co. v. Commissioner of Income-tax, Madras, 51 I.T.R. 393 and F. E. Hardosstle & Co. (P) Ltd. v. Commissioner of Income-tax, Bombay City 1, 47 I.T.R. 394, approved. (iv) The plain and unambiguous words of s. 10 (5A) which had become an integral part of the Act, lent no support to the plea that by a legal fiction the compensation must be deemed to have accrued to the assessee in December 1955. The fact that the assessee included the receipt in question in its profit and loss account in the year 1955 was a wholly immaterial circumstances. That circumstance did not afford any basis for the argument that for this particular receipt the assessee adopted a different system of accountancy. Obviously the entry was delayed because of the dispute. What is relevant is the method of accounting and not the actual entries. [125E-G] JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1535 of
1968.
Appeal by special leave from the judgment and order dated
March 1, 1967 of the Bombay High Court in Income-tax
Reference No. 52 of 1962.
appellant.
M. C. Chagla, A. K. Verma, J. B. Dadachanji, O. C. Mathur
and Ravinder Narain, for the respondent.
The Judgment of the Court was delivered by
Hegde, J. In this appeal by special leave, the questions
that arise for decision relate to the taxability under S. 10
119
(5A) of the Indian Income-tax Act, 1922 (in brief ‘the Act’)
of a certain amount received by the assessee firm as compen-
sation on the termination of its managing agency.
The assessee is a Private Limited Company and at the
relevant time,, it was under voluntary liquidation. It was
incorporated in June 1945 by converting an erstwhile
partnership firm into a Private Limited Company. The
partnership firm had entered into a managing agency
agreement on June 15,1933 with a Public Limited Company
called “The Century Spinning and Manufacturing Co. Ltd.”
Under the said agreement, the assessee was to continue as
managing agents for a minimum period of 21 years and
thereafter until that firm chose to resign its office or is
removed from office by the managed company. During the
period of 21 years stipulated in the agreement, the managed
company had no right to remove the managing firm from its
office except for reasons mentioned in the, agreement.
During the period the assessee continued to act as the
managing agents the agreement provided, that the managing
agents will get a minimum remuneration of Rs. 6,000/- a
month and if its remuneration is found at the close of the
year to be less than 10 per cent of the gross profit of the
company, the managing agents were to be paid a further
additional sum to make the aggregate remuneration received
by it equal to 10 percent of the gross profit of the company
for that year. The Agreement further provided that if the
managing agents’ services were terminated before the period
of 21 years stipulated in the agreement except for reasons
mentioned in clause 15 of the agreement the managing agents
would be entitled to receive from the managed company as
compensation or liquidated damages for the loss of office
the sum mentioned in clause 14 of the agreement.
In about April 1951, a large holding of the managed company
was acquired by a group of shareholders who were hostile to
the managing agents. Thereafter the relationship between
the managing agents and the managed company became strained.
On April 23, 1951, the Directors of the managed company
passed a resolution terminating the services of the assessee
firm as managing agents. This resolution was affirmed by
the shareholders at their extraordinary general meeting held
on May 23, 1951 In
9-M 1245 SupCI/71
120
pursuance of the resolution, the Board of Directors on April
23, 1951, a notice of termination of the managing agency was
issued to the managing agents. In reply the assessee
,claimed compensation of Rs. 50 lacs for the unlawful
termination of its services. But the managed company was
prepared to pay Rs. 2,34,000/- as compensation calculating
the compensation at Rs. 6,000/- a month for the unexpired
period of the agency i. e. 3 years 2 months and 7 days and
Rs. 4600/- as remuneration for the 23 days of April 1951.
The assessee refused to accept that amount. Thereafter the
assessee sued the managed company on the original side of
the Bombay High Court claiming a sum of Rs. 28 lakhs as
compensation for the unlawful termination of its services.
The managed company resisted that suit. The suit was
decreed on November 17, 1955 in the sum of Rs. 2,34,000/-
and that decree was affirmed in appeal. The trial judge as
well as the appellate Bench held that under the terms of the
agreement the assessee was only entitled to liquidated
damages at the rate of Rs. 6,000/- per month for the
unexpired term of its agency. The assessee received the
amount decreed in December, 1955.
Till the insertion of S. 10 (5A) into the Act by the Finance
Act of 1955 (Act 15 of 1955), compensation received by a
managing agent for the termination of his agency was
considered as a capital receipt, but S. 10 (5A) provided
that any compensation or other payment due to or received by
a managing agent of an Indian Company at or in connection
with the termination or modification of his managing agency
agreement with the company shall be deemed to be profits and
gains of a business carried on by the managing agent, and
shall be liable to tax accordingly. This provision is not
retrospective in operation.
As seen earlier, the compensation with which we are
concerned in this case was received by assessee in December,
In the assessment year 1956-57, the Income-tax Officer
overruling the objections of the assessee included the said
amount as the profits of the business of the assessee during
the previous year. Admittedly the assessee maintained its
accounts according to mercantile system of accountancy., The
assessee’s contention before the Income-tax Officer that the
receipt in question cannot be brought
121
to tax in the assessment year 1956-57 as it became due in
1951 was rejected by the Income-tax Officer. In appeal the
Appellate Assistant Commissioner agreed with the view taken
by the Income-tax Officer. He opined that the amount became
due to the assessee only when it was decreed by the High
Court on November 17, 1955 and therefore it was assessable
in the assessment year 1956-57. But on a further appeal,
the Tribunal held that on the facts and in the circumstances
of the case, the compensation in question became due to the
assessee on April 23, 1951 and therefore it could not be
brought to tax in the assessment year 1956-57. At the
instance of the Commissioner, the Tribunal submitted under
s. 66 (1) of the Act, the following two questions of law for
the opinion of the High Court
“1. Whether on the facts and in the
circumstances of this case the compensation
for termination of the managing agency accrued
to the assessee on 23rd April 1951 ?
2. Whether on the facts and in the
circumstances
of this case the compensation of Rs.
2,34,000/and interest thereon was taxable
under s. 10 (5A) of the Indian Income-tax Act,
in the assessment year 1956-57?”
The High Court answered the first question in the
affirmative and the second question as follows :
The amount of compensation of Rs. 2,34,000/- will not be
liable to tax, but the amount of- interest thereon will be
taxable under s. 10,(5A) in the assessment year 1956-57
Aggrieved by that decision, the Commissioner of Income-tax,
Bombay City has brought this appeal.
We shall first address ourselves to the question as to
whether on the facts and in the circumstances of this case,
the compensation for termination of the managing agency
accrued to the assessee on April 23, 1951 ? The answer to
this question depends upon the true effect of the terms of
the agreement between the managing agents and the managed
company. There is no dispute that the termination of the
managing agency did not fall within the scope of clause 15
of the agreement which provides that the managing agent
shall not be entitled to receive from the company
122
any compensation for the loss of the office of Agents to the
company if such loss arises from any of the causes mentioned
therein. It is clear-that was also the view taken by the
High Court in the suit filed by the assessee against the
managed company-that the, assessee was entitled to get
compensation under clause 14 of the agreement. That clause
provides :
“In case the firm shall be deprived of the
office of Agents of the. company for any
reason or cause other than or except those
reasons or causes specified in clause fifteen
of these presents the firm shall be entitled
to receive from the Company as compensation or
liquidated ‘damages for the loss of such
appointment a sum equal to the aggregate
amount of the monthly salary of not less than
Rupees six thousand, which the Firm would have
been entitled to receive from the company for
and during the whole of the then unexpired
portion of the said period of twenty one years
if the said Agency of the Firm had not been
determined.”
In the suit filed by the assessee against the managed
company, the only controversy between the parties was
whether that clause should be read alongwith clause 10 of
the agreement which provided for the payment of remuneration
to the managing agents during the continuance of the
Managing agency agreement or whether the compensation
payable should be determined solely on the basis of clause
14. Replying on the expression “not less than Rs. 6000/-”
in clause 14, the assessee contended that Rs. 6,000/-
referred to in the clause is merely the minimum but the
actual compensation should be determined in the manner
provided in clause 10. The High Court rejected that
contention. According to the High Court clause 14 not only
provided for the payment of damages for improper termination
of the services of the managing agents but it also
stipulated the damages to which they were entitled to. In
its opinion that clause had quantified the damages to which
the managing agents were entitled to. It opined that the
damages payable to the assessee firm were liquidated
damages., The High Court further held that the
123
expression “not less than Rs. 6,000/-” means a definite sum
of Rs. 6,000/-, neither more nor less. We are in entire
agreement with the view taken by the High Court in that
suit. It is plain from the language of clause 14 of the
agreement that the assessee was entitled to a definite sum
under that clause. In other words it was entitled to liqui-
dated damages. Hence we agree with the answer given by the
High Court to the first question referred to earlier.
Now coming to the second question, the answer to the same
depends upon the interpretation to be placed ,on s. 10 (5A).
Earlier we have set out that provision to the extent
necessary for our present purpose. That section takes in
“Payment due to or received”. In the matter of payments,
there are two aspects viz. (1)payments due and (2) payments
received. The mercantile system of accountancy takes note
of “payments due” whereas cash system ,of accountancy
recognises only payments received. Mercantile system of
accountancy, a double entry system is maintained on the
basis of accrual of rights to receive or liability to pay a
certain sum of money, unlike is the case of cash system of
accountancy which merely takes note of actual receipts or
disbursements.
We have earlier, come to the conclusion that the com-
pensation with which we are concerned in this case became
due to the assessee in April 1951 though it was actually
received by the assessee in December 1955. Now arises the
question to what circumstance the expression “due to” in s.
10 (5A) applies and to what circumstance the expression
“received” therein is applicable? They do not mean the same
thing. Our income-tax law is familiar with these two
expressions. That law permits an assessee to adopt his own
system of accountancy subject to certain conditions and his
tax liability is determined on the basis of the system of
accountancy adopted by him. In other words, the Act permits
the assessee to adopt either the mercantile system of
accountancy or the cash system of the accountancy and the
system adopted by him would be the basis on which he should
be assessed. It is not necessary in this case to deal with
the exceptions to that rule. We have to read, s. 10 (5A)
alongwith the other provisions in the Act. If so read, it
is cleat that the expression “due to” in that section refers
to those assessees who maintain their accounts
124
according to the mercantile system of accountancy and the
expression “received by” applies to those assessees who
adopt the cash system of accountancy. As observed by this
Court in Commissioner of Income-tax, Madras v. A. Gajapathy
Naidu (1):
“When an Income-tax Officer proceeds to
include a particular income in the assessment,
he should ask himself, inter alia, two
questions, namely: (1) what is the system of
accountancy adopted by the assessee, and (ii)
if it is the mercantile system, subject ‘to
the deeming provisions, when has the right to
receive accrued. If he comes to the
conclusion that such a right accrued or arose
to the assessee in a particular accounting
year, he should include the said income in the
assessment of the succeeding assessment year.”
Herein also we have to ask ourselves the question, bearing
in mind the fact that the system of accountancy adopted by
the assessee is the mercantile system, as to when the
assessee’s right to get the compensation arose. We have
already held that it arose in April 1951.
It was urged on behalf of the Department that as the
assessee disputed the quantum of compensation to which it
was entitled, we must hold that its right to get the amount
arose when that dispute was determined by the High Court.
We are unable to accede to this contention. As mentioned
earlier, the right of the assessee to get compensation for
unlawful termination of its services and the quantum of
compensation to which it was entitled were clearly pres-
cribed in the agreement. It was also so held by the High
Court in the suit between the assessee and the managed
company. The fact that the assessee was claiming an ex-
orbitant sum to, which it was not entitled to will not
convert its right into a contingent right. In Thiagaraja
Chettiar & Co. v. Commissioner of Income-tax, Madras(2) the
High Court of Madras held that where a managing agent is
entitled under the terms of the managing agency agreement to
remuneration at a certain percentage on the annual net
profits of the company, the remuneration payable to the
managing agent accrued when the net pro-fits
(1) 53 I.T.R. 114. (2) 51. I.T.R. 393,
125
of the company for the year are ascertained. The mere fact
that owing to disputes between the company and the managing
agent the company had not credited the managing agent with
the remuneration due to the latter in its accounts, would
not entitle the managing agent to claim that the
remuneration due to him had not accrued and should not be
assessed to income-tax until the company had credited him in
its accounts with the amount of commission due to him. We
are in agreement with the ratio of that decision and that
ratio governs the facts of the president case.
The ratio of the decision of the Bombay High Court in F. E.
Hardosstle & Co. (Private) Ltd. v. Commissioner of Income
Tax, Bombay City-1(1), is also to the same effect.
It was next urged on behalf of the Department- that s. 10
(5A) is a code in itself and in applying the provisions
therein, no reliance should be placed on the system of
accountancy which the assessee generally adopts. It was
further urged that as the liability under s. 10 (5A) is a
new liability and as the receipt with which we are concerned
was received in December, 1955, after s. 10 (5A) was
incorporated into the Act, we must by a legal fiction deem
that the amount became due only in December, 1955. We see
no basis for this argument. The language of s.10 (5A) is
plain and unambiguous. That provision has now become an
integral part of the Act. Therefore the deemed payment
under that provision stands on the same footing as any other
payment. The fact that the assesses included the receipt in
question in its profit and loss account in the year 1955 is
a wholly immaterial circumstance. That circumstance does
not afford any basis for the argument that for this
‘particular receipt, the assessee adopted a different system
of accountancy. Obviously because of the dispute between
the assessee and the managed company, the assessee did not
enter the amount in question in the year in which it became
due. Method of maintaining accounts is one thing and the
actual entries in the accounts maintained is a different
thing. What is relevant is the method of accountancy and
not the actual entries.
(1) 47 I.T.R. 394.
126
For the reasons mentioned above, we agree with the answers
given by the High Court to the questions of law referred to
it. This appeal is accordingly dismissed, with costs.
G.C. Appeal dismissed.
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