PETITIONER:
THE COMMISSIONER OF INCOME-TAX, MADRAS
Vs.
RESPONDENT:
CHARI AND CHARI LTD.
DATE OF JUDGMENT:
09/04/1965
BENCH:
SHAH, J.C.
BENCH:
SHAH, J.C.
SUBBARAO, K.
SIKRI, S.M.
CITATION:
1966 AIR 54 1965 SCR (3) 692
CITATOR INFO :
R 1966 SC1325 (5,6)
RF 1971 SC1590 (8)
RF 1975 SC1945 (14)
ACT:
Income Tax Act, 1922, s. 10(2)(xv)--Deduction
claimed by assessee of commission paid to director
for special duties--Rate of commission bona fide
determined by assessee--Whether open to revenue to
review such rate.
HEADNOTE:
Managing Agency--Compensation for termination
of--Circumstances in which such compensation is
revenue.
The respondent, a private limited company, carried
on business in tobacco and other commodities and
also acted as managing agents for the N company and
for two other companies. It had three directors,
all of whom were paid a fixed remuneration for
attending to the business of the company. On June,
21, 1951, the respondent company was appointed an
agent of the Central Government for buying,
checking, leaf drying, and retaining and reselling
tobacco under, and in accordance with, directions
issued from time to time. On June 22 1951 the
respondent passed a resolution placing one of the
directors, A, in "special charge" of all the work
under the contract with the Central Government and
agreed to pay him 30 per cent of the net profits
from the contract. Under this arrangement, for the
year ended 31st March 1952, commission at 30 per
cent was calculated and paid to A and was claimed
in the assessment year 1952-53 as a permissible
deduction under s. 10(2)(xv) of the Income-tax Act,
1922. The Income-tax Officer allowed only 10 per
cent of the net profit for the services rendered by
A and disallowed the balance :amount claimed by the
respondent.
The managing agency agreement of the respondent
with the N Company was terminated in September
1'951, when the State Government acquired the
undertaking of that company, and the respondent was
paid Rs. 17,346 as compensation for premature
termination of its agency. This amount was taken
into account by the Income-tax Officer in computing
the respondent's income for the year ended March
31, 1952.
Appeals against the order of the Income-tax
Officer to the Appellate Assistant Commissioner and
to the Tribunal challenging the disallowance of
part of the commission and inclusion of the
compensation for termination of the managing agency
were unsuccessful. On a reference on both these
points, the High Court decided them in the
respondent's favour.
HELD: (i) The contract with the Government was,
for the respondent, an important contract requiring
special attention by a person well acquainted with
the practical details of the business. If for such
special services the management as prudent business
men for advancing the interest of respondent bona
fide regarded 30 per cent of the net profits as
reasonable remuneration, the revenue authorities
were not justified in reviewing that opinion and
reducing the rate of remuneration. [697B, C]
693
Where, on a consideration of the relevant
materials the Appellate Tribunal is of the opinion
that a particular remuneration is not bona fide, or
is unreasonable, the High Court, in exercising its
advisory jurisdiction, has no power to interfere
with that opinion; but in the present case,
material circumstances relating to the nature of
the contract and the special services to be
performed were not at all taken into account by the
revenue authorities. [697C-E]
(ii) Ordinarily, compensation for loss of
office or agency. is regarded as a capital receipt;
but this rule is subject to an exception that
payment received even for termination of an agency
agreement, where the agency is one of many which
the assessee bolds, and the termination of the
agency does not impair the profit-making structure
of the assessee, but is within the frame-work of
the business, it being a necessary incident of the
business that existing agencies may be terminated
and fresh agencies may be taken, is revenue and not
capital. However, in the absence of evidence as to
what effect the determination of the managing
agency of the N company had upon the business of
the respondent, the mere circumstance that the
respondent had managing agencies of two other
companies without more would not bring the present
case within the exception [698H; 699 A-c]
Kelsal Parsons & Co. v. Commissioners of Inland
Revenue, 21T.C. and Kettlewell Bullen & Co.
v.C.I.T. Calcutta, [1964] 8 S.C.R. 93 explained and
distinguished.
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No.
215 of 1964.
Appeal from the judgment and order dated August
24, 1961 of the Madras High Court in Case referred
No. 102 of 1957.
Niren De, Additional Solicitor-General, R.
Ganapathy Iyer and R.N. Sachthey, for the
appellant.
R. Thiagarajan, for the respondent.
The Judgment of the Court was delivered by
Shah, J. The respondent is a private limited
Company. It carried on business in hides and
skins, minerals, tobacco and other commodities, and
also acted as managing agents for the Nellor Power
and Light Company Ltd. and for two other Companies.
T.M. Ayyadurai, T.M. Rangachari and P.C.
Chakrabarti were directors of the Company. Each
director was paid a fixed remuneration of Rs.
4,800/- per annum for attending to the business of
the Company. On June 21, 1951 the respondent was
appointed by the Central Government as its agent
for buying, checking, weighing, leaf drying.
storing. transporting, retaining and reselling
tobacco under and in accordance with the directions
issued from time to time. The Central Government
agreed to pay to the respondent price of the
tobacco purchased, charge at the rate of one anna
per lb. for tobacco not redried, and at the rate of
two annas per lb. for tobacco redried. and
commission on all purchases. On June 22, 1951 the
respondent passed a resolution placing T.M.
Ayyadurai in “special charge” for arranging
purchases of tobacco on credit,
694
inspecting tobacco at Guntur and at Madras Port,
and for supervising shipment of tobacco, and agreed
to pay him 30 per cent of the net profit as
remuneration. Under the contract with the
Government of India Rs. 1,38,454/- became due to
the respondent as commission in the account year
ending March 31. 1952. After providing Rs. 41,473/-
for expenses, 30 per cent of the balance being Rs.
29,094/- was paid to T.M. Ayyadurai as commission
and was claimed in the assessment year 1952-53 as a
permissible deduction under s. 10(2)(xv) of the
Indian Income-tax Act, 1922. The Income-tax Officer
allowed only 10 per cent of the net profit for the
services rendered by T.M. Ayyadurai in the contract
for tobacco purchase and sale. and disallowed Rs.
19,796/- out of the amount claimed by the
respondent.
The managing agency agreement of the respondent
with the Nellore Power and Light Company Ltd., was
terminated with effect from September 28, 1951 when
the Government of the State of Madras in exercise
of the powers conferred upon it by the Electrical
Undertakings Acquisition Act, 1949 compulsorily ac
quired the undertaking of that Company, and the
respondent was paid Rs. 17,346/- as compensation
for premature termination of its agency. This
amount was taken into account by the Income-tax
Officer in computing the income of the respondent
in the assessment year ending March 31. 1952.
Appeals against the order passed by the Income-
tax Officer to the Appellate Assistant Commissioner
and to the Tribunal challenging the disallowance of
part of the commission and inclusion of
compensation for termination of the managing agency
agreement were unsuccessful.
The Tribunal thereafter being directed by the
High Court of Judicature, Madras under s. 66(2) of
the Indian Income-tax Act, drew up a statement of
the case and referred the following two questions
to the High Court:-
“(1) Whether on the facts and in the
circumstances of the case the
disallowance of a sum of Rs. 19,796/-
out of the remuneration paid to Mr.
T.M. Ayyadurai is justifiable; and
(2) Whether a sum of Rs. 17,346/-
which represented compensation received
by the assessee for the loss of the
managing agency of the Nellore Power
and Light Company Ltd. is income liable
to tax?”
The High Court answered both the questions in the
negative.
Allowance in respect of the amount covered by
the first question was sought by the respondent
under s. 10(2)(xv) of the Income-tax Act, 1922,
which provided:
“any expenditure not being an
allowance of the nature described in
any of the clauses (i) to (xiv)
inclusive. and
695
not being in the nature of capital
expenditure or personal expenses of the
assessee laid out or expended wholly
and exclusively for the purpose of such
business, profession or vocation.”
The question whether an amount claimed as
expenditure was laid out or expended wholly and
exclusively for the purpose of such business,
profession or vocation has to be decided on the
facts and in the light of circumstances of each
case. But as observed by this Court in Eastern
Investments Ltd. v. Commissioner of Income tax,
West Bengal(1) the final conclusion on the
admissibility of an allowance claimed is one of
law. The High Court had therefore power to call
upon the Tribunal to submit a statement of the case
under s. 66(2) of the Indian Income-tax Act. In
considering whether the expenditure to remunerate a
person for services rendered is allowable under s.
10(2)(xv) the Income-tax Officer must have regard
to all the circumstances, such as, nature and
special character of the service, practice if any
in the trade for payment of a percentage of profit
to an employee in similar circumstances,
qualifications of the employee for rendering the
service, amount if any paid by the assessee to
another person for rendering similar service,
normalcy of the allowance having regard to the
practice in the trade, existence of any other
extraordinary and abnormal circumstances in the
arrangement or special reasons or circumstances
which may suggest that the transaction was
abnormal, and the like.
The normal business of the respondent was in
hides and skins, minerals and tobacco. It does not
appear, however, that the turnover of the Company
was large. The contract to purchase tobacco on
behalf of the Government of India was apparently
out of the way of the normal business of the
respondent and demanded the setting up of a special
organisation. Under the terms of the contract the
respondent was to be the agent of the Central
Government for buying, checking, weighing, leaf
drying, storing, transporting, retaining and
reselling tobacco under and in accordance with the
directions given to it from time to time by the
Government. The respondent agreed to buy tobacco
within the ceiling price fixed as and when directed
by the Government, and was responsible for buying
proper grades of tobacco, for correctly checking
the weights, for taking delivery from the sellers,
for redrying it whenever so directed, for securing
proper packing for transport by rail road or sea so
as to conform to standards of packing usually
employed in the export of tobacco or standards to
the satisfaction of the purchaser, and for getting
the tobacco inspected by the Tobacco Grading
Inspectorate of the Indian Central Tobacco
Committee according to the AGMARK standards. The
respondent had to place a go down at the disposal
of the Government within their premises at Guntur.
The respondent had to use its best
(1) 20 I.T.R. I.
696
endeavour to buy as cheaply as possible within the
ceilings prescribed and to sell it for such maximum
price as may be obtainable, not being below the
price prescribed by the Government, to re-sell
tobacco which the Government may direct it to sell
by instructions in writing, in such manner and at
such price as may be specified by the Government,
and to finance the entire transaction of purchasing
tobacco in the first instance out of its own funds.
The respondcat was to take all necessary steps to
safeguard the stocks and to maintain fire-fighting
services. Goods purchased by the respondent if not
of the grade or quality were liable to be rejected
by order of the Tobacco Grading Inspector.
Performance of the contract evidently required
expert knowledge of the practical side of the
business of purchasing tobacco, getting it redried
if it was raw, and of packing, storing,
transporting and shipping it.
The respondent had entered into a profitable
contract, but any negligence in purchasing,
storing, packing, transporting and shipping the
goods might have resulted in serious losses to the
respondent. The Income-tax Officer accepted that
the expenditure for payment of remuneration for
attending to the contract was laid out for the
purpose of the business of the respondent, but
reduced the stipulated rate to 10 per cent on two
grounds: that T.M. Ayyadurai was the brother of
T.M. Rangachari, and that he was, as a director of
the Company, bound to attend to all the activities
of the Company including the contract.
There is no evidence that the agreement was
motivated by considerations other than strictly
business considerations. There is also no evidence
that as a director T.M. Ayyadurai was bound to
attend to all the activities of the Company
including the special contract with the Central
Government. The duties which the director was
bound to perform for earning the remuneration of
Rs. 400/- per month are not on the record, but even
in the opinion of the taxing authorities the duties
of T.M. Ayyadurai as director did not cover
attendance to the contract with the Government.
T.M. Ayyadurai and T.M. Rangachari are brothers,
but that by itself is not sufficient to justify an
inference that unreasonable or excessive
remuneration was agreed to be paid. The person who
was called upon to attend to a contract of this
magnitude was required to have expert knowledge of
the business, apply his time exclusively thereto,
travel from time to time, maintain supervision and
control at the stage of purchase, redrying,
packing, transport and loading for shipment.
Presumably T.M. Ayyadurai was such a person, and
that is why he was selected for earning for the
respondent a large amount of commission by duly
performing the contract.
The Appellate Assistant Commissioner merely
paraphrased the decision of the Income-tax Officer
and regarded 10 per cent of the net profits as
reasonable. The Appellate Tribunal observed that
the Appellate Assistant Commissioner had given
“clear and
697
convincing reasons in support of the disallowance”
to which they had nothing more to add. An analysis
of the reasons given by the Income-tax Officer
discloses no grounds to support the view that
remuneration at a rate exceeding 10 per cent of the
net profit was excessive or unreasonable. We are
of the view that the contract with the
Government was for the respondent an important
contract requiring constant and vigilant
application and supervision by a person well-
acquainted with the practical details of the
business. If the management of the respondent as
prudent businessmen for advancing the interest of
the respondent bona fide regarded 30 per cent of
the net profits as reasonable remuneration, the
revenue authorities were not justified in reviewing
their opinion and reducing the rate of
remuneration. It is true that if on a
consideration of the relevant materials, the
Appellate Tribunal is of the opinion that a
particular remuneration stipulated to be paid is
not bona fide, or is unreasonable, the High Court
in exercising its advisory jurisdiction has no
power to interfere with that opinion. But the
material circumstances relating to the nature of
the contract, the services to be performed and the
nature of the duties by the employee were not at
all taken into account by the Tribunal and the
income-tax authorities. We therefore agree with
the High Court that the first question should be
answered in the negative.
The contract under which the respondent Company
was appointed managing agent for the Nellore Power
and Light Company Ltd., was to ensure till 1960,
but it had to be prematurely terminated because the
Government of Madras exercising its powers under
the Madras Electrical Undertakings Acquisition Act,
1949 had compulsorily acquired the electricity
undertaking. With the acquisition of that
undertaking the right of the respondent as managing
agent ceased. Under s. 15 of the Electrical
Undertakings Acquisition Act, the Government was
bound to pay compensation which would include
compensation for termination of the managing agency
agreement. The respondent received Rs. 17,346/as
compensation for termination of the agency,
computed in the manner laid down in s. 15 of that
Act. Prima facie, such a receipt being in lieu of
extinction of an asset of the assessee, is a
capital receipt. It was urged, however, on behalf
of the revenue that the respondent was carrying on
business of taking up managing agencies and that by
the extinction of one of the managing agencies, the
business structure of the respondent was not
impaired. In a recent judgment delivered by this
Court in Kettlewell Bullen and Company Ltd., v.
Commissioner of Income-tax, Calcutta(1). it was
pointed out that:
“It may be broadly stated that what
is received for loss of capital is a
capital receipt: what is received as
profit in a trading transaction is
taxable income. But the
(1) [1964] 8 S.C.R. 93.
698
difficulty arises in ascertainting
whether what is received in a given
case is compensation for loss of a
source of income, or profit in a
trading transaction.”
The Court further observed:
“It cannot be said as a general
rule. that what is determinative of the
nature of the receipt is extinction or
compulsory cessation of an agency or
office. Nor can it be said that
compensation received for extinction of
an agency may always be equated with
price received on sale of goodwill of a
business. The test applicable to
contracts for termination of agencies
is: what has the assessee parted with
in lieu of money or money’s worth
received by him which is sought to be
taxed? If compensation is paid for
cancellation of a contract of agency.
which does not affect the trading
structure of the business of the
recipient, or involve loss of an
enduring asset, leaving the taxpayer
free to carry on his trade released
from the contract which is cancelled,
the receipt will be a trading receipt:
where the cancellation of a contract of
agency impairs the trading structure,
or involves loss of an enduring asset,
the amount paid for compensating the
loss is capital.”
Turning to the facts of the present ease, it
must in the first instance be observed that it is
for the revenue to establish that a particular
receipt is income liable to tax, and beyond stating
that the respondent was the managing agent of the
Nellore Power and Light Company Ltd. and of two
other Companies, there is no other evidence about
the nature of the business of the two other
Companies of which the respondent was the managing
agent. about their relative importance qua the
managing agency of the Nellore Power and Light
Company Ltd., and whether by reason of the
extinction of the managing agency of the Nellore
Power and Light Company Ltd., any enduring asset
was lost to the respondent, or its trading
organisation was adversely affected. The Income-
tax Officer observed that the “Company’s business
of Managing Agency as such had not come to an end”,
the Company still continues as “managing agents of
other companies”. Even after surrender of one of
the agencies, the Company carries on business as
before, its structure not being affected” and
therefore “the receipt is to be considered as
revenue, in accordance with the decision in Kelsal
Parsons and Company v.C.I.R. 21 T.C. No. 608.”, and
with that view the Appellate Assistant Commissioner
and the Tribunal agreed. But in the absence of
evidence as to what effect the determination of the
managing agency of the Nellore Power and Light
Company Ltd., had upon the business of the
respondent, the mere circumstance that the
respondent had managing agencies of two other
companies without more will not bring the ease
within Kelsal Parsons and Company v. Commissioners
of Inland Reve-
699
nue(1). In Kettlewell Bullen and Company’s case(2)
this Court pointed out that ordinarily compensation
for loss of office or agency is regarded as a
capital receipt, but the rule is subject to an
exception that payment received even for
termination of an agency agreement, where the
agency is one of many which the assessee holds, and
the termination of the agency does not impair the
profit-making structure of the assessee, but is
within the framework of the business, it being a
necessary incident of the business. that existing
agencies may be terminated, and fresh agencies may
be taken, is revenue and not capital. Kelsal
Parsons and Company’s case(1) falls within the
exception to the ordinary rule, and circumstances
which brought the case of the respondent within the
exception must be clearly established. The High
Court was of the opinion that compensation received
for taking over the Nellore Power and Light Company
Ltd., was a capital receipt not liable to be taxed,
and on the materials placed before us, we are
unable to disagree with the High Court on this
question.
The appeal therefore fails and is dismissed with
costs.
Appeal dismissed,
(1) 21T.C. 608.
(2) [1964] 8 S.C.R. 93.
?(D)5SCI—6
700