Commissioner of Income Tax Bombay City v. Chunilal v. Mehta and Sons (P) Ltd.

I:Iegde, J. In this appeal by special leave, the questions that arise for decision relate to the taxability under s. 10 (5A) of the Indian Income-tax Act, 1922 (iii 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. lt 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 2 I years and thereafter until thaf firm chose to resign its office or is removed from office by the managed company. Durif!g 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 re-muneration received by it equal to IO percent of the gross profit of the company for that year. The agreement further provided that if the managing agents' services were termi-nated before the period of 21 years stipulated in the agree-ment 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.

fn 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 Direc-tors of the managed company passed a resolution termina-ting 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-Ml245 SupCl'71

pursuance of the resolution, the Board ofDirectors on April 23, 19Sl, a notice of termination of the managing ~gency was issued to the managing agents. In reply the as~ssee claimed compensation of Rs. SO lacs for the unlawful termination of its services. But the managed company was prepared to pay Rs. 2,34,000/- as compensation calcu-Jating the compensation at Rs. 6,000/- a month for the r 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 19Sl. 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, 19S5 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 :0 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, 19SS.

Till the insertion of s. 10 (SA) into the Act by the Finance Act of 19SS (Act lS of 19SS), compensation re-ceived by a managing agent for the termination of his agency was considered as a capital receipt, but s. 10 (SA) 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, 19SS. In the assessment year 19S6-S7, 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 main-tained 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 to tax in the assessment year 19S6-S7 as it became due in 19S 1 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 de-creed by the High Court on November 17, 19SS and there-fore it was assessable in the assessment year 19S6-S7. 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 19S6-S7. 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 :

"!. 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 19Sl?

¶2Whether 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 (SA) of the Indian Income-tax Act, in the assessment year 19S6-S7 ?"

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/- 11·ill not be liable to tax, but the amount of interest thereon will be taxable under s. 10 (SA) in the assessment year 19S6-S7 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, 19Sl? The answer to this question depends upon the true effect of the terms of the agreement between the managing agents and the ma-naged company. There is no dispute that the termination of the managing agency did not fall within the scope of clause 1 S of the agreement which provides that the managing agent shall not be entitled to receive from the company 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 c:lear-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 agree-ment. 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 twentyone years if the said Agency of the FiTm 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 IO J',. of the agreement which provided for the payment of re-muneration to the managing agents during the continuance of the Managing agency agreement or whether the com-pensation 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 comnensation 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 liqui-dated damages. The High Court further held that the 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 tnat clause. In other words it was entitled to liqui-dated damages.. Hence we agree wi~h the answer given by the High Oou!t 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 (SA). 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 accoun-tancy takes note of "payments due" whereas cash system of accountancy recognises only payments received. Mer-cantile 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 19Sl though it was actually received by the assessee in December 19SS. Now arises the question to what circumstance the expression "due to" in s. 10 (SA) applies and to what circumstance the expres-sion "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 accountancv and the system adopted by him would be the basis on \1 h[ch he should be assessed. It is not necessary in this case to deal with the exceptions to that rule. We have to read s. IO (SA) alongwith the other provisions in the Act. If so read, it is clear that the expression "due to" in that section 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. 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: (I) 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 assess-ment 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 s~ 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 pay-able to the managing agent accrued when the 11et profits {l) 53 l.T.R. 114. 12) 51. l.T.R. 393.

C.l.T. v. CHUNILAL \Hegde, !. ) 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 mana-ging 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 com-mission due to him. We are in agreem~nt with the ratio of that decision and that ratio governs the facts of the p.re~ent case.

The ratio of the decision of the Bombay High Cuurt in F. E. Hardosstle & Co. (Private) Ltd. v. Commissioner of Income Tax, Bombay City-I (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 pi>rt of the Act. Therefore the deemed payment under that provision stands on the same footing as any other payment. The fact that the assessee 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 com-pany, the assessee did not enter the amount in questicn iP the year in which it became due. Method of maintaininl! accounts is one thing and the actual entries in the account, maintained is a different thing. What is relevant is · ,, method of accountancy and not the actual entries.

f.or the reasons mentioned abqve, we agree with the answers given by the High Court .to tqe questions of law referred tq it. This appeal is 'accordingly dismissed with costs.

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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.

.R. H. Dhebar, J. Ramamurthi and R. N. Sachthey, for the appellant.

M. C. Chagla, A. K. Verma, J. B. Dadachanji, 0. C. Mathur and Ravinder Narain, for the respondent.