Case: Commissioner Of Income-Tax, Nagpur Vs. Rai Bahadur Jairam Valji And Others

1. This is an appeal against the judgment of the High Court of Nagpur in a reference under S. 66 (1) of the Indian Income-tax Act (XI of 1922), hereinafter referred to as the Act, and the point that is raised for our determination is whether a sum of Rs. 2,50,000 received by the respondent on August 2, 1941, is chargeable to income-tax. While, according to the Department, the amount in question is a revenue receipt liable to be included in the chargeable income, according to the respondent it is capital receipt not liable to tax. The Appellate Tribunal held, affirming the decisions of the Income-tax Officer and the Appellate Assistant Commissioner, that the amount in question was a trading receipt, and was income liable to be assessed. On the application of the respondent, it referred the following question for the decision of the High Court :Whether in the circumstances of the case the sum of Rs. 2,50,000 received by the assessee as damages or compensation for the premature termination of the contract of 9th May 1940 is income assessable within the meaning of the Indian Income-tax ActThe reference was heard by Sen and Deo JJ. who held, disagreeing with the Tribunal, that the sum of Rs. 2,50,000 was a capital receipt in the hands of the respondent, and that it was not liable to be taxed. The appellant then filed an application under S. 66 (A) (2) of the Act for a certificate to appeal to this Court, but that was dismissed, the learned Judges holding that the law on the subject was well settled. The appellant thereafter applied to this Court for special leave under Art. 136, and the same was granted, and hence this appeal3. The respondent is a businessman whose trading activities run in several channels. He is a railway contractor; he runs a rice mill and a sugar factory; he is a supplier of limestone and dolomite. It is with the last of these businesses that we are concerned in these proceedings. The respondent had acquire a quarry at Paraghat and had been himself working it and selling limestone quarried out of it to, among others, a Company called the Bengal Iron Company, Ltd. On January 5, 1935, the said Company entered into an agreement with the respondent for the purchase of all its requirements of limestone and dolomite from the latter at rates specified therein, and these rates were subsequently modified by another agreement between the parties dated December 21, 1935. In 1936 the Company went into liquidation, and its assets and liabilities were taken over by another Company called the Indian Iron and Steel Company, Ltd. under a scheme of amalgamation dated September 8, 1936. This Company continued to purchase limestone and dolomite from the respondent for some time, but later on, finding that the rates were uneconomic owing to increase in the railway freight, it decided to purchase its requirements from other sources, and by notice dated May 29, 1939 informed the respondent accordingly. Thereupon, the respondent filed Suit No. 211 of 1940 in the High Court of Calcutta for specific performance of the contract dated January 5, 1935, as modified on December 21, 1935, and for an injunction restraining the Indian Iron and Steel Company, Ltd. from purchasing limestone or dolomite from any person other than the plaintiff, and on March 13, 1940, an injunction in those terms was actually issued against the Company4. Thereafter, the Company and the respondent entered into an agreement in settlement of all the disputes between them, and the same was embodied in a document dated May 9, 1940. As it is this document that forms the source for the payment of Rs. 2,50,000 to the respondent, it is necessary to refer to the terms thereof in some detail. Under this agreement, the respondent was to work a quarry of the Company at a place called Gangapur for a period of 25 years and to supply the limestone quarried therefrom to the Company according to its requirements. This quarry, it should be stated, was situated near Kulti where the Company carried on its smelting operations, and obviously it would reduce the working expenses, if limestone required therefor could be got from Gangapur. There were, however, no facilities in Gangapur railway station for transporting the goods from the quarry, and so it was arranged that the authorities should be moved for permission to construct a siding at Gangapur, and that the cost thereof should be borne by the Company. It was expected that it would take 18 months before the siding could be completed, and it was agreed that during that period the respondent was to be paid Rs. 4,000 every month. Thereafter, the respondent was to be paid at the rate of Rs. 2-9-0 per ton of limestone which might be loaded in the railway waggons to be arranged for by the Company. The working of the quarry was left entirely in the hands of the respondent. It was he that was to purchase the machinery and the appliances necessary for quarrying. He was to engage his own workmen and put up all the requisite superstructures. After the limestone was raised from the quarry, he was to get it cleaned and rendered merchantable, arid it was thereafter to be loaded in the waggon. There are two clauses in the agreement to which reference might be made. Under cl. 6, the respondent agreedto supply to the Company such other quantities of limestone, if any, as the Company may order besides Kulti requirements. Clause 13 of the agreement enjoined that the respondent was not to engage, during the subsistence of the agreement, in any other contract business for the working of any quarry within an area of 20 miles from the Companys quarry, but this was subject to the proviso that the respondent was free to work any quarry belonging to and held by him5. To continue the narration, the railway authorities did not agree to the construction at Gangapur of a siding and a loopline to the quarry, and so it became impossible to carry out the agreement in the manner contemplated by the parties. It is in this situation that the parties came together, and on August 2, 1941, entered into a new agreement and it is with this that we are directly concerned in this appeal. The agreement recites that the Company feeling difficulty in working their mines referred to in the contract date May 9, 1940, made a proposal for termination of the said contract on certain terms, and that was agreed to. The terms of the agreement are (1) that the Company should pay Rs. 2,50,000 to the sellers as solatium besides the monthly instalments of Rs. 4,000, remaining unpaid under the contract dated May 9, 1940; (2) that the Company should take all the limestone required for its furnaces at Kulti from the respondent for a period of 12 years on terms and conditions set out in an agreement ; (3) that the respondent was to be appointed the loading contractors of the Company for loading all iron ore at Monoharpore for a perio of 12 years from January 1, 1942, on the terms and conditions specified in a separate agreement. Pursuant to this agreement, the respondent was paid a sum of Rs. 2,50,000 and the two agreements relating to the purchase of limestone and the loading of iron ore at Monoharpore were also executed. The balance due on account of monthly payment of Rs. 4,000 provided in the agreement of May 9, 1940, was also duly paid. Now, on these facts, the question is whether the sum of Rs. 2,50,000 received by the respondent was capital or revenue.

Reasoning: 21. (2) The above discussion answers to a large extent the contention of the respondent that the contract dated 9th May 1940, was merely a framework of his business and not the business itself, and that a receipt on account of it must be treated as a capital receipt. The decision relied on in support of this contention is 1935 A C 431. There, two companies, one English and the other Dutch, which were engaged in the manufacture and sale of margarine entered into certain agreements, the object of which was to avoid competition and to augment their profits. An elaborate scheme was devised under which the two companies were to carry on their business independently but in friendly alliance and in accordance with the scheme; and the profits were to be shared between the two companies in certain proportions. The agreements were to be in operation till 1940, but differences arose between the parties in the working of the scheme and the alliance was terminated in 1927, the Dutch company paying to the English company a sum of ? 450,000 as compensation. The question was as to the character of this receipt, whether it was a capital or a revenue receipt, and it was held by the House of Lords that it was a capital receipt and not taxable22. Now, it will be seen that the contracts which were the source of the receipt in question did not in themselves constitute the business which yielded the profits to the two companies. Those profits were derived by them from the manufacture and sale of margarine, and there was nothing in the agreements providing that the companies were to join in the manufacture and sale of the margarine. The position under the agreement is thus stated by Lord Macmillan, who delivered the leading judgment :The three agreements which the appellants consented to cancel were not ordinary commercial contracts made in the course of carrying on their trade; they were not contracts for the disposal of their products, or for the engagement of agents or other employees necessary for the conduct of their business; nor were they merely agreements as to how their trading profits when earned should be distributed as between the contracting parties. On the contrary the cancelled agreements related to the whole structure of the appellants profit-making apparatus. They regulated the appellants activities, defined what they might and what they might not do, and affected the whole conduct of their businessThus, the agreements in question were intended to ensure that the business in margarine was carried on to the best advantaged but did not, in themselves, form part of the business. They were merely collateral to it. For the reasons given in discussing the nature of agency agreements, the agreements between the two companies must be regarded as not pertaining to the trading activities, which yielded profits, and the payment on account of those agreements must be held to be a capital receipt. But these considerations would be inapplicable to the agreement, with which we are concerned. The business which the respondent was to carry on and which was to yield profits to him was the very business to which the agreement relates. It is under this very agreement that he was to be paid Rs. 2-9-0 per ton of limestone loaded by him, and the business which he had to do to earn the amount was to raise and supply limestone as provided in the agreement. There is here no profit-making apparatus set up by the agreement apart from the business which is to be carried on under it. We are accordingly unable to agree that the present case is governed by the decision in 1935 A C 43123. (3) It remains to deal with the contention of the respondent that the business which he was to have carried on under the contract dated 9th May 1950, was practically the entirety of his trading activities, and that the termination of such a contract is tantamount to stopping his doing business and the compensation paid therefor is a capital receipt. Reliance is placed in support of this argument on the decision in, Glenboig Union Fireclay Co. Ltd. v. Commissioners of Inland Revenue, 1922-12 Tax Cas 427.Now, to appreciate the true position, it is necessary to bear in mind the distinction between compensation on account of business carried on under an agreement with a third party when that is terminated, and compensation which is received on account of a business which the assessee is prevented from carrying on by a third person in exercise of an overriding power.In the former case, the payment would in general be a trading receipt referable to the business activities carried on or to be carried on under the agreement and would be taxable as a revenue receipt. There may be exceptions to this. A familiar instance is when the parties agree, as part of the contract to do business, that one of them shall not carry on similar business for a stated period after the termination of the contract, and a compensation is paid therefor. That has been held to be a capital receipt. Vide Beak v. Robson, 1942-25 Tax Cas33. The reason is that it is a payment made not on account of profits which might have been earned in the carrying on of the business but as soltium for not carrying on the business. A payment made in a similar covenant to operate during the period of the contract, however, has been held to be a revenue receipt, because it arises out of the carrying on of the business. Vide Thompson v. Magnesium Elektron Ltd., (1943) 26 Tax Cas 1. It might also happen that one of the parties to the contract might have, in the carrying out thereof, incurred expenses of a capital character and as a result of the cancellation of the contract, those expenses would have been thrown away. A payment made on account of those expenses would bear the character of a capital receipt.But apart from those and similar instances, it might, in general, be stated that payments made in settlement of rights under a trading contract are trading receipts and are assessable to revenue. But where a person who is carrying on business is prevented from doing so by an external authority in exercise of a paramount power and is awarded compensation therefor, whether that receipt is a capital receipt or a revenue receipt will depend upon whether it is compensation for injury inflicted on a capital asset or on a stock-in-trade.The decision in 1922-14 Tax Cas 427 applies to this category of cases. There, the assessee was carrying on business in the manufacture of fire clay goods and had, for the performance of that business, acquired a fire clay field on lease. The Caledonian Railway which passed over the field prohibited the assessee from excavating the field within a certain distance of the rails, and paid compensation therefor in accordance with the provisions of a statute. It was held by the House of Lords that this was a capital receipt and was not taxable on the ground that the compensation was really the price paid for sterilising the asset from which otherwise profit might have been obtained. That is to say, the fire clay field was a capital asset which was to be utilised for the carrying on of the business of manufacturing fire clay goods and when the assessee was prohibited from exploiting the field, it was an injury inflicted on his capital asset. Where, however, the compensation is referable to injury inflicted on the stock-in-trade, it would be a revenue receipt. Vide Commissioners of Inland Revenue v. Newcastle Breweries, Ltd., 1927-12 Tax Cas 927.The principle of these decisions has no application where the compensation paid is in respect of rights arising under a trading contract. A payment made in settlement of that contract is an adjustment of the rights under that contract, and must be referred to the profits which could be made in the carrying out of that contract24. In the present case, the contract dated May 9, 1940 was simply an agreement to carry on business. In settlement of that contract, Rs. 2,50,000 was paid to the respondent. That was not a payment on account of any capital expenditure incurred by him in the execution of the contract that indeed was the point sought to be raised by the respondent, but therein he has failed. It is also to be noted that at no time was he prevented from carrying on business. Clause 6 of the agreement dated May 9, 1940, contemplates that the respondent was to carry on generally the business of supply of limestone even apart from his work in the Gangapur quarry, and the agreement dated August 2, 1941, provides for his supplying limestone for the furnaces at Kulti for a period of 12 years and for loading iron at Monoharpore for a like period. There was, therefore, at no time any agreement which operated as a bar to the carrying on of business by the respondent25. On a consideration of all the facts established, we are of opinion that the receipt of Rs. 2,50,000 by the respondent is a revenue receipt and is chargeable to tax